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FIDUCIARY STANDARDS vs. SUITABILITY STANDARDS

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The Difference Between the Fiduciary Standard and the Suitability Standard
If You Meet with a Financial Professional, Be Sure to Ask a Critical Question

If you make an appointment with a financial advisor on behalf of yourself, your family or your company, make the following inquiry before the meeting ends:

“Do you ever recommend any products while relying on the suitability standard?”

This question is a bit different than the common, “Are you a fiduciary?” And the distinction is very important. Most brokers nowadays are dually registered because they employed by hybrid firms. Hybrids are registered as both Registered Investment Advisors and as a Brokerage firm. This means that in some cases, such as when managing assets for an ongoing fee, the advisor may be required to act as a fiduciary. However, if the advisor recommends an annuity or insurance product, all of a sudden they may now only be acting under the suitability standard with the same client, costing the client a ton of money. So, it is important to not just ask, “Are you a Fiduciary?” and walk away happy if you get a “Yes,” but to dig a little deeper into the advisors business practices.

What is the Suitability Standard?

Investment brokers are frequently asked to abide by suitability standards: when they recommend a financial product to a client, they are ethically bound to recommend a product which is “suitable” for that client.

As laid out in the manual of FINRA (the Financial Industry Regulatory Authority, formerly known as the NASD or National Association of Securities Dealers), the suitability standard has long demanded that a broker make “reasonable efforts to obtain information” on four aspects of a client’s financial life:

  • Financial status
  • Tax status
  • Investment objectives
  • Other information used or considered to be reasonable

These factors (and others) have a hand in determining whether a financial product or securities transaction is deemed “suitable” for a client.1

History of Suitability

Suitability standards emerged in response to an age-old Wall Street problem. Decades ago, stockbrokers garnered all sorts of bad publicity for calling their clients up and recommending “hot” stocks or funds that were utterly inappropriate for them. The investors may have gotten burned, but the brokers got their sales commissions.

Suitability standards are good, make no mistake. The problem is that they could be even better.

Problem with Suitability Standard

Even with a suitability standard, a broker has no specified duty to act in a client’s best interest. So while that broker may recommend a “suitable” fund, stock or other financial product to you, he is not prohibited from recommending an investment that will result in a bigger commission for him or higher costs for you.

If a broker has a proprietary security that seems “suitable” for you, the broker may promote it ardently to you even though better-performing securities might be available.

In 2005, the SEC determined that “broker-dealers will not be deemed to be investment advisers” and therefore are not subject to the same fiduciary standards as Registered Investment Advisors (RIAs) when recommending investments to clients.2

In 2011, FINRA Rules 2090 and 2111 expanded the existing suitability obligations while creating new ones. Any recommendations of “investment strategies” and any recommendations to hold securities within an investment strategy must now be “suitable” for the particular client. And the investor profile compiled by the broker to judge suitability must consider additional factors.3

What is the Fiduciary Standard?

The fiduciary duty is a duty to act in the client’s best interest, even when it is in conflict with the advisors’ interest. This is the standard that Registered Investment Advisors (RIAs) must uphold. An RIA describes a financial firm, while an Investment Advisor Representative is a properly registered person working for a firm that is an RIA. The “Registered” adjective refers to being registered with either the Securities & Exchange Commission (SEC) or a state securities agency.

RIAs have a fiduciary duty (a legal requirement) to act in the client’s best interest regardless of the level of compensation the advisor may receive as a result of recommendations or actions. Fundamentally, this comes down to two points as stated by the SEC:

  • The advisor must avoid conflicts of interest when possible, and disclose them when they exist.
  • The advisor is prohibited from overreaching or taking unfair advantage of a client’s trust.

A Registered Investment Advisor is not supposed to pitch products, strategies or securities transactions with the idea that “this will be a win-win for both of us.” The client’s best interest comes first and it is the only interest that matters.4

Retirement Plan Sponsors’ Fiduciary Standards

As a sponsor of a retirement plan for your workers, you are by definition a fiduciary. So says the Department of Labor. If you violate fiduciary standards, you may be found personally liable and responsible for restoring any losses to the plan or profits from improper use of plan assets.5

If you have hired a third-party administrator (TPA) to help you with your plan, you need to understand whether or not that TPA will assume any share of fiduciary responsibilities. Most TPAs will not.6

How can you tell if a TPA will? Look at the contract you sign. Look for language (in the fine print) stating that the individual or firm recognizes that it will act as a fiduciary under ERISA and the Advisers Act when offering advice to plan participants. If the TPA exercises discretion and control over the retirement plan or some aspect of it, then it could be defined as a fiduciary.6

Experience the Fee-Only & Fiduciary-Only Difference with Balanced Rock Investment Advisors

We are always Fee-Only meaning we are only paid by our client and are only motivated to serve them well. Because we are never selling, we are always a fiduciary for our clients. This means our interests are much more aligned with our clients’ and what’s best for them always comes first.

Balanced Rock is NOT licensed to sell securities through any broker-dealers or insurance companies. This is because we ONLY provide fee-only fiduciary financial planning and wealth management services. We don’t sell. We Advise.

Citations:
1 - finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=3638 [1/10/12]
2 - www.sec.gov/rules/final/34-51523.pdf [4/15/05]
3 - www.wnj.com/Publications/New-FINRA-Rules-on-Knowing-Your-Customer-and- [2/1/11]  
4 - www.sec.gov/about/offices/oia/oia_investman/rplaze-042006.pdf [4/06]           
5 - www.dol.gov/ebsa/publications/fiduciaryresponsibility.html [1/10/12]
6 - www.seethebenefits.com/showbenefit.aspx?Show=740 [1/10/12]

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