Determining whether your financial advisor owes you money is a two step process. The first step is to determine what standard of care your advisor owes you. Registered investment advisors and stockbrokers who manage a client’s account on a discretionary basis are deemed to be fiduciaries. As such, they are legally required to always act in the best interests of their clients, to put a client’s interests ahead of their own.
Stockbrokers who do not have discretion over a client’s account are generally not considered to be fiduciaries. Such stockbrokers are generally considered to be held to a lower standard of care, namely that they can only recommend “suitable” investments. Under the suitability standard, stockbrokers are allowed to put their own best interests ahead of their clients’ best interests.
However, the courts have shown that they are willing to impose a fiduciary standard on stockbrokers, even those who neither have nor exercise discretionary control over client accounts, when necessary to protect investors. As one court stated,
The touchstone is whether or not the customer has sufficient intelligence and understanding to evaluate the broker’s recommendations and to reject one when he thinks it unsuitable.
A common situation I encounter is one where the stockbroker attempts to justify his questionable recommendations on Modern Portfolio Theory (MPT). While MPT itself is subject to legitimate criticism, the bigger issue is how many investors even know about MPT, let alone understand it. Therefore, in such circumstances, a court should be requested to hold the stockbroker to a fiduciary standard and the court should grant such request.
If a financial advisor is deemed to be a fiduciary, one of the primary duties owed to clients is the duty of prudence. Under the duty of prudence, a financial advisor must act solely in the interest of their client, among other duties, by (A) acting with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims; (B) avoiding unnecessary and excessive investment fees/costs; and (C) effectively diversifying a client’s portfolio in order to reduce the risk of large losses.
A debate is currently going on in the financial services industry as to whether anyone who provides investment advice to the public should be held to a fiduciary standard, should always be required to put a client’s interests first. Common sense would indicate that such a proposal is not only just and fair, but in furtherance of the goals of existing securities laws, the protection of investors. Commissions would still be permissible under such uniform fiduciary standard as long as they were in a client’s best interest, such as providing added return commensurate with the added cost.
However, while the debate goes on, experience shows that both fiduciary and non-fiduciary financial advisors are engaging in questionable conduct that clearly harms the investors. In my next post, I’ll discuss the questionable conduct and how to avoid it.
To learn more about James Watkins, visit CommonSense InvestSense.