by Richard Bavetz, FRC℠ | October 8, 2024
With so many using the term 'fiduciary,' it's natural for consumers to feel confused. An unintended consequence of the Department of Labor (DOL) creating the New Fiduciary Rule is that everyone can claim to be a fiduciary.
How can consumers be sure that an advisor is truly a fiduciary?
What's the difference between a “Pure Fiduciary” (Series 65 license Only) and a Broker with multiple licenses, e.g., a Series 6, 63, or 7, and in whose best interest are they obligated to act?
Answering these two questions can help eliminate that confusion for a client trying to make sense of the whole situation.
Pure Fiduciary vs. Fiduciary in Name Only
A distinction needs to be made between what some call a “Pure Fiduciary” and a “Fiduciary in Name Only” to highlight the differences between advisors who are fully committed to acting in their client's best interests at all times and those who use the fiduciary label selectively while in adherence to regulatory requirements created by the New DOL Rule. This distinction can help clarify the varying levels of commitment to the fiduciary standard and cut through the hype that can mislead clients.
Many clients are unfamiliar with the nuances between the fiduciary and suitability standards. Advisors leveraging the New DOL Rule to proclaim themselves as fiduciaries often leave clients with the false impression that the advisor is always bound by a fiduciary duty, when in reality, the scope of the fiduciary obligation may be very narrow. This creates confusion and can erode trust when clients realize that, outside of a specific retirement-related transaction, a broker may still be recommending products based on suitability, often with conflicts of interest present.
The suitability standard requires financial professionals to recommend investment products that are appropriate for a client's financial needs, goals, and risk tolerance. Advisors must ensure that their recommendations align with the client's profile, but they are not required to act in the client's best interest beyond that. This standard typically applied to broker-dealers, is less stringent than the fiduciary standard, which mandates that advisors put their client's interests ahead of their own. The suitability standard allows for potential conflicts of interest as long as the product meets the client's general needs and is deemed "suitable."
The fiduciary standard requires financial professionals to act in their clients' best interests at all times, placing the client's needs ahead of their own. Advisors operating under this standard must provide unbiased advice, fully disclose any conflicts of interest, and strive to minimize costs to the client. The fiduciary duty includes both a duty of care—providing prudent recommendations based on the client’s goals—and a duty of loyalty, meaning advisors must avoid self-dealing or undisclosed incentives. This higher standard ensures that all advice given is focused solely on what is best for the client’s financial well-being.
Fiduciary Standard vs The Department of Labor (DOL)
The New DOL Rule recently expanded the fiduciary obligation to cover retirement advice, but Series 6, 63, and 7 brokers continue to operate under the suitability standard in all other non-retirement scenarios and investment recommendations. This means that outside of rolling over retirement accounts, they are still only required to recommend products that are "suitable" for a client, even if they are not the best option. This discrepancy creates a gray area where an advisor might act as a fiduciary minimally in certain situations but revert to less client-focused actions in most others.
For example, a Series 6 licensed advisor might offer fiduciary advice on rolling a 401(k) over to an IRA but then under the suitability standard, sell a commissionable mutual fund for that IRA. Then, do the same for a taxable account, again using the suitability standard, all while claiming to be a "fiduciary."
Most advisors sell commission-based products, such as mutual funds with high front-end loads, variable annuities, or other investment vehicles where they earn commissions. Even if the fiduciary standard applies to the rollover recommendation, they may still recommend commissionable products as long as they provide disclosures. However, the disclosure doesn’t resolve the inherent conflict of interest. While they may technically be meeting the fiduciary obligation on paper, their recommendations can still be driven by the commissions they earn, compromising the quality of the advice.
This "fiduciary in name only" approach, while often unintentional, can be seen as taking advantage of the DOL rule’s framework without truly embracing the core principles of fiduciary duty, which requires putting the client’s best interest ahead of personal or firm financial incentives. Let’s Compare.
Broker-Dealer vs. Broker
A broker working for a brokerage firm holds multiple licenses, typically a Series 6, 63, or 7, operates under a suitability standard, and may only be required to act in a best-interest capacity in limited situations depending on the services provided (e.g., retirement accounts). The well-meaning individual simply might not realize they’ve entered into an arrangement with their broker-dealer that has an inherent conflict of interest with the client. In addition to providing investment advice, these advisors are primarily product sellers, working for broker-dealers or financial institutions that provide a wide range of products. They are often compensated through third parties on those financial products, such as mutual funds, variable annuities (Series 6), or stocks and bonds (Series 7). This compensation can be derived from commissions, 12b-1 fees, revenue sharing, administrative service fees, and an advisor fee.
