Breaking Down the Fiduciary Rule, Part One: Fiduciary Versus Suitability Standard
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Reaction to the rules changes, perhaps the most significant change to ERISA since its initial passing, have been mixed, but the
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This final version of the new
The fiduciary standard holds that advisors must place their client’s interests above their own and includes a duty of “loyalty and care” that has been at the heart of financial advisory services from the law’s inception.
Quite simply, the fiduciary standard stipulates that the advisor must always act in the best interests of the client. For example, an advisor cannot buy securities for his or her own account before buying them for a client. They are also prohibited from making trades that could result in higher commissions for either the advisor or for their firm. Under the fiduciary standard, client trades have a “best execution” standard, meaning that securities must be bought and sold with the best combination of low cost and efficient execution. Likewise, an advisor must also make every attempt to ensure that all investment advice and analysis is accurate and complete.
But perhaps the most important part of the fiduciary standard is the avoidance of conflicts of interest. If any potential conflicts of interest may exist, those must be disclosed prior to any related trades. This aspect of the fiduciary standard is at the heart of the new
These changes were brought about, primarily, because the fiduciary standard, did not always apply to all potential retirement account advisors until the Labor Department’s new rule. Broker-Dealers, insurance representatives or other financial company representatives aside from investment advisors were required to follow the “suitability standard.”
The suitability standard is very straight-forward, only requiring that those under its purview know a client’s financial situation and recommend products for that situation. Broker-Dealers, insurance representatives and non-advisor financial services personnel are commonly held to the suitability standard.
The differences between these two standards can be summed up briefly. Prior to the rules changes, a broker-dealer or insurance representative would have only needed to make sure that an investment was suitable for a client. However, a registered investment advisor (RIA), working under the fiduciary standard, would have needed to account for many additional considerations. They would need to determine whether fees were reasonable, if the investments were adequately diversified, verify and disclose any conflicts of interest and make sure that the investments be consistent with provisions of a trust or other governing documents.
Additionally, the RIA would need to make sure the recommendation for an investment purchase or sale would be measured a prudent, reasonable, hypothetical person knowledgeable about investments, strategies and purpose of the investments. Under the new
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