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Answering to Suitability vs. Fiduciary

Answering to Suitability vs. Fiduciary

By Cindy Alvarez, Senior Wealth Management Advisor

Not all financial professionals are alike when it comes to working with their clients. 

There are many different regulatory classifications of financial advisors, but the two most common are the (1) Broker-Dealer and the (2) Registered Investment Advisor, or RIA. One of the most significant differences is their classification as Suitability versus Fiduciary. 

Fiduciaries work in many industries. We will reference them as “investment fiduciaries” for the sake of this discussion. So, what is a Fiduciary? The term is defined by Investopedia as:

“A person or organization that acts on behalf of another person or persons, putting their clients’ interest ahead of their own, with a duty to preserve good faith and trust. Being a fiduciary thus requires being bound both legally and ethically to act in the other’s best interests.”

The notion of working in another person’s best interest is often loosely defined depending on who you talk to. Those in the business of wealth management define it as to act honestly and not mislead or withhold critical information from a client. In the financial services industry, this applies primarily to transactions and how professionals are paid for their services. 

For example, on the broker-dealer side of the equation, profits are made from what is known as a bid-ask spread on investments. Think of it in terms of an auction where you have a buyer (the bidder) and a seller (the asker) of stocks or bonds. 

When you work with a broker-dealer, the broker facilitates the buying of investments and the dealer executes the selling of investments to investors at a price higher than the buying price. When this is transacted under one roof, by one investment firm, profits are achieved. This is how businesses make their money. 

You should ask yourself if investments being bought and sold in your portfolio are based on what is best for you? It begs the question if you have received the best price for the investment you own. Who made money on this transaction and how much? You are putting your trust in your advisor that he/she is working in your best interest, working as a fiduciary.

Let it be known that broker-dealers are not classified as a fiduciary, and therefore do not have the legal requirement of working in the best interest of their clients. Registered investment advisors do have a fiduciary responsibility to their clients and are legally obliged to provide material facts and details on financial transactions that prove appropriateness for the decisions they make on behalf of their clients.

Suitability in the advisor-client relationship is defined as making recommendations that are consistent with the needs of a client. As a broker-dealer, you have the minimum suitability standard of “reasonably believing” that any recommendations made are “suitable.” 

Another reason to pay attention to suitability is the loyalty factor where a broker’s primary duty is to their employer, the broker-dealer for whom they work, and not necessarily to their clients. Investments can be made that profit the company beyond a reasonable belief that the investment is suitable for the client. 

FINRA, the Financial Industry Regulatory Authority, defines and regulates the concept of suitability to safeguard investors from predatory practices. Broker-dealers are regulated by FINRA and held accountable to the rules of suitability. RIAs of a certain size are regulated by the Securities and Exchange Commission, or the SEC and are held to the legal fiduciary obligation.

Does it feel as though suitability standards are not of the same stature of fiduciary standards? We may be on to something. 

Some struggle to understand the difference between suitability and fiduciary since both are designed to protect investors from foreseeable harm or excessive risk. RIA firms are bound to fiduciary standards and usually work with a fee-based compensation schedule. Fiduciary standards mandate accurate and complete analysis of information, free of conflicts of interest, when giving clients investment advice.

The fiduciary must initiate the buying and selling of securities under a best-execution standard. This is transacting at the lowest cost and with the highest efficiency. This is quite different from the buying and selling practices of a broker-dealer.

Educating yourself on how advisors are classified, regulated, licensed, and how they work with clients will benefit you in terms of understanding the decision-making processes of your advisor. Working with an advisor who holds a Series 7 license does not mean you are working with an advisor who is licensed to give advice; it means they are licensed to sell investment advisory services and products to you. Advisors with a Series 65 license provides you the safety of knowing you are working with a fiduciary; one who has the obligation to work in your best interest.