The Difference Between Fiduciary And Suitability Standards

Comment by Pat Frederiksen – I have always put the client first. 

My licensing does not demand this, but it has always been how I do business. 

It is called integrity!

By Peter Lazaroff
Opinions expressed by Forbes Contributors are their own.

Today the Department of Labor (DOL) released new rules regarding retirement savings advice, but most investors don’t realize that there anore two standards of care in the financial industry.

The fiduciary standard requires that an adviser put the clients interest first and is adhered to by Registered Investment Advisors and enforced by the Securities and Exchange Commission (SEC).

The suitability standard requires that a broker make recommendations that are suitable based on a client’s personal situation, but the standard does not require the advice to be in the client’s best interest. Brokers, also known as registered representatives, are held to this suitability standard, which is enforced through a self-regulatory organization called the Financial Industry Regulatory Authority (FINRA).

Fiduciary vs Suitability: What’s The Difference?

Imagine you need a new car, but you don’t know much about different options. You head to the closest car dealer, which happens to be a Ford dealership. The dealer asks you to describe what kind of car you need, and you begin listing features and attributes that are best described as a Toyota Highlander.

Under the suitability standard, the dealer could say, “A Ford Explorer would meet all of your needs and we have some of those right over here.” The dealer makes the sale and gets the commission. You have a car that is suitable for your needs, but it isn’t necessarily what’s best for you. Since you don’t have a great deal of knowledge about the auto market, you are in the dark.

Under the fiduciary standard, the dealer would be obligated to say, “It sounds like you are describing a Toyota Highlander. We don’t sell those. In order to get exactly what you described, you would have to go down the street to Toyota and ask for a Highlander. I can sell you a similar model called a Ford Explorer, it’s more expensive and it isn’t exactly what you described.” In this scenario, you have more information about your options and the conflicts driving the dealer.
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The Ford dealer has a clear conflict of interest in this situation. He can only sell Fords and will lose the opportunity to earn a commission if the client buys a Toyota Highlander. Under the suitability standard, the client ends up with a product (Ford Explorer) that isn’t the best fit given their situation and it costs more than the better-fitting product (Toyota Highlander). Worst of all, the client probably has no idea that they weren’t given advice that put their own interests first.

The Difference Between Fiduciary And Suitability Standards
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