Financial Opinion and Insights

Fiduciary – Suitability – What’s the Difference?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

Here’s some `inside baseball’ you probably don’t – but should – care about!  The big debate inside the financial industry  is whether brokers should be required to adopt the fiduciary standard of care toward their clients.  

Historically, they’ve been operating under a suitability standard.  The suitability standard is a somewhat lower standard in that it requires that investment recommendations need only be suitable for the client’s situation.  There’s no requirement that the recommendation MUST be in the client’s best interest.   

The suitability standard, as one can imagine, is much more compatible with a sales environment, where packaged investment products are sold on commission.   If two investment products are both suitable, under the suitability standard, a broker can recommend the product with the higher commission and still be in compliance with the suitability requirement.  

My guess is that the vast majority of brokers do put their clients’ interests first and would select the lower commission product because, like any other business, you keep clients by taking care of them the right way; but, rules are generally written for that small minority that prefer an alternate route to riches.  

According to an article appearing yesterday morning in Investment News, some brokers are afraid it will hinder their ability to sell initial public offerings (IPOs) to the public.  This is a legitimate issue since much of America’s growth capital for emerging companies and their entrepreneurs does originate with IPOs!  But, as I said, it’s the small minority that seem to drive regulation and, in this case, many of  the `boiler room’ operations are likely the targets.  

Registered investment advisors do operate under a fiduciary standard, which requires that recommendations and investment choices MUST put the client’s interest first; and indeed they – including yours truly – have been using this as a marketing differentiator for some time, always touting our ‘non-sales’ business model.  The brokerages moving to a fiduciary standard would likely eliminate this differentiator for RIAs.  

In another article in the same publication, the SEC is quoted as saying they will  “…craft rules that increase investor confidence while preserving brokers’ ability to offer a full spectrum of services.”  We’ve seen how well they do that.  

The debate usually occurs when there are `dually-registered’ entities – those that wear two hats.  When a broker is also an RIA, it often happens that the fiduciary hat is worn during the planning stage only to be taken off when the investment stage arrives.  Often, their clients don’t understand that and confusion can arise – much like the widow who invests at her bank’s brokerage department and is still under the impression she’s dealing with an FDIC-insured entity.  It all-too-often happens – one is enough – that she doesn’t realize she’s no longer dealing with the bank.  

Forbes weighed-in on this yesterday, as well. 

This debate isn’t new.  It has been going on for years!  Not a surprise.  The financial industry is famous for moving at a snail’s pace on virtually everything except getting new products to market.   Many have still yet to discover electronic signatures.  They have, however, whole-heartedly adopted both the telephone and the fax machine, so there is hope.

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