What You Need to Know About Advisors, Brokers and the Fiduciary Standard

On October 29, 2013, the US House of Representatives passed a controversial bill that delays the US Department of Labor and US Securities and Exchange Commission from adopting rules requiring brokers and retirement account financial advisors to put their clients' interests before their own. Let's cut through the confusion of bipartisan rhetoric, complexity of two government regulators, and resistance from many of Wall Street's biggest firms.

The phrase that you need to know is “fiduciary standard.” The fiduciary standard is a code of conduct for the approximately 10,500 registered investment advisors who are regulated by the US Securities and Exchange. The fiduciary standard requires investment advisors to act in the best interest of the client, specifically stating that they must put the clients' interest above their own. This includes acting with prudence, not misleading the client, providing full disclosure of all facts, and disclosing any conflicts of interest. Sounds good, right?

It may surprise you to learn that hundreds of thousands of brokers (including those working for big Wall Street firms), smaller regional brokerages, and insurers are obliged only to recommend “suitable” products because of differing rules enforced by their self-regulatory organization, the Financial Industry Regulatory Authority (FINRA). Further confusing the matter, many brokers call themselves advisors. Brokers are not legally required to place clients’ interests ahead of their own, to disclose conflicts of interest or details of fees.

According to Registered Rep's Advisor Corner: Understanding the Differences between RIAs and Brokers, Suitability and Fiduciary:

Think of it this way. If you walk into a Ford dealership, the Ford salesman is going to do everything he can to sell you a Ford. And a Ford vehicle will likely ‘suit’ your needs. But you could also choose to hire someone to help you determine exactly which vehicle would really be best for you, among the many brands and models out there. Although this person would receive a fee for sevices rendered, he or she would be indifferent as to what car you buy because that form of payment has taken the conflict out of the relationship.


Another metaphor can be found in the medical profession. Today we pay our doctor to evaluate our condition and to prescribe any necessary treatments. What if there were another model where we didn’t have to pay the doctor for that evaluation, but instead the doctor was paid by the pharmaceutical company for prescribing medications, or the surgeon for prescribing surgery? I might be glad that I no longer have to pay the doctor, but unsure about how the potential conflicts might impact my overall health care.

Both examples above allude to potential conflicts that can arise due to a less stringent “suitability” standard. For example, brokers are legally permitted to recommend a higher-priced mutual fund to investors even if they know of a lower-cost alternative with better returns. Many brokers are compensated partly by commissions from mutual funds.

Perhaps most significantly, what this all means to the consumer is that if an investor is wronged by a broker, the investor’s burden is to prove the broker is wrong. The fiduciary standard benefits consumers because if the investor is wronged by a fiduciary advisor, the advisor’s burden is to prove he or she is right.

Runnymede is an SEC registered investment advisor and a fiduciary.

Additional reading:

“fiduciary” by mikecohen1872 is licensed under CC BY 2.0

to a less stringent “suitability” standard.