What Does It Mean to Be a Fiduciary?
We’ve all read plenty of news headlines, watched breaking news stories touting names like Madoff, McCoy, Aequitas and more, as well watched movies like “Wall Street” and “The Wolf of Wall Street, which all highlight profiles of dishonest and egocentric individuals who bring shame to the financial services industry. These people and their stories do not invoke feelings of trust, but rather fuel our minds with skepticism and high levels of uncertainty.
You may be wondering, “what does it mean to be a fiduciary?”. Trust is crucial when working with a financial advisor! You are essentially placing your financial well-being and future in the hands of another with the expectation they grow and protect your hard-earned money with your best interests always front and center. So, how can you be sure you are placing your trust in the right advisor? How do you decrease your chances of being a victim of a financial crime? Do your homework and understand the differences between the various professionals in the financial industry. Not all financial advisors are created equal. Some are held to a higher standard by the industry as a result of their credentials, some are paid only fees from their clients, and others receive commissions based on the products they are able to sell to investors.
There are two key terms worth explaining as we discuss what it means to be a fiduciary: Fiduciary duty vs. Suitability standard.
The Investment Advisors Act of 1940 states that an investment advisor (or anyone in the business of giving investment advice) has a fiduciary duty to their client. It requires that advisors must act in the best interests of the client. Registered investment advisors are required by law to act as a fiduciary. Certified Financial Planners (those who hold the CFP ® designation) are also required to act as a fiduciary per the Certified Financial Planner Board of Standards. These advisors must do the following:
- Place the client’s interests above their own.
- Seek the best prices/terms.
- Avoid conflicts of interest. If a conflict of interest arises, disclose to the client immediately.
- Adhere to a duty of loyalty and care. Advisors are prohibited from using a client’s assets to benefit themselves, such as purchasing securities for their own account before buying them for a client.
- Do their best to ensure advice provided is accurate and thorough.
- Act in good faith and provide all relevant facts to clients.
Broker-dealer is a term used to describe a person or firm in the business of buying and selling securities for its own account or on behalf of its customers. These individuals are not uniformly governed by a fiduciary duty. Instead, they must follow something called the “suitability standard set by the Financial Industry Regulatory Authority (FINRA).
The suitability standard means they must have a reasonable belief that an investment or transaction is suitable for the customer. This “reasonable belief” leaves a lot of room for discussion. It allows broker-dealers to recommend products that can increase their bottom line through commissions but may not necessarily be the best fit for you and your situation. Broker dealers must do the following:
- Reasonably believe their recommendations are suitable for the client in terms of their objectives, financial needs, and specific circumstances.
- Make sure transaction costs are not excessive.
Two important takeaways are glaringly obvious; broker-dealers are not required to put the client’s interests above their own. They are not required to invest clients in the “best fit,” but rather invest their money in something they consider to be “suitable.” Brokers can be incentivized to sell their own products ahead of competing products that may have lower costs so they can generate more commissions.
Rules and regulations in the financial services industry are ever changing. As of June 2019, the SEC voted to push forward a final rule aimed at providing clarification and expanding upon the roles of a fiduciary advisor and a broker. The package addressed four primary areas:
Regulation Best Interest
Requires brokers to act in a client’s “best interest” via disclosure of conflicts of interest. Brokers had to start complying with this June of 2020.
Describes the relationship between the client and the broker or advisor and explains the potential ways to get investment advice via the two groups. The document would be delivered to the client at the beginning of the relationship and would outline potential conflicts, their legal standard of conduct, fees, service, and other information pertaining to the relationship.
RIA Standard of Conduct
The rule interprets the standard of conduct pertaining to Registered Investment Advisor firms currently acting as fiduciaries.
The rule further clarifies and interprets the meaning of investment advice that is “solely incidental” to their business.
What does this new act mean? Broker-dealers are now being held to a “best interest” standard, but it is limited to just when they are providing a recommendation. Registered investment advisors and CFPs are required to apply the best interest standard to the entire relationship because they are required to be fiduciaries at ALL TIMES.
The best way to ensure you are working with a true fiduciary is to search for registered investment advisors who have certified financial planner designations. The Certified Financial Planners Board has an advisor search tool available.
The next line of questioning should be how are advisors paid? There are several ways this can happen:
Commission – Only Financial Advisors
Commission-only financial advisors only make money when they sell investments or a certain financial product. They are often employed by broker-dealers and are only held to a suitability standard.
Fee-Only Financial Advisors
Fee-only financial advisors only make money from client fees. It may be structured as a flat or hourly fee or as a percentage of assets managed. They do not earn commissions on investments, nor do they receive a fee when you buy or trade securities. They have fewer conflicts of interest than other advisors, but still must disclose any conflicts they do have. They are almost always fiduciaries.
Fee-Based Financial Advisors
Fee-based advisors may earn fees like fee-only advisors, but they may also earn commissions or referral fees. What it all comes down to is trust. Make sure whoever you work with is a true fiduciary, that you feel comfortable with them, that you agree with their investing philosophy, and that they look at your entire financial picture (not just your investments). If you are interested in working with a fee-only registered investment advisor fiduciary, please contact us at 410-840-9200 or visit us at www.mainstadvisors.com.
Yahoo Finance. (May 2022). What Is a Fiduciary Financial Advisor?
Forbes. (May 2021). How Fiduciary Duty Impacts Financial Advisors.
NerdWallet. (February 2022). What Is a Fiduciary, and Why Does It Matter?
Barron’s. (May 2022). What Is a Fiduciary, and Do I Need One?
The Balance. (November 2021). What the Investment Fiduciary Rule Means for You.
Main Street Advisors, LLC. June 2022. Main Street Advisors, Inc. is a Registered Investment Advisor. The articles and opinions expressed in this material were gathered from a variety of sources, but are reviewed by Main Street Advisors, LLC, prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of June 2022 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual situation. Always contact your financial/investment professional before making any financial decisions. Main Street Advisors, LLC is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.