American author and philosopher Sam Keen once said, “Deep summer is when laziness finds respectability.” I have always loved this quote, especially now that we are in the throes of another lovely summer here on the East Coast. I particularly like spending more time with friends and family outdoors—at barbecues, the beach, and other outdoor events. So, about a week or so ago, Jill and I were invited to a buddy’s barbecue where I was introduced to a guy—let’s call him Jim. You know when you meet someone and you just hit it off? That is Jim. Jim’s about my age, from Sharon originally, and moved to the Cape, married with three kids, including one in college with two more to follow. Jim and his wife are good middle class, hard-working folks who own two restaurants, both over the bridge.
After we discussed solving all the world’s problems, we naturally moved to the topic of money. Jim asked me about all the buzz in the news lately around the word “fiduciary,” and was it something he really needed to be concerned with? After all, shouldn’t anyone who handles your money be required to do the right thing for the client?
Hmmm...I told you I liked this guy.
While I usually try not to bore my friends with money talk, especially at social events, I felt like I had to clear this up. Jim is now a friend of mine, and I didn’t want him to make what could be a costly mistake by believing this common misperception. Just like Jim, it’s crucial that you, as an investor, understand who’s managing your investments for you.
Folks, that is because not all financial professionals are cut from the same cloth, and the differences between them can involve your financial best interest—and ultimately your long-term financial success. With our time together this week, let’s take some time to review my discussion with Jim to hopefully help you learn about some of the differences in standards between the types of financial professionals, so that you can also choose the adviser who best meets what you’re looking for.
Generally speaking, the standards that a financial adviser abides by are based on the licenses and registrations he or she holds, and who regulates their business.
Firms called broker-dealers provide investors with their access to the markets—individual brokers, larger brokerage houses, just about all the banks, and these days, thanks to the internet, online discount brokerages. Brokerage houses package investment goods and services to sell their clients and execute their buy and sell orders. Even if you’re accustomed to discount online trading, understand that you’re not accessing the markets directly—you’re doing it through a brokerage firm. If you are accustomed to human interaction, the person on the other side of the table or phone is a registered representative (RR), commonly called a broker.
To be a broker, one needs to be licensed and registered to execute trades. They are regulated primarily by the Financial Industry Regulatory Authority (FINRA). FINRA is an independent regulatory body authorized by Congress “to safeguard the investing public against fraud and bad practices.”
FINRA holds brokers to what’s known as the suitability standard. This states that brokers must believe whatever they’re selling “is suitable” for the customer. Unfortunately, it doesn’t require them to do what’s in the customer’s best interest.
What’s the difference? You see, an investment may be “suitable” for you but may not be in your best interest. For example, a financial product that’s inferior to another but yields a higher commission to the broker can still be “suitable” within that definition. Compensation for these brokerage houses and banks tends to be focused on commissions and tends to be more of a sale-driven process. A big challenge with the suitability standard is that it doesn’t require the broker to put your interests above theirs.
Another category of financial professionals is insurance agents. They can offer you insurance products, and they receive compensation in the form of commissions for product sales. Insurance agents are regulated by the Department of Insurance in each state, and just like brokers, they are subject to the suitability standard.
A third category of financial professionals is licensed to offer investment advisory advice and financial planning services. They hold different registrations than a broker or insurance agent and are affiliated with a registered investment adviser (RIA). RIAs are overseen by the Securities and Exchange Commission (SEC) and the individual state securities regulators.
RIAs are held to the fiduciary standard of care, which legally requires them to put their client’s best interest first. RIAs have to make sure their investment advice is made using accurate information and that any potential conflicts of interest either be avoided, mitigated, or at a minimum, disclosed to you.
I explained to Jim that the tricky part here is that many advisers hold multiple licenses and registrations, and may act as an agent, a broker, and/or an RIA representative. As a result, these individuals are subject to multiple regulators and varying sets of rules. Folks, this can get confusing, so you must inquire to find out from them what capacity they are acting in and how they are getting paid, so that you know the standard they are applying. An adviser is typically only required to be held to the fiduciary standard if he/she is acting in the capacity of an investment adviser and giving you advice. If the adviser then executes trades for you in his/her capacity as a broker, well, the adviser needs to meet only suitability requirements. So, this puts the onus on you to find out how the adviser is getting paid—by fee (for investment advice) or commission for a sale of an instrument.
So, it turns out that not all financial professionals are alike. Depending on who you’re speaking with, the advice you’re getting may be suitable for your needs without being in your best interest. As you consider hiring a financial professional to help you manage your wealth, start by doing your research online. The SEC’s Investment Adviser Database will help you find out their license status—IAR, or dually licensed broker. If they are dually licensed, you really need to ask the tough questions about how they’re being paid, and how you’ll know if the advice you’re getting is in your best interest.
Regular Cutter Family Finances readers may recall that I’ve spoken out in favor of a uniform fiduciary standard that would apply to all financial professionals. A Department of Labor rule to implement such a code was killed in federal appeals court in 2018. But that isn’t the end of the story. In May, Labor Secretary Acosta told Congress that new rules are coming, according to Investment News. No time frame has been offered, unfortunately.
Regardless of the action—or inaction—in Washington, DC, it pays to know which questions to ask the next time you meet with your financial professional. What’s your standard?
That’s why I always remind you to be vigilant and stay alert, because you deserve more.