The financial services industry includes a wide range of services designed to help individuals and businesses manage their financial affairs, such as workplace retirement plans. Within the industry, financial advisors and institutions may operate under different standards of care, specifically fiduciary and non-fiduciary standards. Understanding the distinction between fiduciary and non-fiduciary financial services is crucial for individuals and organizations seeking financial advice, as it directly impacts the level of responsibility and the nature of advice they receive.
A fiduciary is a person or organization that acts on behalf of another person or persons to manage assets. The key characteristic of fiduciary financial services is the legal and ethical obligation to act in the best interest of the individual or business. Fiduciaries are bound by a higher standard of care and loyalty, meaning they must prioritize the interests of their clients above their own.
Registered Investment Advisors (RIAs) are regulated by the Securities and Exchange Commission (SEC) or state securities regulators and are legally obligated to act as fiduciaries. They typically charge fees based on a percentage of assets under management or a flat fee, reducing the potential for conflicts of interest.
Trustees are individuals or entities that manage assets held in a trust for the benefit of another party (the beneficiary) are also considered fiduciaries. Trustees must adhere to the terms of the trust and act in the best interests of the beneficiaries.
Plan sponsors, which can include investment and plan committee members, act as primary fiduciaries for workplace retirement plans. As plan administrators, they ensure compliance with regulatory requirements and manage plan operations. As investment managers, they select, monitor and make changes to investment options, acting in the best interest of participants. As fiduciaries, plan sponsors must prioritize the plan participants' interests, avoid conflicts of interest, and adhere to the fiduciary standards of loyalty, care, and transparency, ensuring the effective and ethical management of workplace retirement plans.
Plan sponsors may hire service providers who offer fiduciary services to workplace retirement plans. The most common include advisors who provide ERISA 3(21) investment advice services, those who provide ERISA 3(38) investment management services, and TPAs and recordkeepers who provide some level of ERISA 3(16) plan administration fiduciary services.
Non-fiduciary financial advisors operate under a different set of standards, often referred to as the suitability standard. This standard requires advisors to make recommendations that are suitable for the client’s needs, goals, and financial situation, but it does not necessarily require them to act in the best interest of the client.
Suitability. Advisors must ensure that their recommendations are suitable based on the client's financial situation, risk tolerance, and investment objectives. However, they are not required to prioritize the client's interests over their own.
Limited Disclosure. Non-fiduciary advisors may not be required to disclose all conflicts of interest or fees associated with their recommendations. This lack of transparency can lead to potential conflicts where the advisor’s recommendations may be influenced by commissions or other incentives.
Compensation Structure. Non-fiduciary advisors often earn commissions on the financial products they sell, such as mutual funds, insurance products, or annuities. This commission-based structure can create conflicts of interest, as advisors might be incentivized to recommend products that offer higher commissions rather than those that are in the best interest of the client.
Broker-dealers facilitate the buying and selling of securities and may provide investment advice. They are regulated by the Financial Industry Regulatory Authority (FINRA) and are subject to the suitability standard rather than a fiduciary standard.
Insurance agents selling insurance and other employee benefit products are typically not considered fiduciaries. Their primary obligation is to ensure that the products they recommend are suitable for their clients, but they are often compensated through commissions from the insurance companies whose products they sell.
The primary differences between fiduciary and non-fiduciary financial services lie in the standard of care, level of transparency, and potential for conflicts of interest.
Understanding the distinctions between fiduciary and non-fiduciary financial services is essential for individuals and businesses seeking financial advice. Fiduciaries are bound by a higher standard of care, requiring them to act in the best interests of their clients, avoid conflicts of interest, and maintain a high level of transparency. Non-fiduciaries, while still required to make suitable recommendations, operate under less stringent standards and may have inherent conflicts of interest due to their compensation structures. Individuals and businesses should carefully consider these differences when selecting a financial advisor to ensure their interests are adequately protected.