Sunday, August 17: The Importance of Fiduciary Duty

In the financial arena, professionals can be held to two different codes. The first of these is the fiduciary duty, which legally binds the agent to act solely in the best interest of the client.

Brokers, on the other hand, do not operate under the fiduciary standard. Instead, brokers operate under a different code known as a ‘suitability’ obligation. By definition, this standard requires that the broker must ensure only that the financial products offered are suitable for the potential buyer. This means that the broker does NOT need to place his or her own interests below those of the client; but instead must only reasonably believe that any recommendations made are suitable for clients, in terms of that individual or corporation’s needs.

The distinction may seem to be a small one, but it can make all the difference in the world. But if a broker is not required to act in the client’s best interest, how would that affect an individual? It isn’t as if the broker would intentionally sabotage an account.

The first issue is the suitability obligation opens the door to numerous conflicts of interest. For example, a broker can choose to place a client’s assets into a mutual fund that will net that broker a particularly high commission. Under a fiduciary standard, this would be expressly prohibited. But all that’s required of a broker is showing that the aforementioned fund is suitable to the particular investor. What’s more, there’s nothing to require brokers to disclose these potential conflicts of interest either.

Furthermore, brokers who work for investment banks are often little more than salesmen. Their main job is to market the products offered by the investment bank to clients. Brokers are not only able to act outside of a client’s best interest, it’s openly acknowledged that their greater loyalty is to the firm.

In light of these facts, it’s easy to see why the fiduciary is the stronger of the two standards. Do investors have a choice? Well, some investors may be lucky enough to find a broker willing to operate under a fiduciary standard. Sheyna Steiner writes that investors should ask the following four questions to anyone entrusted with their accounts:

  • Are you acting under the fiduciary standard? Can you put that in writing?
  • Which licenses do you have?
  • Are you a registered investment adviser? Can I get a copy of your SEC/State Regulators Registration Form)?
  • If you are not acting as a fiduciary, are you willing to fully disclose all conflicts of interest and the amount of compensation received from advice and products recommended?
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