Beware: Know Which Standard Your Financial Professional Operates Under

If you are like most investors, someone advises you on which investments you should make. Whether that is a financial planner, an investment firm, a broker-dealer, or someone else, how do you know if (s)he’s giving you good advice? How do you know if (s)he has your best interests at heart?

Unfortunately, you don’t unless you do your homework. For instance, if you have hired a professional investment adviser, you need to know whether or not (s)he is a fiduciary, a person who can buy and sell securities on your behalf without your express consent to each trade. Because fiduciaries have this discretionary authority, they are held to a higher standard than non-fiduciary advisors.

financial professional

Fiduciary Standard

The fiduciary standard came about via the Investment Advisers Act of 1940. This is the standard under which all Registered Investment Advisers must work. (Note that these professionals are advisers with an “e.”) A fiduciary acts on your behalf. As such, (s)he has a duty of care that includes monitoring your investments and financial situation and adhering to the best practices of conduct. Consequently, not only must (s)he prudently determine your best interests, (s)he must thoroughly discuss with you any investment (s)he recommends you make.

Registered Investment Advisers and others operating under the fiduciary standard charge fees only. They do not work on commission, so this better assures you that they really do have your best interests at heart, not their own.

Research shows that half the investors in America believe that all professional financial advisors are fiduciaries and therefore must act in their best interests. This is untrue. Unfortunately, different types of advisors may be held to different standards.

Suitability Standard

The confusion for investors is determining which professionals provide advice (advisers with an “e”) and which sell financial products (advisors with an “o”). Financial advisors, including financial consultants, broker-dealers, etc., operate under the suitability standard instead of the fiduciary standard. This standard requires them only to promptly execute your buy/sell orders, disclose “material” information to you rather than full information, and tell you about any conflicts of interest they have.

Advisors operating under the suitability standard generally work on commission. The suitability standard allows them to recommend high-commission investments to you as long as these investments are “suitable” for you. They need not recommend equally suitable investments that compensate them with lower commissions.

Separating Fiduciaries from Non-fiduciaries

The whole fiduciary/non-fiduciary debate attained new heights in 2015 when the Department of Labor introduced a new rule extending the fiduciary standard to financial advisors that dealt in tax-advantaged retirement accounts such as 401(k)s and IRAs. The new rule died last June, however, when the Fifth Circuit struck it down as being harmful to consumers plus an overstepping of the DoL’s authority.

Various other bodies have proposed new rules extending the fiduciary standard to broker/dealers, including the Securities and Exchange Commission. Its rule, called “Regulation Best Interest,” has yet to be finalized, so no one knows exactly what it will look like.

In the meantime, the debate rages. Your best strategy is to determine if your financial professional is an adviser operating under the fiduciary standard or an advisor operating under the much lower suitability standard. You do this by asking questions. For instance, come right out and ask your current or potential financial professional if (s)he is a fiduciary. And don’t just take his or her word for it. Also, ask what type of compensation (s)he receives and if (s)he receives additional compensation than that which you are paying him or her. Another good question to ask is if your professional is dual-registered. Some professionals get around the whole fiduciary/suitability standard issue by registering as both an investment adviser and a broker-dealer.

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