Advisor Alignment

Many investors are confused by the various titles used by individuals and companies providing financial advice. This makes it difficult for them to identify alignment, which refers to the extent to which the advisor’s interests or motives agree with the client’s.

There are two paradigms that describe the advisor’s allegiance to you as the client:

• Some advisors have a fiduciary duty to you, which means they are legally required to put your interests first, even at their own expense. This is the strongest form of allegiance and the one that is most desirable from the small investor’s perspective.

• Others are only required to provide advice that is deemed suitable for you and your circumstances. Suitable investments are those that are appropriate for your investing objectives, comfort level with risk taking, financial means and age. (For example, investing a 90-year-old widow’s entire nest egg in very risky hi-tech stocks would be unsuitable). There is no requirement that suitable recommendations be “best” suited to you, and no obligation to look out for your best interests.

Unfortunately, the average small investor does not understand this distinction. As of July 2010 brokers do not have a fiduciary duty to clients. Yet, according to a Wall Street Journal article by Jason Zweig, “The Fight Over Who Will Guard Your Nest Egg,” March 28, 2009,

“A report by Rand Corp. last year found that 63 percent of investors think brokers are legally required to act in the best interest of the client; 70 percent believe that brokers must disclose any conflicts of interest.”

In July 2010 the US Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Act affects a vast spectrum of financial activity, calling on various old and new government agencies to create new rules for participants in financial markets. We will touch on several of the Act’s primary elements as our discussion proceeds throughout this book. One section of the Act requires the SEC to determine within six months whether or not to impose a uniform fiduciary duty on any advisor providing retail investment advice. Regardless of what the SEC decides, you should always ask whether an advisor is a fiduciary and ask yourself why you would ever accept an advisor who is not.

Registered Investment Advisors (RIAs) are those who are registered with the U.S. Securities and Exchange Commission (SEC), a federal government body. These advisors have a fiduciary duty to their clients—the highest form of allegiance. Some private sector (non-government) credentials also impose a fiduciary duty on advisors. For example, members of the National Association of Personal Financial Advisors (NAPFA) take a fiduciary oath.

Those who qualify as Certified Financial Planners™ (CFP®) through the Certified Financial Planner Board of Standards also accept a fiduciary duty when engaged in financial planning.  In contrast, as of July 2010, brokers don’t have a fiduciary duty. They are bound only by the suitability requirement. Their governing body is the Financial Industry Regulatory Authority (FINRA).

If you want an advisor who owes you the greatest allegiance and must provide you with the best advice for your situation and circumstances, your logical choice must be to utilize the services of a fiduciary. If you only need help executing trades, a (non-fiduciary) broker may be sufficient. If so, consider using a discount brokerage that doesn’t make trade recommendations and will execute trades for you at lower fees.

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