Financial Abundance

Did you know that many financial advisors are not required to act in the role of a fiduciary?  Many financial advisors are instead subject to a business standard that only requires that the recommended investments be “suitable” for their clients.  Other financial advisors are subject to a more strict fiduciary standard which means the advisor has “a duty to act in the best interests of their client.”

To understand the difference, we must look at the current regulatory environment.  Commissioned based brokers or a broker-dealers are regulated by the Financial Industry Regulatory Authority (FINRA).  Brokers are often called “registered representatives” and work for such firms as Merrill Lynch, Smith Barney, Edward Jones, Wachovia, UBS or Wells Fargo.  Insurance agents, who offer investment products, are also almost always brokers.

FINRA only requires registered representatives and broker-dealers to provide a “suitable” investment to their clients, based on the client’s financial situation and their other holdings.  FINRA does not require for registered representatives and brokers to act in the client’s best interests.  Since FINRA only requires the “suitable” business standard, the registered representative or broker-dealer does not need to disclose any potential conflicts of interests that their investment advice might include.  This often leads to a broker recommending a product with a commission fee (load) when the same product is available as a “no-load” product.

Investment advisors, often called registered investment advisors or RIAs, are a different type of financial advisor.  RIAs are regulated by either the SEC or their state securities regulator.  RIAs are subject to the Investment Advisory Act of 1940, which requires that they have a “fiduciary duty to act in the best interests of their client”.  Investment advisors are paid through a fee structure, either on an hourly basis or as a percentage of assets under management (AUM).  RIAs are typically “fee only” advisors that do not receive any commissions and are always held to a fiduciary standard.

Some financial advisors present themselves as “fee based” advisors.  These advisors will be acting in the fiduciary capacity of an RIA when providing financial planning advice and typically charge a fee for this advice.  However, when these same advisors implement the proposed plan, they sell commissioned-based products.  When they sell commission-based products, they are operating as a registered representative/broker and are regulated by FINRA.  When these products are sold, the advisors are no longer acting as a fiduciary and need only to meet the “suitable” standard for the product that they sell..

If this seems confusing, you are not alone.  New government regulatory proposals are intended to undo this morass.  However, it is unclear how a broker can maintain a fiduciary relationship with their client while selling a commissioned based product, when a similar (or even the same) non-commissioned product is available.  

Since major banks, brokerages and insurance companies are dependent upon the revenues from their commissioned based products, it is doubtful that registered representatives who sell these products will ever be required to have a fiduciary duty when selling products to their clients.   Hopefully the new regulations will require the up-front disclosure of the commissions being paid to the sales person for each product sold, before it is sold, as well as any other potential conflicts of interest.  With this disclosure, the consumer will know how much of the total cost of the products is being used for compensating the broker-dealer and the sales person.

I believe that every financial advisor should have a fiduciary duty to put their client’s interest before their own.  However, until government regulations require this, consumers should be aware of the difference between commissioned based sales people with only a “suitability” standard and fee only planners who have a fiduciary duty to their clients.