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Understanding the Difference between Suitability and Fiduciary Standards

June 09, 2020
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If you’ve been in the market for a new investment advisor, chances are you’ve come across the terms suitability and fiduciary standards. While on the surface they may seem similar, it is important to understand the difference between those advisors who are held to a fiduciary standard versus those who are held to a suitability standard, particularly before choosing someone who you are going to trust to manage your money.

What is the “fiduciary standard of care?”

The fiduciary standard of care requires that a financial adviser act solely in the client’s best interest when offering personalized financial advice.

Who follows the fiduciary standard?

Under federal law, in particular the Investment Advisers Act of 1940, investment advisers are regulated by the Securities and Exchange Commission (SEC) or appropriate state authorities and are required to provide services to their customers under the fiduciary standard. 

Investment advisers and investment brokers, who work for broker-dealers, tailor their investment advice to individuals and institutional clients but are not governed by the same standards. According to the Investment Advisers Act of 1940, investment advisers working directly for clients are legally required to place their clients' interests ahead of their own.

The act also requires that advisers make their best effort to ensure their investment advice is made using accurate and complete information and that the analysis they provide is as accurate and thorough as possible. Fiduciaries must disclose potential conflicts of interests and place trades under a "best execution" standard, meaning they will strive to trade securities with the best combination of low cost and efficient execution.

As fiduciaries, the SEC has stringent rules for investment advisers and determines how advisers are able to charge their clients. Advisors are able to assist in the financial decisions of individuals and institutions who make financial decisions in order to plan for retirement, college payments, or in building their own, often taxable, investment portfolios.

Suitability

Unlike investment advisers, brokers serving the broker-dealers they work for follow a suitability standard as set by the Financial Industry Regulatory Authority (FINRA) Rule 2111. FINRA Rule 2111 requires that a firm or associated broker have a reasonable basis to believe their recommended transaction or investment strategy is suitable for the customer. Broker-dealers are considered by the SEC to be financial intermediaries who help connect investors to individual investments and are held to a "suitability obligation," which means they are required to  recommend suitable investments. This means, the broker-dealer is only required to believe that the decisions they make will benefit their client and that the transaction costs are not excessive. Their primary income comes from commissions earned from making transactions for the underlying customer.

KEY TAKEAWAYS

  • Different types of financial advisers are held to different standards for managing their clients' money.

  • Fiduciaries have a legal obligation to act in the best interests of their clients, not just suitable for them. They are held to a higher standard to provide a Duty of Care and a Duty of Loyalty. 

  • A breach of fiduciary duty can occur when an adviser who is held to a fiduciary standard puts their own interests ahead of their clients' interests.

The best way to find out whether your adviser is a fiduciary is to ask if they are a Registered Investment Advisor.  Registered Investment Advisors are required by law to act as a fiduciary and put their clients’ interest first. Interested in learning more or working with an advisor who is held to a fiduciary standard to always put your interests first? Contact us for an introductory call to start the conversation.