If you meet with a financial advisor, be sure to ask a critical question. If you make an appointment with a financial advisor on behalf of yourself, your family or your company, make the following inquiry before the meeting ends:
“Are you held to a suitability standard or a fiduciary standard?”
This distinction is very important. You should be aware of the difference.
What is a suitability standard? Financial Advisors and Financial Planners are frequently asked to abide by suitability standards: when they recommend a financial product to a client, they are ethically bound to recommend a product which is “suitable” for that client.
As laid out in the manual of FINRA (the Financial Industry Regulatory Authority, formerly known as the NASD or National Association of Securities Dealers), the suitability standard has long demanded that a broker make “reasonable efforts to obtain information” on four aspects of a client’s financial life:
- Financial status
- Tax status
- Investment objectives
- Other information used or considered to be reasonable
These factors (and others) have a hand in determining whether a financial product or securities transaction is deemed “suitable” for a client.1
Suitability standards emerged in response to an age-old Wall Street problem. Decades ago, stock brokers garnered all sorts of bad publicity for calling their clients up and recommending “hot” stocks or funds that were utterly inappropriate for them. The investors may have gotten burned, but the brokers got their sales commissions.
Suitability standards are good, make no mistake. The problem is that they could be even better.
Even with a suitability standard, a broker has no specified duty to act in a client’s best interest. So while that broker may recommend a “suitable” fund, stock or other financial product to you, he is not prohibited from recommending an investment that will result in a bigger commission for him or higher costs for you.
If a broker has a proprietary security that seems “suitable” for you, the broker may promote it ardently to you even though better-performing securities might be available.
In 2005, the SEC determined that “broker-dealers will not be deemed to be investment advisers” and therefore are not subject to the same fiduciary standards as Registered Investment Advisors (RIAs) when recommending investments to clients.2
In 2011, FINRA Rules 2090 and 2111 expanded the existing suitability obligations while creating new ones. Any recommendations of “investment strategies” and any recommendations to hold securities within an investment strategy must now be “suitable” for the particular client, and the investor profile compiled by the broker to judge suitability must consider additional factors.3
What is a fiduciary standard? This is the standard that Registered Investment Advisors must uphold. An RIA may be an individual or a financial firm. The “Registered” adjective refers to being registered with either the Securities & Exchange Commission (SEC) or a state securities agency.
RIAs have a fiduciary duty (a legal requirement) to act in the client’s best interest regardless of the level of compensation the advisor may receive as a result of recommendations or actions. Fundamentally, this comes down to two points as stated by the SEC:
The advisor must avoid conflicts of interest.
The advisor is prohibited from overreaching or taking unfair advantage of a client’s trust.
A Registered Investment Advisor is not supposed to pitch products, strategies or securities transactions with the idea that “this will be a win-win for both of us.” The client’s best interest comes first and it is the only interest that matters.4
Retirement plan sponsors must also meet fiduciary standards. If you sponsor a retirement plan for your workers, then you are by definition a fiduciary. So says the Department of Labor. If you violate fiduciary standards, you may be found personally liable and responsible for restoring any losses to the plan or profits from improper use of plan assets.5
If you have hired a third-party administrator (TPA) to help you with your plan, you need to understand whether or not that TPA will assume any share of fiduciary responsibilities. Most TPAs will not.6,7
How can you tell if a TPA will? Look at the contract you sign. Look for language (in the fine print) stating that the individual or firm recognizes that it will act as a fiduciary under ERISA and the Advisers Act when offering advice to plan participants. If the TPA exercises discretion and control over the retirement plan or some aspect of it, then it could be defined as a fiduciary.6
Seek strong standards. When you enter an advisory arrangement with a financial professional or financial consulting firm, the agreement you sign should tell you whether the advisor is held to a suitability standard or a fiduciary standard. In the opinion of many investors and financial professionals, a fiduciary standard clearly amounts to a higher standard.
We are a Utah, fiduciary, fee-only, Registered Investment Advisor firm.
If you or someone you know needs help managing retirement assets or need help setting up an investment savings plane feel free to give us a call.
1 – finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=3638 [1/10/12]
2 – www.sec.gov/rules/final/34-51523.pdf [4/15/05]
3 – www.wnj.com/Publications/New-FINRA-Rules-on-Knowing-Your-Customer-and- [2/1/11]
4 – www.sec.gov/about/offices/oia/oia_investman/rplaze-042006.pdf [4/06]
5 – www.dol.gov/ebsa/publications/fiduciaryresponsibility.html [1/10/12]
6 – www.seethebenefits.com/showbenefit.aspx?Show=740 [1/10/12]
7 – montoyaregistry.com/Financial-Market.aspx?financial-market=why-choose-an-independent-financial-advisor&category=5 [1/10/12]
This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. NYSE Group, Inc. (NYSE:NYX) operates two securities exchanges: the New York Stock Exchange (the “NYSE”) and NYSE Arca (formerly known as the Archipelago Exchange, or ArcaEx®, and the Pacific Exchange). NYSE Group is a leading provider of securities listing, trading and market data products and services. The New York Mercantile Exchange, Inc. (NYMEX) is the world’s largest physical commodity futures exchange and the preeminent trading forum for energy and precious metals, with trading conducted through two divisions – the NYMEX Division, home to the energy, platinum, and palladium markets, and the COMEX Division, on which all other metals trade. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This material was prepared by MarketingLibrary.Net Inc., for Mark Lund, Mark is known as The 401k Advisor, Investor Coach, The Financial Advisor, The Financial Planner and author of The Effective Investor. Mark offers investment advisory services through Stonecreek Wealth Advisors, Inc. an independent, fee-only, Registered Investment Advisor firm providing 401k consulting for small businesses and financial Advisor services for professional athletes and individuals. Stonecreek is located in Salt Lake City, Murray, West Jordan, Sandy, Draper, South Jordan, Provo, Orem, Lehi, Highland, Alpine, and American Fork in Utah.