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Who Does Your Financial Advisor Work For?

Joseph A. Grutta

Have you ever asked your financial advisor who they work for? Do they truly represent your best interests or those of the firm they work for? Are they acting on your behalf? Is their advice based on a fiduciary standard or a suitability standard? Do you know the difference?

These are very important questions to know the answers to before turning your hard-earned money over to someone to manage on your behalf. For many years, I have encouraged people who are looking for help managing their money to ask questions, lots of questions. One of the best questions you can ask is, “Do you act as a fiduciary?”

What is a Fiduciary Duty?

According to Nolo’s Plain-English Law Dictionary, a fiduciary duty is “a legal duty to act solely in another party’s interests.”1 Parties owing this duty are called fiduciaries. The individuals to whom they owe a duty are called principals. Fiduciaries may not profit from their relationship with their principals unless they have the principal’s express, informed consent. They also have a duty to avoid any conflicts of interest between themselves and their principals or between their principals and the fiduciaries’ other clients.

A fiduciary duty is the strictest duty of care recognized by the U.S. legal system.2 So what does it mean to act as a “fiduciary”? In simple terms, it means the interest of the client (principal) comes first. The client and advice given to the client are at the center of the fiduciary relationship — NOT the advisors and NOT the firm.

More specifically, an advisor, financial planner, or financial consultant who claims to act as a fiduciary is held to standards defined in the 1940 Investment Advisors Act. Besides acting in your best interest, they must also:

  1. Give you undivided loyalty and act in good faith.
  2. Avoid engaging in activity that is a conflict of interest and disclose any potential conflict if one exists.
  3. Provide a full disclosure of any advice they offer.

The fiduciary standard of care requires that a financial advisor acts solely in the client’s best interest when offering personalized financial advice. Under federal law, in particular the Investment Advisers Act of 1940, investment advisors are regulated by the Securities and Exchange Commission (SEC) or appropriate state authorities and are required to provide services to their customers under the fiduciary standard.

Certified Financial Planner™ (CFP®) professionals providing financial planning services must also abide by the fiduciary standard, as defined by the CFP Board. Broker-dealers and their brokers are also regulated under federal law, including under the Securities Exchange Act of 1934, but are not required to provide services to their clients under the fiduciary standard of care.

Instead, brokers provide services under the suitability standard of care, which generally requires only the broker’s reasonable belief that any recommendation is suitable for the client. It is important to recognize that a financial recommendation that is “suitable” for a client (as legally required for broker-dealers) may or may not be a financial recommendation that is in the client’s best interest (as legally required for investment advisors).

 

What is a Suitability Standard?

The Suitability Rule

Brokers, who are most often compensated by commission, generally only have to fulfill a suitability obligation, which is defined as making recommendations that are consistent with the best interests of the underlying customer. Brokers and their broker-dealers are regulated by the Financial Industry Regulatory Authority (FINRA) under standards that require them to make suitable recommendations to their clients.

Instead of having to place his or her interests below that of the client, the suitability standard only details that the broker has to reasonably believe that any recommendations made are suitable for clients, in terms of the client’s financial needs, objectives, and unique circumstances. A key distinction in terms of loyalty is also important, in that a broker’s duty is to the broker-dealer he or she works for, not necessarily the client served.

The suitability standard can end up causing conflicts between a broker and a client. The most obvious conflict has to do with compensation. Under a fiduciary standard, an investment advisor would be strictly prohibited from buying a mutual fund or other investment because it would garner him or her a higher fee or commission. Under the suitability requirement, this isn’t necessarily the case, because as long as the investment is suitable for the client, it can be purchased for the client. This can also incentivize brokers to sell their own products ahead of competing products that may cost less.

While the term “suitability” was previously the standard for transactional accounts or brokerage accounts, the new Department of Labor fiduciary rule is predicted to have toughened things up for brokers.

As the upcoming DOL Rule unfolds, anyone with a retirement account who makes recommendations or solicitations for an IRA or other tax-advantaged retirement accounts would be considered a fiduciary and must adhere to that standard. However, the new law does not apply to other sorts of accounts, including after-tax investment accounts that may be earmarked as retirement savings.

Broker-Dealers & Brokers Are Not Fiduciaries

Standard brokers and broker-dealers are not considered fiduciaries for their clients. But some brokers have started offering fee-based services, maintaining potential conflict of interests. This created confusion among clients, so the SEC passed regulations that required them to clarify their non-fiduciary status. The rule required this statement in their advertisements and agreements:

“We do not have a fiduciary or advisory relationship with you, and our obligations to disclose information regarding our business, conflicts between our interests and yours, and other matters are more limited than if we had fiduciary or advisory duties to you.”3

If you are still wondering what that means to you, here is an easy way to think of what acting as a fiduciary means: you wouldn’t expect your butcher to give objective dietary advice. If you want advice about what to eat, you go to a dietician. By analogy, when you want financial advice, you go to a fiduciary.

We all understand the difference between an advisor and a sales person. We would not expect a Toyota salesperson to send us to the Honda dealership, even if the Honda was a better fit for our needs. The Toyota salesperson’s job is to sell us a Toyota.

In recent months, it has become a hot topic in the financial industry due to recent new regulations issued by the Department of Labor. Now that the Department of Labor has institutionalized the fiduciary rule, more financial professionals are going to be required to act in their customers’ best interests. Where can you actually find someone who will really, truly do that for you?

The problem is, things can get confusing when we have salespeople (brokers or agents) calling themselves advisors. There is no other industry where it is so hard to figure out who does what. Everyone in the traditional financial services industry calls themselves an advisor, so you would expect that to mean they are giving you advice that will be in your best interest.

And sometimes they are. Other times, things are not so clear. We have all heard plenty about advisors who clearly put themselves and the firm they work for ahead of the clients. To make matters more confusing, there are some advisors who aren’t legally able to call themselves fiduciaries but still act like one and put their clients’ interests first. On the flipside, there are some advisors who are regulated as fiduciaries that may put their own interests ahead of the client.

There is a debate in the industry about how to solve this problem, but don’t hold your breath. Instead, start by asking yourself if the advisor you are consulting or working with acts like a fiduciary:

  • Do they put your interests ahead of their own and the firm they work for?
  • Does the firm they work for have a culture of putting clients’ interests first?
  • Do they work hard to make sure you know how they are paid and disclose any conflicts of interest?

If you have any doubts, have a candid conversation. Ask them. While it’s not a foolproof way to find someone you can trust, it will put you in a better place to evaluate the nature of this relationship.

1 http://www.nolo.com/dictionary/fiduciary-term.html
2 Breach of Fiduciary Duty Law & Legal Definition. Legal Definitions Legal Terms Dictionary. https://en.wikipedia.org/wiki/Fiduciary
SEC Rule 202(a)(11)-1

About the Author:

Joseph A. Grutta has been a CERTIFIED FINANCIAL PLANNER™ professional since 1984. As an Enrolled Agent (EA), he is permitted to offer professional tax advice to his clients. Joseph also has a Series 65 security license, which allows him to offer advisory services, and a Series 7 license, allowing him to manage client investments. It’s this combination of extensive tax knowledge and overall financial qualifications that gives you the best value for your money. For more information, please visit his website:  www.jagfs.com. You can also contact his office at (321) 777-8482 or at info@jagfs.com.

Securities and Advisory Services offered through Centaurus Financial, Inc., Member FINRA/ SIPC, a Registered Investment Advisor. JAG Financial Services and Centaurus Financial, Inc. are not affiliated. Supervisory Branch: 1602 Village Market Blvd SE, Suite 430, Leesburg, VA 20175, (800) 699‐0299. 

 

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