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27 Jul Standards of Care in the Finance Industry: Fiduciary vs. Best Interest

Posted at 17:28h in fiduciary by Clara Moses 0 Comments

There is a wide variety of financial professionals out there, and although there is some crossover between the responsibilities that fall under each title, one key difference is that they are not all governed by the same standards. The various titles and standards can be confusing, especially for people who have never worked with a professional before. This can make the process or finding help even more daunting for beginners who may already be hesitant about letting someone else handle their money. If you’re in that boat, look for a fiduciary financial advisor. You can confidently trust these professionals, and here’s why…

This type of advisor is held to the fiduciary standard of care, which was established in the Investment Advisers Act of 1940 and is regulated by the Securities and Exchange Commission (SEC) or state securities regulators. One common type of fiduciary sought out for financial advice are Registered Investment Advisors (RIAs). They are required to register with the SEC and file a Form ADV, which is a public disclosure form that outlines how the advisor is paid, their investment strategy, and any past or current disciplinary or legal actions taken against them. Here is a breakdown of the rules that financial professionals held to the fiduciary standard of care are required to follow:

  • Advisors must put their clients' interests above their own.
  • They must avoid to the greatest extent, any conflicts of interest between their clients and themselves.
  • If there are any potential conflicts of interest, they must disclose them in the appropriate manner.
  • They must not buy securities for their account prior to buying them for a client.
  • Their advice must be made using accurate and complete information, requiring the most thorough analysis possible.
  • They must strive to trade securities with the best combination of low cost and efficient execution.

If any of these rules are broken, that advisor may be breaching their fiduciary duty and can be sued for damages if this results in any financial losses for their clients. This type of regulation is very beneficial for clients and learning more about it can put a worried mind at ease. However, it’s important to note that not every advisor is held to the fiduciary standard of care.

In the recent past, you may have heard the term “suitability standard” being used. This was set by the Financial Industry Regulatory Authority (FINRA). Broker-dealers were often only held to this standard of care, meaning they had to reasonably believe that their recommendations were suitable for their client’s financial needs, but they didn’t necessarily have to be the best choice, or the one with the lowest fees. This helped insurance and investment firms sell products that were most profitable for them. Broker-dealers and other non-fiduciary advisors may have been incentivized to sell products from the firms they were associated with as it’s how they made their commissions, which in many cases was their primary income.

Thankfully, in September of 2019, the SEC put stronger rules info effect that require brokerage firms to avoid and disclose potential conflicts of interest. By June of 2020, all firms were required to come into compliance with what is officially known as the SEC Regulation Best Interest: The Broker-Dealer Standard of Conduct. This meant they must release a Form CRS Relationship Summary that provides clients with simple, easy-to-understand information about the nature of their relationship with their financial professionals. Most notably, while it was acceptable for a broker-dealer to place their client’s financial interests below their own when making recommendations under the suitability standard, this is no longer the allowed. Here’s what the rules include now:

  • Financial professionals must exercise reasonable care when making a recommendation to a client, always looking out for the client’s best interests.
  • They must disclose specific facts about the relationship with their client and the recommendations they give them.
  • Any conflicts, limitations on services or products, and monitoring services must be revealed.
  • Conflicts that create an incentive for them to place their interest or their firm’s interest ahead of a client’s must be mitigated by the firm.
  • Limitations on offerings must be prevented.
  • Sales contests, quotas, bonuses, and non-cash compensation based on the sale of specific securities or types of securities within a limited period must be eliminated.

Although Regulation Best Interest draws from key fiduciary principles, it does not mandate full fiduciary duties. A lot of us wear multiple hats at our workplaces, and financial professionals are no exception. The main reason you may prefer to work with a fee-only, fiduciary advisor is because they are legally bound to keep their “fiduciary hat” on at all times. Those who are held to lesser standards of care may swap out of that and don their “best interest/suitability hat” at times. When you work with true, full-time fiduciaries, they will not switch roles and you can count on them to consistently fulfill their duties.

Also, not everyone who claims to be a fiduciary is always putting their clients first so it’s crucial to do your own research. It can be hard to find this information online, but the best place to start is on the National Association of Personal Financial Advisors (NAPFA) website. There you can search through the fee-only fiduciaries near you. The SEC’s online database also has information about advisors, including their ADVs and CRSs.

The easiest option is to simply ask a financial professional if they are licensed with an insurance company or brokerage firm. If the answer is “yes,” then they are not a true fiduciary. You may also ask them to show you a signed fiduciary oath, stating that they are not licensed or affiliated with any firm that receives compensation for recommending or providing financial or insurance products.

Knowledge is power. There are trustworthy advisors out there who will put your needs above their own gain, you just need to look in the right places. At The Wealth Conservatory, we pride ourselves on being fee-only fiduciaries. Please feel free to reach out to us with any questions about this topic or about what we do here.

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