SUITABILITY VS. FIDUCIARY STANDARDS

If your investment advisor is a Registered Investment Advisor, he or she does share fiduciary responsibility with the investment committee. On the other hand, a broker, who works for a  brokers-dealer, may not. Some brokerage firms don't want or allow their brokers to be fiduciaries.

Investment advisors, who are usually fee-based, are bound to a fiduciary standard that was established as part of the Investment Advisors Act of 1940. They can be regulated by the SEC or state securities regulators. The act is pretty specific in defining what a fiduciary means, and it stipulates a duty of loyalty and care, which simply means that the advisor must put their client's interests above their own. For example, the advisor cannot buy securities for his or her account prior to buying them for a client, and is prohibited from making trades that may result in higher commissions for the advisor or his or her investment firm.

It also means that the advisor must do his or her best to make sure investment advice is made using accurate and complete information, or basically, that the analysis is thorough and as accurate as possible. Avoiding conflicts of interest is important when acting as a fiduciary, and it means that an advisor must disclose any potential conflicts to placing the client's interests ahead of the advisor's. Additionally, the advisor needs to place trades under a "best execution" standard, meaning he or she must strive to trade securities with the best combination of low cost and efficient execution.

THE SUITABLITY RULE

Broker-dealers, who are often compensated by commission, generally only have to fulfill a suitability obligation, which is defined as making recommendations that are consistent with the best interests of the underlying customer. Broker-dealers are regulated by the Financial Industry Regulatory Authority (FINRA) under standards that require them to make suitable recommendations to their clients. Instead of having to place his or her interests below that of the client, the suitability standard only details that the broker-dealer has to reasonably believe that any recommendations made are suitable for clients, in terms of the client's financial needs, objectives and unique circumstances. A key distinction in terms of loyalty is also important, in that a broker's duty is to the broker-dealer he or she works for, not necessarily the client served.

Other descriptions of suitability include making sure transaction costs are not excessive or that are recommendation is not unsuitable for a client. Examples that may violate suitability include excessive trading, churning the account simply to generate more commissions or frequently switching account assets to generate transaction income for the broker-dealer. Also, the need to disclose potential conflicts of interest is not as strict a requirement for brokers; an investment only has to be suitable, it doesn't necessarily have to be consistent with the individual investor's objectives and profile.

The suitability standard can end up causing conflicts between a broker-dealer and client. The most obvious conflict has to do with compensation. Under a fiduciary standard, an investment advisor would be strictly prohibited from buying a mutual fund or other investment because it would garner him or her a higher fee or commission. Under the suitability requirement, this isn't necessarily the case, because as long as the investment is suitable for the client, it can be purchased for the client. This can also incentivize brokers to sell their own products ahead of competing products that may be at a lower cost.

While the term "suitability" was the standard for transactional accounts or brokerage accounts previously, the new Department of Labor Fiduciary Rule has toughened things up for brokers. Now, anyone with retirement money under management, who makes recommendations or solicitations for an IRA or other tax-advantaged retirement account, is a fiduciary and must adhere to that standard. However, the new law does not apply to other sorts of accounts, including after-tax investment accounts that may be earmarked as retirement savings.

Advisory services offered through J.W. Cole Advisors, Inc.


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