Key Takeaways:
- The fiduciary standard is defined by obligations to act in the best interest of a client when providing advice.
- The suitability standard requires that recommendations be appropriate based on a client’s objectives and financial situation.
- Different regulatory frameworks and professional designations may be associated with each standard.
- Broker‑dealers and registered representatives have traditionally operated under the suitability standard in many contexts.
- Investment advisers registered under applicable laws are generally subject to the fiduciary standard when providing advisory services.
- Conflicts of interest, including compensation structures, can be treated differently under each standard.
- Disclosure and transparency regarding standards of care are factors in client‑advisor relationships.
Fiduciary and Suitability Standards
When it comes to investment advice, there are two main standards. Everyone who calls themselves a financial advisor and charges for investment advice is legally required to follow one of them.
Fiduciary
The first is the fiduciary standard. Established as part of the Investment Advisors Act of 1940, the fiduciary standard states that an advisor must put their clients’ interests above their own. They must follow the very best course of action, regardless of how it affects them personally or their income.
A fiduciary’s advice must be the result of thorough and accurate analysis, and they must execute it as efficiently and cost-effectively as possible. It is important to avoid conflicts of interest as a fiduciary, so any potential conflicts must be clearly disclosed to their client.
Suitability
The other standard is called the suitability rule. This standard is not nearly as strict as the fiduciary standard. Advisors simply have to give advice that is suitable for a client based on their financial needs, objectives, and specific circumstances. They are not required to give the best advice, as long as their advice is not clearly bad. They can recommend investments that pay the highest commissions as long as they align with the client’s overall goals, even if there are much better investments available.
An advisor who follows the suitability rule’s loyalty is to the company that employs them. A fiduciary’s loyalty is to the client.
Difference Between Standards
This is what the difference between the two standards would look like if they were applied to car salesmen. Let’s say a young family comes to a dealership looking for a vehicle to use to take the kids to school, sports, go to the grocery store, etc.
A fiduciary salesman would sit down with the family and discuss their goals, finances, and needs. He would then probably recommend an efficient mid-size sedan, minivan, or small SUV.
A salesman following the suitability standard would make different recommendations. Since they are only required to provide the family with something that will get them from point A to point B, they could recommend a Porsche or a Hummer. They can recommend whatever earns them the highest commission as long as it can transport the family, no matter how uncomfortable or impractical it is.
Who Uses Each Standard?
As you can see, there is a big difference between the two standards to which financial advisors are held. The standard that an advisor follows depends on the kind of company he or she works for.
Registered Investment Advisors are legally required to follow the fiduciary standard. All of their advisors, also called Investment Advisor Representatives, must always put their clients first and their loyalty is to the client above all else.
Broker-dealers follow the suitability rule. Their brokers, even if they call themselves financial advisors, do not have to put client interests above their own. Their loyalty is first and foremost to their broker-dealer.
Does Your Advisor Use the Right Standard?
If you don’t know which standard your advisor adheres to, the best way to find out is to just ask. A fiduciary advisor will be forthcoming and not hesitate to put it in writing. If your advisor is not open about it or follows the suitability rule, you may want to reconsider your relationship.
When you feel sick, you go to a doctor, not a pharmaceutical sales representative. You know the former will work to help you get well, while the latter will simply sell you medicine. When it comes to the investments for your retirement plan, do you want to work with someone who will put your needs first or someone who will just sell you investments?
If you are looking for a fiduciary investment advisor for your employer-sponsored retirement plan, give our office a call at (949) 718-1600 or email us at info@beaconpointe.com. Beacon Pointe is a fiduciary, and our advisors will put your needs first and always act in your best interest.
Important Disclosure: This content is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. Some information may have been obtained from third-party sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. An investor should consult with their financial professional before making any investment decisions.
