Do you receive financial advice to the Fiduciary Standard of Care or the Suitability standard?
It’s important to know!
Deciphering today’s complex financial services industry can be difficult, even for the financially sophisticated. Two words: fiduciary and suitability. These are critical in understanding the motivation behind the person offering you financial products or advice.
Recognizing the difference between the fiduciary and suitability standards may also help you to appreciate the level of care you receive from a trusted financial advisor. Although the distinction between the fiduciary and suitability methods of offering advice is rarely discussed by “broker-led” large financial or insurance companies, I feel it is essential for investors to know the difference.
Wolf Wealth Advisors believes that the fiduciary model of disclosure and transparency is in the “best interest of the client.”
Broker, and or insurance agent (the suitability standard):
• offers products for sale from a range of products carried by the company he or she represents;
• is paid commissions calculated as a percentage of the amount of money invested into the product.
Advisor Registered Investment Advisor (RIA) or Investment Advisor Representative (IAR) (the fiduciary standard):
• offers “best advice” taking into account the needs of each individual client;
• is paid a quarterly fee calculated as a percentage of the assets under advisement.
The fiduciary standard requires advice to be provided in the best interests of the client including the disclosure of possible conflicts of interest.
The suitability standard states that a broker or insurance licensed agent only needs to check the suitability of a prospective buyer, based primarily upon financial objectives, current income level and age, in order to complete a commissionable sale of a financial product. In a way, when they check the suitability of a potential buyer, they are measuring how much financial product can be sold, not the needs of the investor. No disclosure of possible conflicts of interest is required.
Common differences between the two standards involve commissions; for example, commissions and incentives paid by mutual fund companies or insurance companies. These inducements can create conflicts between the investor’s requirements and the motives of the advisor. When a broker or insurance agent suggests the purchase of a proprietary product, such as a mutual fund or an annuity, can that suggestion be relied upon to be fair for the client?
Why should you care?
The differences discussed above were a contributor to the 2008 credit crisis, especially within the selling of complex financial products based on housing debt. More recently, the initial public offering (IPO) of Facebook stock was roiled by alleged conflicts of interest by those offering the stock.
Every day, financial products are sold for a commission and include internal costs and fees which are difficult to find and define. The dollar value of these commissions and additional internal costs are usually deducted from the amount an investor invests in a financial product. The total return of such a product may therefore be reduced by the value of these hidden costs.
In 2010, the Wall Street Journal brought this issue to the attention of the investment public with their article: “The Hidden Costs of Mutual Funds.”(The Hidden Costs of Mutual Funds published March 1st, 2010. Copyright Wall Street Journal.) A further example of how low the bar is set for broker disclosure of costs and conflicts can be found within the article “Shining a Light on Murky 401(k) Fees.”(Shining a Light on Murky 401(k) Fees published November 13, 2010. Copyright Wall Street Journal.)
Since 2008, the US Government has also begun to care about how financial recommendations are delivered to members of the general investing public. The lack of “self-policing,” protection of client interests, and frequent scandals have led our legislative system to pass the Dodd-Frank Wall Street Reform and Consumer Protection Act.
One goal of this legislation was the creation of a single standard for financial advice based upon the current fiduciary standard.
Informed investors should ask: “Why does the government feel I need protecting, and from what?”
President Obama signed into law the Dodd-Frank financial reform law, July 21, 2010, giving the Securities and Exchange Commission the authority to write a regulation that would require all financial advisers to act in the best interest of their clients. The fiduciary standard of care currently only applies to RIA’s and IAR’s; not brokers and insurance agents. It truly is a shame that four years later, we still don’t require all financial professionals to do what’s in the client’s best interest.