Are All Financial Advisors Fiduciaries?

In the financial advisory industry, the concept of fiduciary duty is of utmost importance. A fiduciary duty requires advisors to act in the best interests of their clients, prioritizing the needs of their clients over their own. However, not all financial advisors are fiduciaries, which can lead to confusion and potential conflicts of interest. This article takes a look at the distinctions among different types of financial advisors and examines whether all of them are bound by fiduciary duty.

Understanding Fiduciary Duty

Fiduciary duty refers to a legal and ethical obligation to act in another party's best interest. For financial advisors, this means providing advice and recommendations that prioritize the client's financial well-being, avoiding conflicts of interest, and fully disclosing any potential conflicts. The fiduciary standard is a higher duty of care compared to the suitability standard, which only requires that recommendations be suitable based on the client's financial situation, objectives, and risk tolerance.

Types of Financial Advisors

Financial advisors typically fall into one of the following four categories:

1. Registered Investment Advisors (RIAs). Registered Investment Advisors (RIAs) are required by law to adhere to fiduciary duty. Governed by the Investment Advisers Act of 1940, RIAs must act in their clients' best interests. They typically charge fees for their services, either as a percentage of assets under management or on an hourly or fixed-fee basis. This fee-only model helps mitigate conflicts of interest, aligning the advisor's compensation with the client's success.

2. Broker-Dealers. Broker-dealers, on the other hand, operate under a different regulatory framework. Historically, they have been subject to the suitability standard rather than the fiduciary standard. This means their recommendations must be suitable for the client, but not necessarily in the client's best interest. Broker-dealers often earn commissions on the products they sell, which can create potential conflicts of interest. However, the introduction of Regulation Best Interest (Reg BI) by the Securities and Exchange Commission (SEC) in 2020 has sought to elevate the standard of conduct for broker-dealers, though it still falls short of the fiduciary standard.

3. Financial Planners and Consultants. Financial planners and consultants can fall under different regulatory categories, depending on their credentials and how they market their services. A Certified Financial Planner™ (CFP®), for example, is required to act as a fiduciary when providing financial planning services. The CFP Board's standards mandate that CFPs act in their clients' best interests, reflecting the fiduciary duty. However, not all financial planners are CFPs, and those without the designation may not be held to the same fiduciary standard.

4. Insurance Agents. Insurance agents, who often sell life insurance and annuities, are typically not fiduciaries. They are generally held to the suitability standard, meaning their product recommendations must be suitable for the client but not necessarily the best option available. Their compensation structure, which includes commissions from insurance companies, can create significant conflicts of interest.

401(k) PLAN ADVISORS ACTING AS FIDUCIARIES

When it comes to advisors who provide fiduciary services for 401(k) plan investments, employers generally have two types to choose from. Each type assumes a different level of fiduciary responsibility under ERISA (Employee Retirement Income Security Act).

An ERISA 3(21) fiduciary is an investment advisor. This type of advisor provides advice to the plan sponsor but don’t make any decisions themselves regarding plan investment options. An ERISA 3(38) fiduciary is an investment manager. This type of advisor has the authority to make changes to the plan’s investment choices. Employers can choose services based on the level of responsibility they wish to delegate.

It’s important to note that no matter which level of fiduciary responsibility the 401(k) advisor assumes, the plan sponsor still retains some level of fiduciary responsibility, must prudently manage the advisor’s performance, and make sure that their fees are reasonable given the services performed.

Regulatory Authorities and Standards

The following organizations provide regulatory oversight for the financial advisory industry:

SEC and Regulation Best Interest. The SEC regulates both RIAs and broker-dealers. Regulation Best Interest (Reg BI) aims to enhance the quality of recommendations provided by broker-dealers. While it imposes a higher standard than mere suitability, it does not equate to the fiduciary duty required of RIAs. Reg BI mandates that broker-dealers disclose conflicts of interest and put their clients' financial interests ahead of their own profits when recommending securities.

FINRA. The Financial Industry Regulatory Authority (FINRA) oversees broker-dealers, ensuring they comply with industry standards and regulations. While FINRA enforces the suitability standard, its rules do not impose fiduciary duty on broker-dealers.

Department of Labor (DOL). The Department of Labor's fiduciary rule, introduced during the Obama administration, aimed to extend fiduciary duty to all financial professionals advising on retirement accounts. However, this rule faced significant legal challenges and was eventually vacated in 2018. Despite this, the DOL continues to influence fiduciary standards, particularly concerning retirement advice. On April 23, 2024, they released the Retirement Security Rule, defining who is an investment advice fiduciary for purposes of the Employee Retirement Income Security Act (ERISA).

The Department also released final amendments to class prohibited transaction exemptions (PTEs) available to investment advice fiduciaries, including PTE 2020-02, "Improving Investment Advice for Workers & Retirees." The rule and amended PTEs will protect retirement investors by requiring trusted advice providers to follow high standards of care and loyalty when they make investment recommendations. The rule and amendments to the PTEs are tentatively scheduled to take effect on September 23, 2024, although there have been court challenges to the new rule.

Final Thoughts 

Not all financial advisors are fiduciaries. RIAs are legally required to act in their clients' best interests, adhering to fiduciary duty. In contrast, broker-dealers, insurance agents, and some financial planners may only be held to the suitability standard, potentially leading to conflicts of interest. Clients seeking unbiased, client-centered advice should consider working with fiduciary advisors, such as RIAs or CFPs, who are committed to acting in their best interests.