The “F” Word….Fiduciary Standard of Care

Not that one that immediately came to mind! The one that applies to the world of investments and investment advice. The word I am referring to is Fiduciary. Most are not aware that the financial industry operates on two standards of care, Suitability or Fiduciary. The suitability standard of care applies to broker-dealers, insurance salespeople and representatives of other financial service companies. In essence the “suitability” standard the rep needs to

  • know their client and their financial situation and
  • recommend products that are suitable for the clients situations.

In fact, it is good, as far as it goes.

The fiduciary standard does take the process quite a bit further. For example, the additional requirements include

  • to put the clients’ best interests first,
  • act with prudence in concert with the skill, diligence and good judgment of a professional,
  • provide full and fair disclosure,
  • avoid conflicts of interest and
  • manage, disclose any unavoidable conflicts in the clients favor.

If one is simply buying a “product”, suitability and its inherent simplicity, has advantages for a large financial institution. When selling products, and mass distribution is the plan, the number of internal intermediaries couldn’t possibly be held to a higher standard. So why is the fiduciary standard being fought so hard against by the established financial services industry? Simply, it puts more burden on the entire firm. The firm must then focus on “is this the “best solution” that they are aware of” or “is the solution merely a “pretty good product”.” Clearly, there are many fine individuals preserving clients under the suitability standard, but the reality is that it also leaves open some holes to slip through. The mainstream financial services industry has spent millions of dollars lobbying against the Fiduciary standard of care being applied to the 401(k) plan market. It adds a significant layer of complexity for them to deal with.

An interesting paper was released recently by the University of Minnesota and the University of Chicago entitled “The Market for Financial Advisor Misconduct”. In that study the disciplinary records of 1.2 million financial advisors registered from 2005 through 2015 representing about 10% of the total employment of the finale and insurance industry are reviewed. Within it there are numerous “shocking” statistics about the percent of advisors in some firms (as high as 19%) noted for some misconduct and the number of times an advisor was disciplined or terminated and less than a year later was found back in the industry.

The purpose of this article is not to go over all those statistics. Rather, it is to illuminate the difference between the two standards of care. Fee-Only advisors adhering to a fiduciary standard of care will provide clients with a much better opportunity to meet financial goals and dreams smoothly and effectively.

To learn more about Bob Klosterman, view his Paladin Registry profile.

Other posts from Bob Klosterman