These forms of compensation create bias and can lead to potential conflicts of interest, as the advisor is strongly incentivized to recommend products that provide third-party compensation rather than better performance. The broker-dealer sets the framework for the types of investments available that provide the extra revenue (e.g., Preferred Family of Funds, Program Funds, Full Participation Funds) and the compensation structure, and the advisor must adhere to the guidelines and product offerings provided by the broker-dealer. This creates a conflict of interest because the advisor’s duty to the client would be secondary to their obligation to the broker-dealer, especially when the products that generate higher commissions for the advisor and the firm are prioritized.
Ultimately, these incentives take away from the product's performance and, therefore, don’t align with the client’s best interest. For example, a broker-dealer may push a higher-cost mutual fund or variable annuity because it’s more profitable for the firm, even if a lower-cost option would perform better and, therefore, be better for the client. In this role, their obligation requires them to follow the guidance of their broker-dealer, which influences the products they can offer and how they conduct business. The advisor faces a conflict: acting in the client's best interest would mean recommending the lower-cost product, but their obligation to the broker-dealer creates an undue influence to offer the higher-cost, commission-generating option instead. While the suitability standard allows them to recommend investments that simply align with the client’s risk tolerance and financial situation, the incentives drive the investment advice.
The Pure Fiduciary vs. Inherent Conflict
In contrast, A Pure Fiduciary has chosen to take a different path than the advisory community at large. They hold only a Series 65 license (Investment Advisor Representative or IAR) and are legally bound to act in the best interest of their clients at all times, not just part of the time. Operating under the fiduciary standard means that the advisor has chosen to obligate themselves to the highest standard of care in the financial industry, well beyond the suitability standard; to set aside their own interests entirely, in favor of the client’s interests.
A fiduciary maintains their primary focus on the client and must avoid conflicts of interest, provide transparent advice, and prioritize the client’s financial well-being ahead of all other interests. Transparency and disclosure are insufficient to resolve the fundamental conflict of interest posed by the aforementioned forms of compensation. Therefore, a fiduciary is prohibited from earning commissions or other incentives from selling investment products, like commissionable mutual funds, which quite possibly create the greatest source of bias in the financial system. Instead, a Fiduciary typically charges fees directly for their advice, often through hourly rates, flat fees, or a percentage of assets under management (AUM). Because of this fee structure, their compensation is aligned with the client’s success, creating less potential for conflicts of interest.
The Ultimate Dilemma: Fiduciary Duty vs. Business Model
Broker-dealers typically have preferred products, some of which may generate higher commissions and/or revenue-sharing arrangements. These incentives detract from the product's performance and don’t align with the client’s best interest. For example, a broker-dealer may push a higher-cost mutual fund or variable annuity because it’s more profitable for the firm, even if a lower-cost option would perform better and, therefore, be better for the client. In this scenario, the broker faces a conflict: acting in the client's best interest would mean recommending the lower-cost product. However, their obligation to the broker-dealer creates an undue influence to offer the higher-cost, commission-generating option instead.
Even if the mutual fund performs well, commissions and/or high cost of ownership create a drag on long-term performance, making it harder for the portfolio to recover and grow. Over time, compounding can significantly boost investment returns, but high upfront fees and a high cost of ownership reduce the amount that can compound. This affects the immediate investment and the client's long-term financial growth, especially when multiple transactions or fund switches incur additional costs.
At its core is an inherent tension for brokerage licensed advisors: their business model is based on earning commissions from product sales dictated by the broker-dealer. This conflict may push some advisors toward leaving commission-based brokerage roles and transitioning into fee-only fiduciary roles (Series 65), where their loyalty can be entirely focused on the client. Others will have to navigate a complex balancing act of meeting fiduciary obligations while adhering to broker-dealer pressures; it’s a challenging act to pull off.
A Series 65-only investment advisor must prioritize the client’s best interest as a fiduciary, setting aside their interests entirely, offering unbiased, fee-based advice. They may not offer commissionable mutual funds or participate in revenue sharing arrangements. A broker with Series 6, 63, or 7 licenses primarily operates under a suitability standard, which involves recommending suitable products but allows for potential conflicts of interest due to commission-based compensation. Registered representatives of broker-dealers, are simultaneously required to uphold loyalty to their broker-dealer while trying to act in the client’s best interest. This dual loyalty can lead to a "terminal state of conflict," where their legal obligations pull them in opposing directions.
In summary, the only true solution to this conflict of interest is to remove the commission-based incentive altogether. Advisors who operate on a fee-only basis are compensated directly by their clients, aligning their interests fully. Without the pressure of earning commissions from products, these advisors can focus on offering their clients the best, most cost-effective solutions. This model ensures that the advisor’s compensation is tied to the client’s success, not the sale of particular products.
Richard Bavetz, FRC℠ is a Federal Retirement Consultant℠ and Investment Advisor with over 25 years of experience. As a Fiduciary, he works with High-Net-Worth investors, Foundations, and Endowments, offering dynamic & innovative investment portfolios in a relationship-centered advisory role.
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