In 2016, the Department of Labor shocked the investment world by starting the process of requiring investment advisors who provide services to retirement plans (like IRAs and 401(k)s) to act in a “fiduciary” capacity. The term fiduciary, as defined by Merriam-Webster’s is “held or founded in trust or confidence”.1 In other words, the DOL submitted a set of rules to require advisors to be legally bound to act in the best interest of their clients. While the implementation of the rules has been stalled by Congress, the idea has thrown the world of investment advisors into a tailspin.
If you are like most, the idea that it is legal in the United States for financial advisors to act in any capacity OTHER than a fiduciary capacity is surprising. Unfortunately, it is true. You, like most, may believe that every advisor is required to place your interests above his or her interests at all times. Unfortunately, they are not. Even worse, the definitions are so convoluted that it is difficult for the average consumer to identify a fiduciary from a non-fiduciary. I hope this post helps.
Not All Advisors Are Created Equal
When it comes to narrowing the field to advisors who truly have your best interest at heart, there are essentially three different types of advisors and advisory firms in the U.S.:
• Investment Advisor Representatives (IAR): IARs are employees of independent, Registered Investment Advisor firms that are regulated by the SEC or state securities commissions. These advisors must always act as fiduciaries and must prove compliance to their regulating bodies. These advisors are generally compensated by a fee paid directly from the client (not commissions or compensation that comes from their affiliated company) and are often known as “Fee-Only” firms. IARs generally offer full pricing transparency and full disclosure of any conflicts of interest. This is easily the smallest segment of the investment advisory profession, accounting for fewer than 20% of the advisors in the U.S.
• Registered Representatives: Registered “Reps” are employees of brokerage firms and are regulated by FINRA. Registered Reps are held only to a “suitability” standard which simply requires the advisor to determine whether the investment is suitable for the client; not necessarily the best for the client, not necessarily the least expensive and without the disclosure of any conflicts of interest. These advisors are generally compensated by a commission that is charged on the sale of the products they sell. This is the largest segment of the advisory profession.
• Dually Registered Advisors: Dual registration means that the advisor may be registered with the SEC or the state securities commission as well as with FINRA. This allows the advisor to claim the standard of fiduciary at one moment and then, when the time is right, sell products on a suitability standard and charge a commission without full disclosure. Yes, amazingly, it is legal in the U.S. to call yourself a fiduciary while only serving in that capacity part of the time. It seems that most of the IARs in the U.S., who should be trusted as fiduciaries, are dually registered, making them non-fiduciaries when it is expedient.
How Can I Find a Fiduciary Financial Advisor?
As you can probably already guess, finding a true fiduciary financial advisor can be difficult, especially with the specter of dual registration. It is possible to identify the true fiduciaries by looking at their registration documents with the SEC or state securities commissions but the documents can be hard to understand and you must know exactly what to look for. Alternatively, you can conduct your own investigation by asking a few, very simple questions to eliminate the non-fiduciary advisors:
“How are you and your company compensated?”
• A flat fee, hourly fee or a fee as a percentage of assets ONLY = fiduciary
• Commissions or “I am paid by the company, you don’t pay me anything” = non-fiduciary
• Fees and Commissions, Fee-based, Hybrid fee and Fee Offset = dually registered
“Do you receive ongoing income from any of the products you recommend in the form of 12(b)1 fees or trailing commissions?”
• Yes = non-fiduciary
• No = maybe a fiduciary
“Is your firm registered as an Investment Advisor and do you have an ADV Part II disclosure you can provide?”
• Yes = fiduciary (but may be dually registered)
• No = non-fiduciary
“Are you willing to sign a Fiduciary Oath?”
• Yes = fiduciary
• No = watch your wallet
For a more comprehensive tool to compare advisors, click here to access the National Association of Personal Financial Advisors Financial Advisor Comparison Tool. This is a free checklist and answer key to help you know the right questions to ask.
Feel free to present this questionnaire to Brown Financial Advisory. We have always been an independent, SEC registered, Fee-Only, fiduciary company. And since it is the right thing to do, we plan to keep it that way.