In the investment field, there are two primary parties who are able to offer investment advice. They are investment advisory representatives and investment brokers who work for brokers-dealers. Many clients may consider the investment advice they receive from each party as similar, but there is a key difference. The difference pertains to two competing standards that advisors and brokers must adhere to, and the distinction has important implications for individuals who hire outside financial assistance. Investment advisory representatives are bound by a fiduciary standard and investment brokers are bound by a suitability standard.
What is the Fiduciary Standard? Investment advisory representatives have a duty of loyalty and care, and put their clients’ interests above their own. For example, the advisor cannot buy securities for his or her account prior to buying them for a client, and is prohibited from making trades that may result in higher commissions for the advisor or his or her investment firm. The registered investment advisor must also do his or her best to make sure investment advice is made using accurate and complete information. Avoiding conflicts of interest is important when acting as a fiduciary, and it means that an advisor must disclose any potential conflicts to placing the clients’ interests ahead of the advisor’s. Additionally, the advisor needs to place trades striving to trade securities with the best combination of low cost and efficient execution.
What is a Suitability Standard? Brokers must make recommendations that are consistent with the best interests of the underlying customer. Instead of having to place his or her interests below that of the client, the suitability standard only details that the broker-dealer has a reasonable belief that any recommendations made are suitable for clients, in terms of their financial needs, objectives and unique circumstances. A key distinction in terms of loyalty, the broker’s duty is to the broker-dealer he or she works for, not necessarily the client served.
What are the potential conflicts? Under the fiduciary standard, a registered investment advisor would be strictly prohibited from buying a mutual fund or other investment because it would garner him or her a higher fee or commission. Under the suitability requirement, this isn’t necessarily the case, because as long as the investment is suitable for the client, it can be purchased for the client.
Are Investment Advisory Representatives and Investment Brokers paid differently? Typically, investment advisory representatives are paid fees based on assets under management, whereas investment brokers are paid commissions.
How do you know if an Investor Advisor is well trained on his or her Fiduciary Duties? The Center for Fiduciary Studies created a designation of Accredited Investment Fiduciary, AIF®, which marks the successful completion of a specialized program on investment fiduciary standards of care. AIF® designees demonstrate a thorough understanding of the Prudent Practices for investment advisory representatives.
Download the article “Choosing A Financial Advisor: Suitability vs. Fiduciary Standards”.
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