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Fiduciary vs. Suitability: Investment Advisors vs. Brokers

Bradley Troy • Dec 11th, 2012

Investment Advisor vs. Broker

If you are a Fiduciary for your company’s retirement plan, and are searching for a partner to select and monitor the investment line-up in your company’s plan, there are some important distinctions that may impact your decision.

Those who provide investment selection and monitoring for retirement plans are likely either an Investment Advisor or a Broker. Many people use the terms interchangeably and don’t spend much time thinking about the difference between the two. But when you are making decisions that impact the financial future of your employees and your own fiduciary obligations, you should know the difference.

Investment Advisor VS Broker – and the standards they follow

Advisors Defined

The Investment Advisers Act of 1940 defines a “Registered Investment Advisor” as:

“a person or firm that, for compensation, is engaged in the act of providing advice, making recommendations, issuing reports or furnishing analyses on securities, either directly or through publications.” Advisors provide advice and recommendations, and are paid a fee (that is not at all associated with the investments chosen).

Advisors follow the Fiduciary Standard
The fiduciary standard was established as part of the Investment Advisors Act of 1940. The U.S. Securities and Exchange Commission (SEC) holds Advisors to a fiduciary standard that requires them to act in the best interest of the client – specifically stating that they must put their clients’ interests above their own. The fiduciary standard also dictates that the Investment Advisor must divulge any possible conflicts.

Similar to a doctor’s Hippocratic Oath, the fiduciary standard holds an Investment Advisor to an ethic and to honest regulation. It requires higher standards and is more stringent than the suitability standard.

Brokers Defined

The Securities Exchange Act of 1934 defines “Broker” as:
“any person engaged in the business of effecting transactions in securities for the account of others.” Brokers are paid via commissions tied to investments in the funds they select for their client’s retirement plans.  

Brokers follow the Suitability Rule

Brokers are held to a different standard that is set by their governing body, Financial Industry Regulatory Authority (FINRA). They must follow the suitability rule—which states that a Broker needs to believe that recommendations given are consistent with the interests of the client’s financial needs and circumstances at the time. The rule does not set standards around conflicts of interest or a need to place clients’ interests before one’s own — as a result, many believe the suitability rule leaves room for conflicts to arise between a Broker and client. One of the biggest conflicts concerns commissions paid to the broker for managing investments in the company’s fund offerings.

For example:

Let’s say a broker gets paid a higher commission for steering a 401(k) participant to invest in a fund run by his or her firm. There is an inherent conflict of interest here that begs the question – is there a better fund for investors’ money than the one being recommended? The mutual fund could easily meet the suitability standard and the broker would not have violated any regulation. However, participants may be getting hit with higher fees than other suitable alternatives simply because their broker was seeking a higher commission.

Wouldn’t you want to know if the person overseeing the investments in your company’s plan is selecting investments that pay them more and/or come with higher costs for your plan participants?

The Butcher vs. The Dietician

We’ve found a fun little video that I’ll often send to plan fiduciaries that helps to illustrate the difference between a Broker and an Advisor. It uses a clever metaphor of what happens when going to a butcher vs. a dietician when deciding what to eat.

The Facts

Here’s a quick chart that outlines what you need to know…

 

Regulated by

Standard Followed

Can be a Plan Fiduciary?

How are they Paid

Obligated to put investor’s interests first?

Obligated to Disclose Conflicts of Interest?

Investment Advisor SEC Fiduciary Standard Yes Fee for service Yes Yes
Broker FINRA Suitability Rule No Paid by brokerage firm based on commissions from trades made No No

For more information about the fiduciary standard and how it may impact your business, read this report from the US Department of Labor or contact the Fiduciary Consulting Group today at FCGplans@psafinancial.com.

This material is not intended to replace the advice of a qualified advisor.  Information has been obtained from sources believed to be reliable and is for illustrative purposes only.  It should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. It is for your use only, and disclosure to a third party is not permitted. PSA does not endorse or sponsor any entities mentioned herein and cannot be responsible for the content of other websites.
Investment Products are not FDIC or Other Governmental Agency insured, not bank guaranteed, and may lose value.  Investment Advisory Services offered through PSA Financial Advisors, Inc, a Registered Investment Advisor.  Securities offered through PSA Equities, Inc, a registered Broker/Dealer, Member FINRA/SPIC. Blog1212071dmt

 

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About the Author: Bradley Troy, CFP®, CAP®, ChFC®, CLU®, vice president of Wealth Management, specializes in helping business owners, highly compensated professionals and other advisors implement creative solutions for wealth transfer, tax reduction/deferral, business succession, and financial planning. With more than 24 years of experience in the financial services industry and various management roles, Bradley has built a practice with a large focus on charitable planning, estate planning, qualified plans, non-qualified plans, life insurance and investments.