This may come as a shock, but not all advisors are legally required to act in your best interest. In fact, many of the largest players are set up as Broker-Dealers, in which the advisors owe no fiduciary duty to their clients.
Investment advisors can be broken into two groups: Broker-Dealers (BDs) and Registered Investment Advisors (RIAs). Both types of firms generally offer similar services, but they vary greatly in terms of the level of care provided to clients: RIAs must act as fiduciaries for their clients (put client interests ahead of their own), while BDs have no such requirement.
This seeming oversight is a result of federal securities laws. When these laws were enacted, Congress drew a distinction between Registered Investment Advisors, who are regulated as advisors under the Investment Advisors Act of 1940, and Broker Dealers, whose agents are regulated as salespeople under the Securities Exchange Act of 1934.
This is a huge distinction. If you’re in the market for advisory services, do you want to work with someone who is trained and regulated as an advisor? Or someone who is trained and regulated as a salesperson?
Depending on which route you go – Broker-Dealer or Registered Investment Advisor, your advisor will be subject to different legal standards when they offer advisory services.
If you choose to work with an RIA (like us), then you can rest assured that the products and strategies recommended are in YOUR best interest, and your best interest only. A fiduciary duty means that your advisor is legally required to put your interests ahead of theirs in each and every decision they make.
But that all goes out the window with Broker-Dealers. Since agents of BDs are regulated as salespeople, they owe a much lower standard of care to clients. This is known as the suitability standard, and simply requires that transactions be “suitable” for the client’s needs.
Unfortunately, suitability is a vague concept in finance, and so this requirement carries very little weight. It basically just means that a transaction can’t be completely unsuitable for the client.
In order to help you better understand the differences between working with an RIA (fiduciary) versus a BD (non-fiduciary) it might help to walk through a few example situations you may encounter.
Example 1: With RIAs, all conflicts of interest must be disclosed up front, or the advisor can be held liable. With BDs, many conflicts of interest are permissible without having to be disclosed to the client. In some cases BDs don’t even have to disclose the fees they’re receiving from outside sources tied to the products they recommend.
Example 2: RIAs have a duty to help you minimize investment related expenses paid outside the firm. They can’t stick you in a more expensive fund just because they’ll get additional compensation on the back end from recommending that particular fund. With BDs, this is totally permissible.
Example 3: RIAs cannot purchase a security for the firm or advisor accounts before buying the same security for client accounts (if intended). In this case, the RIA must uphold a “best execution” standard, which involves buying for client accounts FIRST, in order to achieve the lowest execution price for the client. In contrast, BDs can trade their own accounts ahead of client accounts, and can even take the other side (trade against) client accounts.
It should be noted that the Securities and Exchange Commission (SEC) recently enacted new standards of conduct rules which took effect in September 2019. In an attempt to improve the standard of care provided by BDs, the SEC created Regulation Best Interest (Reg BI). This only applies to BDs, and it requires them to act in the best interest of their clients.
While this is a step in the right direction, BDs fought back against this additional oversight, and as a result, the Reg BI standard only applies to the moment a transaction is recommended. In other words, clients will receive something close to a fiduciary standard, but only for brief moments in time.
In contrast, the fiduciary duty maintained by RIAs applies throughout an advisor’s entire relationship with its clients. The new updates are a move in the right direction, but advisory clients will still find themselves in much better hands working with an RIA.