One of the least discussed but most important factors to consider when hiring a financial advisor is whether or not they are a fiduciary. This means the advisor has a legal obligation to put their clients’ interests ahead of their own. Most consumers assume that their advisor is acting in this capacity, when many times he is not.
The law regards the job of advisor as a position of trust and requires those with a fiduciary obligation to disclose any conflicts of interest and to act with a heightened sense of duty toward clients. Registered Investment Advisors with the Securities and Exchange Commission are held to this standard. As of July 1, 2008, Certified Financial Planners had the ethical standards by which they are held revised, making it explicit they too must put clients’ interests first, act as fiduciary and disclose the scope of their engagement and their compensation when engaging in planning activities.
Because a broker’s job is considered to be transactional as they are often placing trades on a client’s behalf, they are held to a different regulatory standard. Their duty is to make a recommendation that is “suitable” to their client’s circumstances. If a brokerage house manages a large cap growth mutual fund that has an internal expense ratio of 1.50% and an additional 12b-1 marketing fee of 1% that is paid to the broker, this would be considered suitable instead of recommending another large cap growth fund with much lower internal costs.
In the financial services industry, there has been a lot of talk about how consumers are confused about the difference between brokers who call themselves “financial advisors” or “investment advisors” and Registered Investment Advisors who are held to a fiduciary standard. In the past each were paid very differently – advisors charged management fees and brokers received commissions. Over the past several years many brokers have begun charging fees, giving consumers the impression that they are acting as fiduciaries.
The recently proposed financial regulatory reform legislation gives members of Congress the opportunity to improve the world of consumer finance. Fortunately Mary Shapiro, head of the Securities and Exchange Commission, has stated that the SEC might recommend creating a single standard that applies to advisors and brokers – a fiduciary standard.
In the interim, make sure you question your financial advisor as to which standard they are held.
By Chris Carleton, CFP®