Most financial advisers fall into one of two categories regarding the standard of care they must provide when offering financial advice. Financial advisers must provide advice in accordance with a fiduciary standard or a suitability standard.
An adviser registered with the SEC or their state securities office has an obligation to comply with the Investment Advisers Act of 1940. This act specifies that a registered investment adviser (RIA) is a “fiduciary” to their clients. An RIA has the fundamental obligation to act solely in the clients’ best interest. A fiduciary must provide his or her clients a duty of undivided loyalty and utmost good faith. Additionally, a fiduciary must disclose conflicts of interest or potential conflicts of interest before and during an advisory engagement. They also must adopt a code of ethics and fully disclose how they are compensated. A fiduciary relationship is generally viewed as the highest standard of care available under law.
Broker-dealers are regulated under a different federal law, the Securities Exchange Act of 1934.Broker-dealers are not required to provide advice under a fiduciary standard of care, they are required to provide advice under a “suitability standard of care”. A suitability standard of care requires that the broker-dealer have a reasonable basis for believing that the recommendation is suitable for a client. In determining what is suitable the adviser must consider the clients income, net-worth, investment objectives, risk tolerance and other security holdings.
The suitability standard doesn’t require the adviser act in the clients’ best interest, only that it is suitable. What’s best for the client may not be best for the adviser. There may be multiple options that are “suitable” for the client, but they all may not be in the clients’ best interest.
For example, assume you are having dinner at a nice restaurant and you ask the waiter for a good quality, reasonably priced wine. The waiter highly recommends a $50 bottle of California red wine. You enjoy the wine and it was suitable for what you requested. However, you later discover you could have ordered an excellent house wine for only $6 per glass. If the waiter was acting in your best interest he would have given you an opportunity to taste the house wine.
Working with a fiduciary adviser, who always works in your best interest, can have a positive impact on your financial success. To find a fiduciary adviser choose a registered investment adviser or go the National Association of Personal Financial Advisers website, www.napfa.org, for a list of fiduciary advisers in your area.If you’re unsure if your adviser is a fiduciary, ask if they are willing to sign a fiduciary oath.You can find good advisers who provide advice to a fiduciary standard and who provide advice to a suitability standard. Work with someone whom you trust and puts you at ease. Actively participate in the management of your finances and ask a lot of questions.