Forbes: Know The Differences Between Brokers And Advisers: Suitability Vs. Fiduciary Standards – Gregory Kushner
In light of the financial chaos that has resulted from the global pandemic, many investors are turning to professionals for advice rather than trying to manage their portfolios on their own. During the long bull market, many investors may have believed they were very smart with their investments, since they were making nice returns, so why pay someone for advice? The obvious truth is, as the old saying goes, “Bull markets make a lot of geniuses.” As a result of the steep decline in the equity markets from their peak, perhaps there are not as many geniuses out there. As I’ve discussed before, if an investor is going to pay for advice, it is critical to understand how the person providing advice gets paid and what their responsibilities are to the investor.
In my experience, most investors do not understand the important differences between large brokerage firms like many familiar Wall Street firms you know (“brokers”) and Registered Investment Advisers (“advisers”), but learning about them can empower investors to seek the appropriate professionals for advice.
I believe the most significant distinction between brokers and advisers is that advisers have a fiduciary duty to their clients, and brokers do not. The fiduciary standard requires that Registered Investment Advisers always act in the best interests of their clients. The existence of such a duty drives much of what advisers must and should do to fulfill their obligation to clients. Advisers must always act with clients’ interests at the forefront, must avoid conflicts where possible and must disclose all material conflicts whenever they exist. Brokers, while subject to certain regulatory requirements, are not held to this higher standard of conduct.
Advisers have a legal obligation to act in clients’ best interests. Alternatively, brokers are held to the suitability standard, a lesser regulatory measure that simply requires brokers to recommend investments they believe are suitable for the investor, though that does not necessarily mean their recommendations are what is best for the investor. This is a critical distinction.
Obviously, there are great professionals within the brokerage industry that act in the best interests of their clients, but there are others who ultimately might not be looking out for their clients’ needs. Just because a Registered Investment Adviser must adhere to a higher standard does not guarantee the advice provided will be good advice, just that the firm and the adviser must exercise a higher standard of care.
Fees And Commissions
Importantly, because brokers do not have a fiduciary duty to their clients, the fees and commissions relating to recommended suitable investments are structured and disclosed differently. Brokers’ fees and commissions are generally based on transactions, which means any time a client engages in one, the brokers receive some form of compensation. There are other instances when brokers recommend products or services that result in additional commissions.
Additionally, brokers can only sell products approved on their platform. Think of going to your local Lexus dealer and asking the salesman if the best car for your needs is a Lexus or a Jaguar. The salesman is never going to tell you the Jaguar might be a better car for you as he wants to sell you what he has on his lot, not someone else’s. Similarly, brokers are highly motivated to sell products that are on their platform. Many times when we have examined offerings such as real estate or private equity investments that have been approved on the brokerage platform, we’ve seen excessively high fees, such as high acquisition fees, management fees charged from the moment capital is committed, though not necessarily called, and large back-end splits with the operators/promoters. Often, an investor is in a significant “hole” from the start to overcome the high commissions and fees assessed in these types of investments.
Freedom To Find Opportunities
Contrast this approach to the best practices of independent advisers, as there is generally no “platform” advisers must stick to for selection of investments — they can look anywhere to find what they believe are the best investments for their clients. In many instances, these opportunities have fewer fees and costs (of course, fees can vary widely), but it is the fiduciary duty of advisers to negotiate the best possible fee structures on behalf of their clients. Registered Investment Adviser fees are generally assessed as a percentage of assets, all of which are charged the same (unless otherwise agreed), so there is no motivation to select a higher-commission/higher-fee product when a lower-cost alternative is available.
Which type of financial consultant would be best for your situation? Investors’ portfolios often may not yet be large enough for a multi-family office like my firm, which has a $1 million minimum account size, but some accept smaller accounts. If you select a broker versus an adviser, be aware they may try to push you toward specific investments that might bring the broker more money. It is perfectly normal to ask about how the brokers are compensated for everything they do. If you choose an adviser, you should be provided with a detailed schedule of fees charged and a copy of Form ADV, a filing each adviser must update annually with either the Securities and Exchange Commission or the state if they are a smaller adviser.
Advisers generally charge their clients one asset-based fee for management of client assets. Some advisers provide other services besides investment advice, such as tax preparation and bill paying, for which the firm may charge separate fees. Regardless of the way fees are calculated, advisers’ recommendations are always dictated by the fiduciary duty standard, and should there be conflicts, those conflicts must always be disclosed to the client.
Whichever way investors choose to go, it is extremely important to thoroughly check out the specific professional(s) you will be working with. You can check out brokers at www.brokercheck.org and advisers at https://adviserinfo.sec.gov. Good luck out there.
View the original article on Forbes: https://www.forbes.com/sites/forbesfinancecouncil/2020/06/17/know-the-differences-between-brokers-and-advisers-suitability-vs-fiduciary-standards/#7891528525b5
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.