Suitability Versus Fiduciary Duty

Contents

1. The suitability standard
2. The fiduciary standard
3. How each standard treats a conflict
4. Who answers to which standard
5. A line of disclosure from 2005
6. The 2010 reform fight
7. The Labor Department rule
8. What the public understood
9. The SEC answer of 2018
10. The historical echo

Brent O’Mara holds the Certified Fund Specialist and Accredited Investment Fiduciary designations, and the second of those names one side of a comparison that American law has never fully resolved. Two standards govern advice about money in the United States. One asks whether a recommendation was suitable for the person who received it. The other asks whether it was in that person’s best interest and whether the professional who made it kept his or her own interest out of the way. A short glossary in a national business newspaper put the gap in a sentence: a suitable investment is not necessarily in the client’s best interest, and the glossary added that an adviser may be nothing more than a salesman.¹

The suitability standard

Under suitability, the test is fit. A Minnesota business columnist described the rule as requiring that advice be suitable for the client, taking account of factors such as age and income.² A personal finance writer in 2005 put it more bluntly: brokers need only adhere to a much less strict rule, meaning the investments they recommend must be suitable, based on the client’s goals and circumstances, and in the real world that means brokers who are not fiduciaries do not have to do what is best for the client, so long as what they do is not bad.⁷

The fiduciary standard

The fiduciary standard asks more. The same 2005 column called it the standard that registered investment advisers must follow: the adviser is legally required to put the client’s interest first and to disclose all potential conflicts of interest.⁷ The entry on the Investment Advisers Act explains where that duty comes from, and the trustee’s older obligation in trust law is where the vocabulary was formed.

How each standard treats a conflict

The sharpest difference lies in what happens when the professional’s interest and the client’s diverge. In the columnist’s summary, a fiduciary standard requires professionals to steer clear of conflicts of interest, while the suitability standard only requires disclosing them.² A public television explainer gave the practical consequence: suitability lets an adviser choose among several suitable options, each carrying a different commission for the adviser, and the worry is that the product sold is the one that pays the adviser most.³

Figure

The two standards as a 2016 column drew them

	Fiduciary standard	Suitability standard
Who it binds	Registered investment advisers	Much of the rest of the business, including stockbrokers
What advice must be	In the client's interest, with conflicts avoided	Suitable for the client, given factors such as age and income
How a conflict is handled	The professional must steer clear of it	The professional need only disclose it

Who answers to which standard

Registered investment advisers meet the fiduciary standard; much of the rest of the business, including stockbrokers and broker dealers, is held to the suitability gauge.² A 2016 report attached numbers: registered advisers, who had long been required by statute to serve their clients’ interest, were roughly 15 percent of the industry, and the other 85 percent of brokers and advice givers often stood outside that requirement.⁴ Complicating matters, a person can be registered both ways. A 2017 piece noted that advisers can be dually registered as brokers, subject only to suitability in that role, and recommended asking whether a professional works to the fiduciary standard at all times.⁵ The entry on what a registered investment advisor is describes the registration itself.

A line of disclosure from 2005

The argument is older than most readers assume. In July 2005 a syndicated columnist wrote that the most important question a consumer could ask was whether the adviser would serve as a fiduciary and would put that promise in writing.⁷ That column also described an SEC rule adopted that April requiring brokerage firms that were not registered as advisers to state prominently that the account was a brokerage account and not an advisory account, and that the firm’s interest might not be the same as the customer’s.⁷

The 2010 reform fight

When Congress rewrote financial law after the 2008 crisis, the two standards became a bargaining chip. A Los Angeles newspaper reported in May 2010 that the House version demanded a high standard for all advisers while the Senate version did not, substituting a study of the issue, and quoted an author’s observation that under existing law brokers and insurance agents only needed to show that the product they sold was not blatantly wrong for the customer.¹⁰ A spokesman for the state securities administrators told the paper that the battle had been going on for years.¹⁰

The Labor Department rule

The next round came from a different agency. In April 2016 the Labor Department issued a rule requiring that advice on retirement accounts be in the client’s best interest, with full compliance set for January 2018, and the White House estimated that conflicted advice cost working and middle class families $17 billion a year.³ A business magazine described the practice the rule targeted, placing retirement assets in products that paid high commissions, as legal so long as the investments could be portrayed as suitable, and reported that the Labor Secretary set June 9, 2017 as the implementation date after a sixty day delay.⁹ Before finalizing the rule the department had held four days of hearings with testimony from nearly eighty witnesses and had received more than 3,000 public comments; one goal was to cover the advice given when a worker rolls a 401(k) balance into an IRA, which had previously been treated as one time advice outside the fiduciary standard.⁴ That chapter is covered under the retirement plan law and its fiduciaries.

Figure

What 401(k) savers knew in 2017

correctly identified the definition of a fiduciary

42 percent

believed fiduciary and financial advisor meant the same thing

20 percent

did not know what a fiduciary was at all

27 percent

What the public understood

Through all of this, surveys found the public lost. A 2017 survey of more than 1,000 workers contributing to a 401(k) plan found that 42 percent could correctly identify the definition of a fiduciary, 20 percent thought the word meant the same thing as financial advisor, and 27 percent did not know what it meant at all.⁵ In 2018 a consumer coalition, joined by a planners’ standards board and a planning trade group, hired a communications firm to test the SEC’s proposed disclosure forms in sixteen ninety minute interviews in California, Pennsylvania and Missouri, and found that even after reading them, many consumers could not explain the difference between an adviser’s fiduciary duty and a broker’s obligation to make suitable recommendations.⁶

The SEC answer of 2018

In April 2018 the SEC proposed its own standard for brokers, and critics said at once that it resembled suitability. The agency’s chairman told a House committee that the new standard had fiduciary principles at its core, the same principles he said were found in the adviser standard, while arguing that brokers deserved a different standard of care because their business model differed.⁸ The trade press noted that a federal appeals court had vacated the Labor rule the month before.⁸ The rule that followed is described under Regulation Best Interest and Form CRS.

Figure

The argument across fourteen years

1. 01
   2005A syndicated columnist calls whether an adviser will act as a fiduciary the most important question a consumer can ask.
2. 02
   2010The House and Senate reform bills differ on whether every adviser must be a fiduciary; the Senate version calls for a study.
3. 03
   April 2016The Labor Department issues a rule requiring advice on retirement accounts to be in the client's best interest.
4. 04
   June 9, 2017After a sixty day delay, the Labor Secretary sets the rule's implementation date.
5. 05
   March 2018A federal appeals court vacates the Labor rule.
6. 06
   April 2018The SEC proposes a best interest standard for brokers; its chairman says fiduciary principles are embodied in it.

The historical echo

Read in sequence, the sources rhyme. In 2005 a columnist told readers to find out if their adviser would serve as a fiduciary and to get that answer on paper.⁷ In 2017 another told them to confirm that the adviser was a fiduciary at all times.⁵ In 2018 the SEC’s chairman was asked what brokers should call themselves if the word adviser was taken away.⁸ The vocabulary shifted from suitability to best interest to fiduciary principles, but the underlying question stayed where the 2005 column left it. Whether a given arrangement serves a particular household well depends on a person’s circumstances, tax and estate questions among them, and is a matter for qualified professionals rather than for a glossary.