Don’t you love it when people have your best interest at heart? It’s just a good feeling. There is peace of mind when you know someone is looking out for you. That’s really what is at the core of the recent overhaul in the regulation of financial advice.
I would bet that if you’re reading this article you’re an “investor” on some level. Maybe you’re a 401K participant, a recent retiree or you contribute to an IRA. If I narrow it down even further, you are a “do-it-yourselfer” or you employ someone like to me provide you with investment advice. If you seek the advice of a professional you’re undoubtedly confronted with many choices of service providers operating under titles such as certified financial planner, financial consultant, insurance agent, registered investment advisor and stockbroker.
These titles can be confusing because on the surface it is not clear whether these professionals are legally required to have your best interest in mind when making investment recommendations.
The Department of Labor (DOL) recently announced changes in the regulation of the financial advice given on retirement savings. Central to this discussion are two terms: fiduciary and suitability. What does it mean for an advisor to operate on a fiduciary standard, and how does it differ from a suitability standard?
The DOL has described a “fiduciary” as someone who is required to put their clients’ best interest before their own profits. Fiduciaries include registered investment advisors and others who hold themselves out to be fiduciaries like trustees and certain retirement plan consultants.
Fiduciaries are required to act impartially and provide advice that is in their clients’ best interest and in doing so must act with care, skill, prudence, and diligence that a prudent person would exercise based on the current circumstances. A fiduciary must avoid misleading statements about fees and must avoid conflicts of interest.
Fiduciaries are typically compensated by payment of a fee rather than a commission. Fiduciaries to retirement plans, plan participants, and IRAs are also prohibited from receiving payments that create conflicts of interest. For example, given two comparable investment choices for a client, a fiduciary should typically recommend an option with lower management fees. Fiduciaries are personally liable for breaches of their fiduciary duties.
While fiduciary advice centers around putting clients’ best interest first the suitability standard is more focused on judging the suitability of a product for a prospective investor. Suitability is based primarily on that person’s financial goals, income and age. Unless agreed otherwise, under this standard the rules do not legally require a recommendation of the most cost effective product, a disclosure regarding conflicts associated with the investment, or disclosure of the compensation received when making that recommendation. Under the new DOL rule, it may mean that common forms of broker compensation, such as commissions and revenue sharing, will be restricted.
The primary goal of the recent regulatory changes was to create a single standard for retirement financial advice based on a fiduciary model. And when you think about it, when it comes to your money, who doesn’t want their best interests to come first?