Fiduciary Standards

Fiduciary Standards

Independent Registered Investment Advisors (RIAs) are held to higher standards than stockbrokers. Independent RIAs are held to a Fiduciary Standard while stockbrokers are only held to a Suitability Standard.

Fiduciary Responsibility

Advisors who are fiduciaries must always act in the best interest of their clients. They must set aside personal interests to serve the client. They must also disclose all their fees and any conflicts of interest. Investment Advisory firms are required to put your interest first.

They do not engage in other business activities like investment banking or underwriting. Brokerage firms normally do engage in these types of businesses. These other activities often become a conflict of interest. A brokerage firm may be taking a company public and thus heavily promoting it to their customers. Or they may hold a large stock position and offer incentives for brokers to “move it”.

Suitability Standard

A stockbroker is not a fiduciary. They do not have to disclose their various compensation structures or their conflicts of interest. Stockbrokers, may use terms such as financial advisors, financial consultants, and investment specialists, but could merely be a  salesperson for a brokerage firm. They do not have to act in your best interest, they only have to meet suitability standards.

Suitability standards basically say that the brokerage firm can recommend certain securities or investments if they believe that they are suitable for a particular investor, or more broad-based, any investor. There may be plenty of "suitable" investments, but that doesn't mean they are in the investor's best interest. A high-commission, high-expense proprietary mutual fund with a lagging track record could be deemed suitable.

Stock and bond trades are also affected. Trades can incur high costs as brokers trade in and out of their firm’s own inventory. Individual bonds are especially prone to high markups because their pricing is not as transparent as stocks.

As of December 31, 2006, the SEC states that brokerage firms may not offer “financial planning” services, except in accounts regulated as investment advisory accounts. In other words, brokerage firms will be subject to fiduciary standards if they perform financial planning services. Two things to look out for:

  1. Most brokerage firms do not want their sales reps to be fiduciaries so they are positioning themselves as offering everything but deemed "financial planning" services. Read their disclosures carefully.
  2. If a broker does put on the fiduciary hat for the financial plan service, he or she does not have to continue wearing it when it comes to the implementation of recommendations. Now you see the fiduciary, now you don't.