Fiduciary Ethics

Regulators are (correctly in our opinion) focusing a great deal of attention on the very different legal and ethical standards that brokers and Registered Investment Advisors (RIAs) are held to.  The SEC’s concern stems from the fact that investors generally aren’t aware of the meaningful differences and their legal implications.  Barry Ritholtz does a nice job summarizing these differences in a recent Washington Post column.

The quick and dirty version is that RIAs are held to a fiduciary standard, the highest ethical and legal standard of the land, whereas brokers are held a suitability standard, one that is self-imposed and is based on commercial (sales) standards of ethics.  Fiduciary standards were designed to protect the investor; the RIA fiduciary is required to serve the client’s interests first and always.  Period.

Suitability standards, on the other hand, are driven by the commercial ethics of selling stocks, bonds (and so on) in the role of Broker.  The broker must be fair and sell “suitable” investments, but their role in giving investment advice is incidental to their business (you read that correctly, their investment advice is incidental to their business).  As Ritholtz points out, the suitability standard results in three perverse outcomes for investors:

1)      It favors the brokerage firm and its employees over the investor.

2)      It costs much more than services provided under other standards.

3)      And it creates an inherent conflict of interest between the adviser and the investor.

No wonder, as Ritholtz points out, the mere mention of the word “fiduciary” puts Wall Street into full-blown lobbying mode.