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Choosing an Advisor: Fiduciary vs Suitability Standard

If you are searching for a professional to assist you with financial planning and investment decisions, you will undoubtedly encounter a number of folks who advertise their services under various job titles.  Unless you look carefully, you might get the idea that financial advisorsfinancial plannersfinancial consultants, insurance agents, and stockbrokers all do pretty much the same functions and have the same legal requirements.  In fact, that assumption is inaccurate, and it is important for you to understand several key differences before you make your decision.

Despite the variety of job titles, financial services are essentially delivered by two categories of professionals:  Registered Investment Advisors and broker-dealers.  These two categories of professionals are held to different standards of care as pertains to your interests:  Fiduciary Standard versus Suitability Standard.

Registered Investment Advisors and Fiduciary Standard

Registered Investment Advisors are regulated by the Securities and Exchange Commission (SEC) or state securities regulators.  The SEC stipulates that Registered Investment Advisors can provide a broad range of financial/investment advisory services such as financial planning for college education and retirement, estate and investment planning, and asset management.  Typically, Registered Investment Advisors do not “sell” proprietary investment products, and their compensation comes from fees they charge.  These fees can be billed on an hourly basis, as a percentage of assets under management, or as a flat fee retainer.  While some advisors may charge commissions on trades; typically, commissions are charged only if an advisor has a separate broker-dealer arrangement in addition to her or his Registered Investment Advisor business.  To avoid a conflict of interest, the advisor would be required to disclose any broker-dealer arrangement to his or her clients.  Currently, only Registered Investment Advisors have a legal responsibility to act as a fiduciary.

Registered Investment Advisors are bound to a fiduciary standard that was established in the Investment Advisor Act of 1940.  The Investment Advisor Act defines a fiduciary standard in which investment advisors must always act in the best interest of their client and must always put their client’s interest ahead of their own interests.   Therefore, advisors cannot recommend higher expense investments simply because the advisor will receive more compensation from that investment.  It also means that advisors must make sure that their advice is accurate, complete, and as thorough as possible.  The Registered Investment Advisor’s ultimate responsibility is to provide clients with objective advice.  As a Registered Investment Advisor, True North Capital Alliance conforms to its responsibility to serve as a fiduciary.

Stockbrokers and the Suitability Standard
To satisfy federal regulations, a “stockbroker” or any financial services person acting as a registered representative working on behalf of a broker-dealer only has to fulfill the suitability rule for his/her clients.  The suitability rule merely states that brokers must make recommendations that are consistent with the best interest of the customer.  The suitability rule does not require the broker to place his or her interest below that of the client.  This means that as long as the investment fits the needs of the client in some way, the broker is free to pick the investment that pays her/him more money even though if may mean higher expenses for the client.  Research clearly shows that the higher the fees associated with an investment, the lower the performance. While the suitability standard does prohibit activities such as excessive trading of accounts to generate commissions (i.e., “churning”), it still leaves a significant conflict of interest in place between the broker and the client.  Ultimately, it is important to realize that the broker’s primary role is to represent his/her broker-dealer, not the client.
While we acknowledge that some brokers provide quality financial advice for their clients, we believe that compensation does affect behavior.  Therefore, we strongly believe that your best chance of getting consistent, objective financial advice is to choose an advisor whose compensation is aligned with your interests.  In addition, advisor fees should be reasonable and clearly tied to services rendered.  For more discussion about the effect that fees have on investment performance, see the article titled Fees Matter… A Lot.

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Advisory services are provided through True North Global Research, Inc., d/b/a True North Capital Alliance, a Minnesota Registered Investment Advisor, with notice filing in Texas

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