Fiduciaries VS. Brokers

Published February 24, 2017

It is critical for all investors seeking financial advice is to understand the legal obligation a broker has to a client and how this compares to the legal obligation of a fiduciary. Understanding the difference between a broker and a fiduciary has taken on added importance following President Trump’s executive order to review the Labor Department proposed fiduciary rule for possible revision or repeal. This new fiduciary rule would have taken effect on April 10, 2017 and would have greatly expanded the number of advisors who have a fiduciary obligation to their clients.
There are two basic types of financial advisors who dispense financial advice, brokers and fiduciaries. Advisors who have a fiduciary responsibility to their clients are typically referred to simply as “fiduciaries.” By law, fiduciaries must remove potential conflicts of interest and put the needs of clients above their own. You can be reasonably assured that fiduciaries are giving you the best advice they have available; this is their legal responsibility to you the client. The fiduciary standard binds an advisor to work in your best financial interest; for example lawyers and certified public accountants have fiduciary responsibility to their clients. It is always important for you to ask how your financial advisor is being compensated; you can be reasonably assured that fiduciaries have attempted to rule out any conflicts of interest. What you would like your financial advisor to say to you is “This is the fee you are going to pay me, and none of the advice I give you, none of the products I recommend to you will result in any greater compensation to me. My compensation will be the same whether you follow my advice or not.” If the Labor Department rule had gone into effect then many more financial advisors would have had a fiduciary responsibility to their clients.
A broker, on the other hand, is only required to sell a “suitable” (legal term) product and unlike fiduciaries, brokers are not required to remove all potential conflicts of interest. Brokers are not required to put the needs of their clients above their own. “It remains extraordinarily difficult for investors to figure out who is acting in their best interest and who isn’t,” said Barbara Roper, director of investor protection at the advocacy group Consumer Federation of America. This is especially difficult when your advisor is a broker and does not have a fiduciary responsibility to you. A broker’s legal obligation is to offer a client a suitable product. Of the products that are suitable they can recommend the one that pays them the highest commission and not necessarily the one that is best for the client. This kind of recommendation would be a violation of a fiduciary’s responsibility but not a broker’s responsibility.
In the movie Liar, Liar, the main character (played by Jim Carrey) is unable to lie. After a sexual encounter, he tells his lover, “I’ve had better.” As you might think, this does not go over well with the lover. When you receive investment advice you do not want to end up saying, “It could have been better.” Does anyone want to have a dinner in a “suitable” restaurant or take a “suitable” vacation when the best is available at the same price? Why then would you want to purchase “suitable” investment products when a better product is available at the same price?
The standard of “suitability” is the standard most brokers use and means that the broker will pick an investment that is suitable for your situation. The fiduciary standard requires an advisor to work in your best financial interest. This distinction can have a potentially dramatic impact on your investment returns.
When you hire any financial advisor it is important that you understand how they will be compensated for their advice. Will the advisor earn a fee based on a percentage of assets under management, an hourly rate, or a commission earned on the product you buy? Can they earn a bonus if they sell a certain amount any financial product? It is important to understand how the advisor is compensated so that you can be assured that your interest and their interest are aligned. If they are not willing to share how they are compensated it might be a sign that you should find another financial advisor.
For more information on how to invest in the stock market purchase a copy of Savvy Investing available at any online bookstore.