Craig Lemoine, Ph.D., CFP®, Director of Consumer Investment Research
Being a fiduciary is holding a duty to a client that a financial advisor will act in the best interests of the client rather than the best interests of the advisor, the advisor’s employer, or any other entity.
This may sound simple. But it requires processes, procedures and structures to ensure the client is always put first.
When talking about financial advisors we often use the term “fiduciary standard of care” to describe how those who are obliged to or have opted into a fiduciary standard are required to treat clients and consumers.
Fiduciary vs. Non-Fiduciary
Not every financial professional is required to hold a fiduciary standard of care. Financial advisors who charge asset management fees, direct financial planning fees, hourly fees or retainer fees to a client are structurally investment advisor representatives. They work for a registered investment advisor (RIA) firm. RIAs are required to register either with the SEC or the states they do business in. State or federal RIA registration requires the firm to serve firm clients at a fiduciary standard. Any of their employees or representatives also must maintain this stand of care.
Financial professionals who are registered agents of a broker/dealer or an insurance company may not refer to themselves as a financial advisor and are not required to hold a fiduciary standard.
Financial professionals registered as agents of broker/dealers are required to follow FINRA Regulation Best Interest (REG BI) which requires they act in the best interest of their retail customers at the time a recommendation is made, but they do not have an ongoing obligation to the customer to provide ongoing advice or monitoring of accounts. They must also provide a brief Client Relationship Summary (Form CRS) to their retail clients.1
Some financial professionals choose to opt-in to a fiduciary standard of care when they hold the Certified Financial Planner™ (CFP®) designation. The CFP® designation requires those holding this designation to act as a fiduciary when providing financial advising or financial planning services. A financial professional working at a brokerage firm, but who holds a CFP® designation, has chosen to act as a fiduciary.
Duties of a Fiduciary
The concept of a fiduciary is to at all times put a client’s best interest before that of the advisor or their firm. This concept does not have a standard checklist and it’s not derived from a single law. The concept of a fiduciary has evolved over time, but generally contains the following three duties:
- Duty of loyalty – Place the interests of a client over their own. Avoid or disclose any material conflicts of interest and property manage any conflicts. Act without regard to the interests of the advisor’s employing firm.
- Duty of care – Act with care, prudence and diligence when making recommendations to a client. Consider the client’s goals, risk tolerance and objectives in providing investment advice.
- Duty to follow client instructions – Respect and comply with the obligations, duties, policies and restrictions of any client engagement.
Why Choose a Fiduciary? An Example
The following example will help illustrate the obligations a fiduciary financial advisor holds to their client.
Jorge is a financial planner who holds the CFP® certification and is an investment advisor representative of a nationally known investment advisory firm. Jorge recently acquired a new client, Jeni. Jeni (65) is about to retire and has a significant amount of money in her employer defined benefit pension plan. Jeni’s mother is still living (85) and in great health, and Jeni’s maternal grandmother lived until 100.
Jeni recently received a letter from her retirement plan offering to provide her a lump sum of $2 million dollars instead of a promised substantial lifetime pension. Jeni engaged Jorge as her financial advisor and paid him a flat financial planning fee. Jorge performs some calculations and finds that Jeni would need to take a moderate amount of investment risk on the $2 million to earn a historical rate of return that would create a larger cash flow than the pension.
If Jorge recommends Jeni take the $2 Million, he and his advisory firm would benefit greatly. They would be able to charge asset management fees on the money. However, Jorge is hesitant considering Jeni’s family life expectancy, the security of the underlying pension, and the amount of investment risk required to outperform the promised cash flows.
Because Jorge is a fiduciary, he needs to be loyal to Jeni. He must use prudent skill in making a recommendation and consider Jeni’s goals, other assets, risk tolerance and the type of portfolio that would best meet Jeni’s long-term goals. Jorge must also consider Jeni’s cash flow, housing situation, and other assets and liabilities in this decision. Being a fiduciary requires a more holistic analysis, honoring the terms of their financial planning engagement and working in Jeni’s interest, not the firms.
In the end, Jorge’s recommendation will be informed, prudent, and in Jeni’s best interest. He cannot consider firm revenue in this decision and must act as a fiduciary.
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1 FINRA.org, “Registration Best Interest (REG BI) Overview” https://www.finra.org/article/regulation-best-interest-%28reg-bi%29-overview
Craig Lemoine is not affiliated or registered with Cetera Advisor Networks LLC. Any information provided by Craig Lemoine is in no way related to Cetera Advisor Networks LLC or its registered representatives
