An Unfair Fight: Broker vs. Investment Adviser
Financial advisors are now heavily involved in the recruiting process for college athletes about to become professional athletes. The selection of a financial advisor is an extremely important decision for an athlete to make, and it is imperative that he make an informed decision and one solely in his best interest.
After doing a background check of your potential advisors on BrokerCheck or SEC’s Investment Adviser search, the first thing these young guys must understand is the difference between a broker and an investment adviser.
You may have thought that a broker and an investment adviser were the same (as their definitions below are very similar), but these professionals are regulated under two very different standards of care when they recommend to buy or sell a financial product. Brokers are regulated under the suitability standard and investment advisers are regulated under the fiduciary standard.
Broker: An individual that buys and sell securities (stocks, bonds, mutual funds, etc.) for its customers.
Investment Adviser: An individual or company who is paid for providing advice about securities to their clients.
Suitability Standard (applies to a broker): When recommending a financial product, a broker must have reason to believe that the recommendation is suitable - though NOT required to be in your best interest - for you based on a host of factors, including your income, tolerance for risk, and your stated investment objectives. This is the lowest standard of care in the industry.
Fiduciary standard (applies to an investment adviser): When recommending a financial product, an investment adviser must act solely in the client's best interest and disclose any conflicts of interest. This is the highest standard of care in the industry.
Why Are There Two Standards of Care?
Because there are lobbyists, trade groups, and financial institutions that make a ton of money on this inherent lack of understanding by the majority of the U.S. population. If every single American who invests with a financial advisor knew the difference between these two standards of care, would they ever choose a broker? Would they want a person who only needed a reasonable explanation to invest in a product or one who had to invest solely in your best interest?
Back in 2010, the Obama administration’s proposed a rule that would protect retirement accounts by making the fiduciary standard apply to all financial advisors. Seems like having our financial advisors act in our best interests would make sense for all Americans with retirements accounts.
But then the U.S. Chamber of Commerce, the Insured Retirement Institute, the Financial Services Institute, the Financial Services Roundtable, and the Securities Industry and Financial Markets Association sued the Department of Labor claiming they did not have the authority to enact the new law.
In June 2016, despite the lawsuit and an attempt by Congress to block it, this rule became “effective” but, and more importantly, enforcement of the rule was delayed until April 2017. And now, the Trump administration’s Department of Labor has proposed delaying this rule again for another 18 months until July 2019. What do you think will happen in July 2019? Delay or death.
So athletes and Americans will continue to struggle with the difference between these two standards of care.
What's the Difference Between the Suitability Standard and the Fiduciary Standard?
Journalist Peter Lazaroff of Forbes wrote an article on this same topic and described the difference between the two using a real world example (my emphasis added):
"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.
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."
You may say to yourself, “Clearly, I should be investing my money with an investment adviser since his standard of care is so much higher.”
Not so fast.
Dually Registered Investment Adviser
Complicating this, investment advisers can act “dually” as both broker and investment adviser. So in this scenario, when you meet the investment adviser, he/she may tell you he is an investment adviser and not tell you that he/she is dually registered to also act as a broker.
This means he/she can wear the investment adviser hat at one period of time but then wear the broker hat when recommending products to you. Then the product only needs to be “suitable” instead of a product that is solely in your best interest.
This is Madness! What Can I Do About This?
For one, you can find out if your investment adviser is a “dually” registered investment adviser at the SEC's website.
Enter the individual’s name and press “Search.” In the results, find the individual you are looking for and see whether he/she is listed as a “Broker,” “Investment Adviser,” or both. If both are listed, then your adviser is a dually registered investment adviser.
With this knowledge, you could speak to your dually registered investment adviser about which standard he/she acted in when he/she recommended your investments. You could ask if he/she would be willing to only recommend investments under the fiduciary standard. You could also find an investment adviser who is not dually registered and therefore all recommendations would be pursuant to the fiduciary standard.
You can also go to this site by the National Association of Personal Financial Advisors to find investment advisers who only act as fiduciaries. Additionally, these advisers must sign a Fiduciary Oath yearly and subscribe to a Code of Ethics. (Standard disclosure: I am making no money whatsoever if you click on these links).
Additionally, you can check out BrightLights Resources page which has a number of helpful and free resources for you to help educate you to make the best financial decisions you can.
Overall, this information is important for you to understand why your broker and/or investment adviser is recommending certain financial products. Knowledge is power!
Contact BrightLights for your free consultation.