Fiduciary or Suitability: Which Suits You?
by Peter Boyle
At Clifford Associates, we believe the clients of firms offering feebased investment advice should to be provided a uniform level of investor protection. As a result, we applaud a recent decision by the U.S. Court of Appeals. In that ruling, the court struck down a Securities Exchange Commission (SEC) rule that would have exempted brokers who provide investment advice on fee-based accounts from regulation under the Investment Advisers Act (“Act”).
It is our belief that the SEC’s primary role is to protect the investor. Instead of providing exemptions, it should be working toward uniform fiduciary standards for all advice-givers whether investment adviser or broker-dealer.
Five years ago, the SEC proposed this rule to exempt certain fee-based programs of brokers from registration, fiduciary and disclosure requirements of the Investment Advisers Act. Many organizations objected to the proposed rule because its interpretation resulted in two disparate standards of market conduct—one, a fiduciary standard for people registered under the Act and a second, lower suitability standard for brokers acting as fee-based consultants or advisers.
For those who have not followed these events or do not fully appreciate what might seem like trivial distinctions, some background and review is warranted. While the lines continue to blur between providers of investment services, these providers still differ not only in the type of services offered and how they charge for them, but also in the regulatory requirements and important obligations due their clients. These key distinctions, including whether a provider has a clear obligation to act in each client’s best interests or disclose potential conflicts of interest, depend on which legal category the provider falls within under our securities laws.
The securities law recognizes two types of providers: investment advisers, who are in the business of giving advice about securities, and brokers, who are in the business of buying and selling securities on behalf of their clients.
Investment Advisers
Investment Advisers (such as Clifford Associates) are subject to a fiduciary duty. This means they have to put your interests ahead of theirs at all times by providing advice and recommending investments that they view as being in your best interest. Investment advisers are also required to provide up-front disclosures about their qualifications, what services they provide, how they are compensated, possible conflicts of interest, and whether they have any record of disciplinary actions against them.
Brokers
Brokers, by contrast, are generally not considered to have the same fiduciary duty to their clients, although this standard may apply in certain circumstances. Instead, brokers are required to: 1) know their clients’ financial situations well enough to understand their financial needs, and 2) recommend investments that are suitable for them based on that knowledge. Brokers are not required to provide upfront disclosures of the type provided by investment advisers, including, but not limited to their conflicts of interest.
A couple of simple illustrations can highlight the differences in standards: 1) Two different investments could be equally suitable for a given client, but one might compensate the financial professional to a greater extent. Investment advisers require such a disclosure while broker rules would not. 2) A bond can be sold to a client from a brokerage firm’s inventory (principal trade) to profit the firm, with little required disclosure. This activity is essentially prohibited for investment advisers without complete disclosure.
Financial Planners
Financial planners are not separately regulated and, in fact, have no legal definition. Instead, they could be considered a hybrid. Their regulation and the level of responsibility they owe clients depend on the type of services they provide. Planners who provide investment advice must be registered or licensed as investment advisers and are subject to a fiduciary duty. Those who trade securities must be registered or licensed representatives of brokers. Some financial planners perform other activities that do not involve securities and therefore are not regulated under laws governing either investment advisers or brokers.
These legal requirements are further complicated by the fact that different standards can apply when investment providers serve as both investment advisers and brokers. For example, investment advisers who also buy and sell securities for customers must meet the requirements applicable to both investment advisers and brokers. The same is not true of brokers. Brokers are permitted to offer investment advice in connection with their brokerage services without being regulated as investment advisers. As a result, the advice they offer is subject to the suitability standard that governs brokerage activities rather than the higher fiduciary duty that applies to investment advisers.
It is important to note that missing from this discussion are banks. With the exception of mutual funds managed by banks, banks are specifically excluded from regulation under the Investment Adviser’s Act, further adding to investor confusion on the subject.
Considering the recent investment scandals, much could be done to provide uniform regulation and disclosure requirements. While not without flaws, the Act and standards of practice espoused by the investment adviser industry and its member associations should to continue to lead this discussion. The Court of Appeals decision, we believe, is a great step in the right direction.
The Investment Adviser Association, of which we are a charter member, has published a client service pamphlet from which much of this information was derived. If you or someone you know would like further information on this topic, please let us know.
