Ask Money

Fiduciary responsibility? Or is "suitable" enough

Chris Farrell Sep 24, 2010

Question: Do the new financial regulations make the “fiduciary responsibility” of a broker to his client into a situation whereby the broker or his firm must guarantee the success of an investment? That is, if the client is advised by the broker to buy stock “X” because it should go up, and the client buys it based totally on this information, but instead it goes down, is the broker responsible for covering the client’s loss? William, Saint Louis, MO

Answer: The quick answer is no: There is no guarantee about investment performance in the legislation or the rule the SEC is contemplating. Nor should there be a regulation like that.

To elaborate, the financial services reform bill punted the question about fiduciary responsibility to the Securities and Exchange Commission. It will be a disgrace if the SEC doesn’t require all kinds of financial advisors to put their client’s interests first, the meaning of fiduciary responsibility. The customer comes first. However, considering the track record of the SEC I’m afraid the agency could lose its nerve and not do right by the investing public.

At the moment, many brokers and investment advisors are regulated by a much looser standard than fiduciary. All they have to do is follow a “suitability” guideline. Their investment ideas have to be appropriate or suitable for the client. For instance, it isn’t suitable for a broker to convince an 80 year old investor to buy a junk bond mutual fund (that the broker gets a big commission from the to push, too).

Now, neither the suitability-standard nor the fiduciary-standard say that the advisor is responsible for covering a client’s loss. For instance, there isn’t any guarantee that if a competent and ethical investment advisor (and most are just that) operating under the fiduciary standard recommends that it makes sense for the client to risk some money into an S&P 500 equity index fund. The stock market eventually crashes. The advisor ins’t on the hook to make up for the loss. Markets fluctuate, the world changes, and good investment ideas sometimes don’t work out.

The advisor is responsible for taking into account your circumstances and goals, and shopping around for a good price and investment option. For their part, investor still have to adhere to the Caveat Emptor standar–Investor Beware.

The reason why so many in the brokerage industry opposes a fiduciary standard is that it will could cut into firm profits. Advisors would have to look at the best priced alternatives for their clients and not just peddle the products manufactured by their firm. Fact is, most investors assume that their advisor operates with a fiduciary standard. The SEC should codify that perception into law.

Chuck Jaffe, the Marketwatch columnist, makes that point and others in a really nice article tinged with outrage. He comes down hard on the side of imposing a fiduciary standard on all investment advisors, And he’s right.

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