Fiduciary Vs. Suitability: What’s the Difference? – The Investment Advisers Act of 1940 states that investment advisers work for clients and must place clients’ interests ahead of their own. This is called the fiduciary standard. On the other hand, brokers serve the broker-dealers they work for, although they must believe that their recommendations are suitable for clients, according to the Financial Industry Regulatory Authority.
How the fiduciary standard works
Investment advisers’ fiduciary standard is regulated by the Securities and Exchange Commission or state securities regulators. The act defines what a fiduciary does, stipulating that advisers must place their interests below that of their clients — a duty of loyalty and care. Advisers:
- Can’t buy securities for their own accounts prior to buying them for clients.
- Are prohibited from making trades that may result in higher commissions for themselves or their investment firms.
- Have to do their best to make sure investment advice comes from accurate and complete information.
- Must ensure that their analysis is as thorough and accurate as possible.
- Must disclose any potential conflicts.
- Have to place trades under a best execution standard, striving to trade securities with the best combination of low cost and efficient execution.
The SEC has stringent rules for investment advisers, noting that they’re allowed to assist in financial decisions of individuals and institutions that make financial decisions to plan for retirement, to make college payments and to build their own investment portfolios. The rules also determine how advisers should charge clients.
If an adviser who’s a fiduciary fails to uphold these standards, that can constitute a breach of fiduciary duty. Clients may be able to sue for damages if a breach of fiduciary duty results in financial losses. You can search for and review an adviser’s public disclosure using the SEC’s online database.
How the suitability standard works
Brokers are subject to the suitability standard, generally defined as the duty to make recommendations that suit the best interests of their clients. It is not as stringent as is the fiduciary standard followed by advisers. Rather, it means:
- That brokers need to believe that the decisions they make benefit their client.
- That transaction costs may not be excessive and may not rack up unnecessary trading fees.
- That all recommendations must be suitable given the client’s age, goals, resources and other circumstances. However, they don’t necessarily have to be consistent with the investor’s objectives and profile.
How does this differ from the fiduciary standard in practice? A broker-dealer’s income comes from commissions earned from making transactions for his or her underlying customer, the securities dealer. This means that broker-dealers can sell a bond from the firm’s inventory of fixed-income securities even if there is a competing product at a lower cost. Their job is to sell their own products to generate a higher commission.
It’s important to know the difference between the fiduciary and suitability standards. Ask your adviser whether he or she is a fiduciary, for starters. Find out whether your adviser sells investment products. There are fee-only financial planners who charge a fixed price and don’t sell products.
Also, keep in mind that this is just one factor in choosing a financial planner, and there are additional, subtle aspects of both the fiduciary and suitability standards. Also, the fiduciary standard is not a guarantee of honesty or competence. Pam Krueger, creator, co-host and executive producer of the PBS series “MoneyTrack,” has noted that Bernie Madoff operated under the fiduciary standard. “And at the same time, I know some excellent, skilled advisers who put clients first but work for firms still operating under the lesser suitability standard.”
To find an adviser, try the Financial Planning Association and the National Association of Personal Financial Advisors.
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