Updated on Monday, August 17, 2020
A fiduciary financial advisor is a financial advisor who is legally and ethically bound to act in their clientsâ€™ best interests at all times. Whatâ€™s surprising to many, however, is that not all financial advisors are fiduciaries, meaning some are legally allowed to make a profit at their clientsâ€™ expense.
Hereâ€™s what you need to know about the differences between fiduciaries and non-fiduciaries, how recent regulations impact them and how the financial advisor you choose may affect your investments.
So what is an investment advisorâ€™s fiduciary duty? Generally speaking, financial advisors bound by fiduciary duty must put their clientsâ€™ best interests before their own.
Currently, all financial advisors who are registered with the Securities and Exchange Commission (SEC) â€” known as Registered Investment Advisors (RIAs) â€” are bound by fiduciary duty. However, not all financial advisors are RIAs, and therefore some donâ€™t adhere to the fiduciary standard. That means that some financial advisors are legally able to put their own interests ahead of their clientsâ€™ and recommend investments that make them a profit at their clientsâ€™ expense.
In recent years, there have been attempts to bring more conformity to the industry in terms of how and to whom fiduciary duty applies.
Department of Laborâ€™s fiduciary rule: In 2016, under President Barack Obama, the Department of Laborâ€™s fiduciary rule went into effect. It required all financial services professionals providing advice on retirement accounts, such as 401(k) plans and individual retirement accounts (IRAs), to follow fiduciary standards. In 2018, however, the rule was struck down by a federal court after a change in the administration.
Regulation Best Interest: After that, the Securities and Exchange Commission (SEC) took matters into their hands and created a new rule, called Regulation Best Interest (Reg BI), which took effect in June 2020. It differentiates between RIAs, who are financial advisors that only provide advice, and broker-dealers, who provide advice and sell products and investments from which they may earn a profit.
Previously, only RIAs were required to meet fiduciary standards, while broker-dealers were required only to follow the less-stringent suitability standard (see more below). The new rule doesnâ€™t go as far to require broker-dealers to follow the fiduciary standard, but it does require them to make recommendations in the best interests of their clients and sets out requirements that are more stringent than the suitability standard.
Under Regulation Best Interest, brokers may no longer call themselves advisors if they arenâ€™t following the fiduciary rule. RegBI also lays out stipulations they must adhere to, including the following:
Additionally, both RIAs and broker-dealers must now disclose important information about their company in a document: a new client (or customer) relationship summary, also known as Form CRS. This includes information about their fees, any conflicts of interest and which standard of conduct they follow.
The fiduciary standard
The suitability standard
Currently, RIAs are the only financial advisors required to adhere to the fiduciary standard. Broker-dealers follow the less-stringent suitability standard, which only requires that they make recommendations that are â€śsuitableâ€ť for the customer based on factors including their tax and financial status, objectives and risk tolerance. Whatâ€™s suitable, however, doesnâ€™t always necessarily mean whatâ€™s best for you.
As of June 2020, however, broker-dealers must also act in their clientsâ€™ best interest. Previously, broker-dealers could recommend products that would earn them the highest commission, even if they werenâ€™t necessarily the best ones for their clients. Now, they must act in their clientsâ€™ best interest, but only at the time they make a transaction recommendation. Those who abide by the fiduciary standard must act in their clientsâ€™ best interest at all times, including while providing ongoing advice and monitoring client accounts.
The duty of a fiduciary financial advisor is to hold their clientsâ€™ trust by making decisions in their clientsâ€™ best interests. The importance of fiduciary duty lies in the confidence it provides a client so they donâ€™t have to second-guess the motive for the advice theyâ€™re given. They can be rest assured that they are being given the best, most objective advice that the advisor has to offer. They donâ€™t have to wonder if theyâ€™re being steered in a direction because their advisor stands to make a larger commission.
Think of it like going into a shoe store to purchase a pair of shoes. Under fiduciary duty, the salesperson would advise you to purchase the pair of shoes that fits you best and looks best on your feet. Without fiduciary duty, the salesperson might try to convince you that the too-small, odd-looking pair is amazing, because itâ€™s a more expensive shoe that will mean a bigger commission for them. Of course, thereâ€™s no fiduciary rule when it comes to shoe sales, but it illustrates the point as to the difference between working with a fiduciary financial advisor as opposed to a non-fiduciary.
As of now in the financial industry, only RIAs are required by law to meet the fiduciary standard. Financial advisors arenâ€™t, however, the only professionals who are bound to fiduciary duty by law.
Other professions that involve trust with their clients, such as real estate agents, clergymen, physicians and attorneys, are also fiduciaries. While the precise rules vary by profession, in general, they all require that the professional act in the best interest of their clients.
A breach of fiduciary duty involves an action in which the fiduciary puts their own interests before a clientâ€™s. In the case of a financial advisor, a breach of fiduciary duty would involve the advisor making recommendations that earn them a profit at a clientâ€™s expense. Examples of breach of fiduciary duty may include actions like charging excessively high commissions, misrepresenting potential conflicts of interest or any cases in which a client loses money due their advisorâ€™s fraudulent or negligent actions.
If a client believes there has been a breach of fiduciary duty, they can sue the advisor for damages, including trading losses and well-managed account losses.
According to the National Association of Personal Financial Advisors (NAPFA), non-fiduciary advisors cost investors up to $17 billion a year. Thatâ€™s a lot of money, which could have been in the pockets of individual investors.
The fees and services that fiduciaries and non-fiduciaries offer may be similar, but itâ€™s the missed opportunities that can result in this loss to investors. For example, a non-fiduciary may advise you to purchase a â€śgoodâ€ť product because they will receive a larger commission or another incentive, such as a prize, for selling that product. However, there may be a better product that would have benefited you more financially that they didnâ€™t recommend because it didnâ€™t offer an incentive for them.
That doesnâ€™t mean that all non-fiduciaries are going to provide bad financial advice, but choosing a fiduciary provides extra assurance that your financial best interest is that advisorâ€™s biggest priority. You donâ€™t have to worry that their advice may be costing you potential cash.
There are a number of factors to consider when choosing a financial advisor, but determining if theyâ€™re a fiduciary is one of the most important. While Regulation Best Interest provides more assurance that all advisors are working in your best interest, the fiduciary rule is the most-stringent standard, and fiduciaries provide the most reassurance that youâ€™re getting your best advice possible.
So, how do you find a financial advisor who is a fiduciary? There are a number of ways to find an individual or firm that abides by fiduciary duty: