- Jim Cantrell
Is your financial advisor a fiduciary?
What is the fiduciary standard?
Fiduciaries are regulated by the Securities and Exchange Commission (SEC) or a state’s securities regulators. No matter which governing body is overseeing the fiduciary, the goal is the same – to ensure the advisor places the interests of the client above his or her own interests. Fiduciaries have a duty of “loyalty and care,” which means that the advisor cannot buy securities for his or her own account prior to buying them for a client, and the advisor is prohibited from making trades that might result in higher commissions for the advisor or the advisor’s firm.
Nearly every investment advisor is able to conform to this standard during the advisory part of a client’s engagement. As long as the investment advisor is gathering information about a client and using that information to make recommendations for possible investments, meeting a fiduciary standard – in other words, acting in the best interests of the client – is easy. It’s much simpler to give objective advice when all that’s being provided is advice. That all changes once securities are bought and sold.
For fee-based or commission-based advisors, such as those working for a broker-dealer, once an investment product is bought or sold, the fiduciary standard no longer applies. Instead, fee-based and commission-based advisors are held to a suitability standard once the advisor starts to sell the plan.
What is the suitability standard?
The suitability obligation states that broker-dealers are required to make recommendations that are suitable for clients, in terms of the client's financial needs, objectives and unique circumstances. The broker/dealer does not need to place the client’s needs above his or her own. He or she must simply be able to show that, even if the investment wasn’t the best possible option, it was suitable for the client’s situation and objectives. The suitability standard is regulated by the Financial Industry Regulatory Authority (FINRA) rather than the SEC. The suitability standard allows an advisor to shift loyalties at the time of the sale, making it possible to recommend only investment products from one broker-dealer and for the advisor to receive a commission, fees, or prizes for selling particular investment products.
The vast majority of FINRA-regulated advisors following the suitability rule are good people who want to help clients achieve their financial objectives. However, we believe human nature makes it incredibly difficult to be completely objective 100 percent of the time. If an advisor makes a larger commission on one investment vs. another or is eligible to win a prize based upon sales of a particular product, how can he or she possibly disregard the incentive if both products are fairly similar and likely to be “suitable” for the client’s needs? We believe our clients deserve the best, most objective advice 100 percent of the time. In other words, someone who is always a fiduciary.
How you can determine if your financial advisor is a fiduciary 100 percent of the time
The only way to understand if a financial advisor is a fiduciary 100 percent of the time is to ask specific questions about compensation. Fee-only financial advisors who belong to The National Association of Personal Financial Advisors (NAPFA) are required to place the clients’ interests ahead of their own and are able to ensure unbiased objectivity by refusing to accept any form of compensation other than fees paid directly from their clients. A fee-only financial advisor will not earn commissions, prizes, or gifts of any sort in relation to the sale of a specific investment product. If you are not sure how an advisor is compensated, request a copy of the contract you have or will be expected to sign. Do not rely on the advisor’s website or marketing materials. There are many ways to describe a firm’s relationship with its clients that make the firm sound 100 percent objective and as though they meet the fiduciary standard all the time, when in fact they do not. Here’s the language we use in our contracts:
A. FEE-ONLY GUARANTY We agree to restrict compensation solely and exclusively to the professional fees received directly from clients for professional services rendered to clients. Whenever we recommend that you own a specific financial product, or utilize the services of a specific custodian/broker/insurance firm, FSI and its employees will not accept any sales commissions. Nor will any prizes, vacation trips, gifts or meals valued in excess of $100 from those specific financial product vendors or custodians be accepted.
B. FIDUCIARY OATH We shall exercise our best efforts to act in good faith and in your best interests. FSI, or any party in which FSI has a financial interest, does not receive any compensation or other remuneration that is contingent on any client’s purchase or sale of a financial product. We do not receive a fee or other compensation from another party based on referral of clients or clients’ business.
Understanding when an advisor is (and is not) a fiduciary can help an investor determine how much homework is required to evaluate the advisor’s recommendations. While it certainly is possible to receive good recommendations from an advisor operating under the suitability standard, knowing that an advisor is a fiduciary 100 percent of the time can provide peace of mind that what matters to you, matters to your advisor too.