There has been a lot of talk over the past couple of years about the standards to which financial advisors are held. That is due to the fact that there are a number of different kinds of financial professionals, a lot of them use the same title of Financial Advisor.
Industries such as healthcare do not have this problem. Relationships and responsibilities of professionals are clearly delineated. You have doctors, nurses, pharmaceutical sales representatives, etc. While not all doctors take the Hippocratic oath, they must abide by the American Medical Association’s Code of Ethics which states that while caring for a patient, they must regard responsibility to the patient as paramount. And clearly, pharmaceutical sales representatives’ main goal is to sell medicine, not take care of patients.
The issue with financial services is that there are multiple standards, and those that ascribe to different standards all use the same job title. This makes it difficult for retirement plan sponsors to understand what they are signing up for.
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.
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’ interest 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 in the most efficient and cost-effective manner possible. It is important to avoid conflicts of interest as a fiduciary, so any potential conflicts must be clearly disclosed to their client.
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 email@example.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.
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