Know Who’s Giving You Financial Advice: Broker or Adviser

President Obama has talked a lot about “middle class economics” and this discussion has now expanded into the investment world. Recently the White House released a fact sheet stating that protecting workers and retirees from conflicted investment advice is part of the president’s focus.

The president’s proposal is to hold financial advisers handling retirement accounts (IRAs) and retirement plans to a fiduciary standard. What does that mean? Brokers would be held to a higher standard, requiring them to put their clients’ financial interests ahead of their own. Speaking at an event hosted by the AARP Inc., formerly known as the American Association of Retired Persons, Obama said, “It’s a very simple principle: You want to give financial advice, you’ve got to put your client’s interests first. You can’t have a conflict of interest.” Shouldn’t brokers already be doing this?

At the heart of this debate is the difference between the fiduciary standard and the suitability standard and the difference is critical in understanding the motivation behind the person offering you financial products or advice.

Broker

A broker is held to the suitability standard. They offer financial products for sale from a range of products carried by the company he or she represents. A broker is paid commissions, which can be flat rates or calculated as a percentage of the amount of money invested into the product.

Adviser

An adviser is held to the fiduciary standard and offers “best advice,” taking into account the needs of each individual client, disclosing all possible conflicts of interest. Advisers are paid a quarterly fee calculated as a percentage of the assets under advisement.

The lower suitability standard means brokers must sell “suitable” products even if they are not the most cost-effective or the best performing option for the investor. The broker only needs to check the suitability of the investor based primarily upon financial objectives, current income level and age in order to complete a commissionable sale. No disclosure of possible conflicts of interest is required.

Under the proposed new standards, brokers would be required to disclose if they are recommending products that are underperforming or more expensive than other available options. President Obama said there are many brokers who receive “back-door payments or hidden fees for steering people into bad retirement investments that have high fees and low returns,” reducing retirement nest eggs.

The White House Council of Economic Advisers said conflicted investment advice for retirement accounts costs about $17 billion each year nationwide.

Just because a broker receives a commission doesn’t mean the investor has been mistreated or swindled. The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) already have rules on the books that help protect investors and savers.

For the average investor, the real question is do you know if you are working with an adviser (fiduciary standard) or a broker (suitability standard)? Regulators have long been aggravated by brokers using the title “financial adviser.” Investors need to simply ask your current or prospective financial advisers if they are acting as a broker or an adviser. Ask them to formally list all methods in which their company can receive commissions. If they cannot or will not provide this list, find an adviser that will.

Phoebe Venable, chartered financial analyst, is President & COO of CapWealth Advisors LLC. Her column on women, families and building wealth appears each Saturday in The Tennessean.

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