What is a Fiduciary? Dual Registration Can Make It Harder to Tell

About Plancorp | Financial Planning

 Peter Lazaroff By: Peter Lazaroff

Many successful investors know what a fiduciary is and want to work with an advisor who is legally required to put clients’ interests first. But even people who understand the value of a fiduciary might be surprised to learn that not all fiduciaries are the same. 

The differentiator? Dual registration.

An estimated 80% of assets under management by Registered Investment Advisors (RIAs) are managed by firms dually registered as both fiduciaries and brokers. This means they act as a fiduciary only some of the time, creating the opportunity for conflicts of interest — and your interests may lose out.

That’s why it’s critical to know whether your advisor is a true fiduciary or duly registered. But before we get to that, let’s take a step back and review some definitions.

What is a Fiduciary?

A fiduciary is a financial professional who is legally required to make decisions in a client’s best interest. This means developing financial plans and choosing investment options that are ideally suited to your goals and personal circumstances. 

A fiduciary’s only source of compensation is the fee they charge clients, whether that’s a flat dollar amount or a fee based on a percentage of assets under management. With no other incentives to influence their judgment, fiduciaries only consider what’s best for you when developing solutions for your retirement, estate planning, tax, insurance, or education savings needs. 

Once a financial professional is something other than a fiduciary, the different terms and implications quickly get confusing. 

Non-fiduciary financial professionals can earn income from other sources, such as commissions on product sales, and are held to a weaker (and confusingly named) “Regulation Best Interest” standard. This standard was established by the SEC to raise the bar for brokers adhering to the “suitability standard.” 

The suitability standard is enforced by the National Association of Securities Dealers (NASD) and the Financial Industry Regulatory Authority (FINRA) — two self-regulatory organizations. As the name implies, it only requires that advisors make recommendations that are “suitable” for a client’s needs. 

To illustrate the difference between the fiduciary and suitability standards, I typically use a car dealership analogy: 

Imagine you walk into a Ford dealer, and as you describe your needs to the salesman, it becomes clear that the best car for you is actually a Toyota Highlander. Under the suitability standard, the dealer could say that the Ford Explorer is a lot like a Highlander, and since it provides most of what you’re looking for, it’s suitable. They sell you the Explorer and receive a commission. 

Under a fiduciary standard of care, the salesperson would be legally required to suggest you go to the Toyota dealership to get exactly what you need. Or, they might tell you that they can sell you an Explorer that is a bit more expensive and doesn’t fit all your needs, allowing you to make the decision between the two vehicles yourself. 

Although Regulation Best Interest supplants the suitability standard in the brokerage world and addresses some of the really bad situations we saw in the past, it stops short of eliminating many questionable practices. Including the phrase “best interest” in the standard’s name arguably creates more confusion, since those words are in the definition of fiduciary.

Speaking of confusing, it used to be simple to know that your advisor was a fiduciary by choosing to work with a Registered Investment Advisor (RIA). But with firms increasingly registering as both brokers and fiduciaries, you might not be getting what you expect. 

The Risks of Dually Registered Advisors 

Dually registered advisors wear two hats: They can act as fiduciaries when formulating your financial plan, but as brokers when implementing that plan. Brokers often make money by recommending investments from a “preferred funds” list — basically a list of funds that give brokers a cut of the revenue when their clients invest in those products. 

Revenue sharing agreements create a conflict of interest for advisors acting in both roles. A preferred fund may not be the best option for a client, but the firm will make a profit by recommending it. 

Dual registration can also generate “double-dipped” fees, meaning you’ll be charged a percentage of your assets under management and fees from the funds your advisor recommends. Advisors often don’t clearly disclose these fees, leaving you in the dark about how much you’re really paying for the service. 

Returning to our car-buying metaphor, in a dual registration scenario, you might actually be in a Toyota dealer offering the Highlander that’s in your best interest to own. But putting on their broker hat, the salesperson could then choose to only show you the Highlanders loaded up with features at the highest trim levels — because those are the ones that generate the highest profits for the dealer. Not great, but at least in this scenario you’re getting more features or an upscale model in exchange for a higher price. With investments, you’re basically paying more for a fund that offers no additional benefit to you.

How to Tell if Your Financial Advisor is a Fiduciary 

The added complication of dual registration makes it even more important to ask your advisor to confirm that they will act as fiduciaries at all times and whether they receive any other forms of compensation besides the fees you pay. 

Alternatively, you can visit the Security and Exchange Commission’s Investment Advisor Public Disclosure (IAPD) website, which allows you to look at a firm’s Form ADV and Form CRS. Form ADV is the form investment advisors use to register with the SEC, and Form CRS is a client relationship summary that describes all services a firm offers as well as associated fees, costs, and conflicts of interest. It must clearly state whether the firm is duly registered. 

Some firms choose to go a little further in their fiduciary commitment by registering with the Certified Centre for Fiduciary Excellence (CEFEX). CEFEX firms must uphold fiduciary practices that exceed the letter of the law and agree to annual audits to confirm their approach. These audits are more rigorous — and more frequent — than the SEC’s approach to checking up on fiduciary commitments.

Ensuring that your advisor works for a firm that isn’t dually registered and that’s willing to submit to additional oversight over their fiduciary commitment can give you confidence that you’re working with someone who’s always putting your needs and interest first. 

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This material has been prepared for informational purposes only and should not be used as investment, tax, legal or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal and accounting advisors.

 

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Peter Lazaroff, Chief Investment Officer, first took an interest in investing when his grandmother gave him a single share of Nike stock for his 13th birthday. Today, nearly 20 years later, his investment insights are highly sought after by local and national media. More »