How to Discuss Suitability Versus Best Interest Standards with Clients

The American College of Financial Services
November 18, 2016

 The U.S. Department of Labor Conflict of Interest Rule (aka the DOL rule, or simply the fiduciary rule) requires a higher standard of care than the suitability standard requires, called the best interest standard, from advisors providing advice inside retirement accounts like IRAs or defined contribution plans like 401(k)s. The best interest standard will now be mandatory for financial advisors providing advice to IRAs, requiring them to only provide recommendations that put their client’s needs before their own.

Advisor explaing suitability vs best interest.

Currently, many advisors and broker-dealers operate under the suitability standard of The Investment Advisers Act of 1940. In contrast to the best interest standard, the suitability standard merely requires that advisors ensure an investment or recommendation is “suitable” for a client, but not necessarily in the client’s best interest. The existing standard left room for blurry interpretations and ultimately led to the DOL redefining fiduciary responsibility to better protect investors.

Quick Breakdown of the Differences Between Suitability and Best Interest Standards

The suitability standard is simpler and requires broker-dealers, insurance firms, and advisors to:

  • Understand their client’s financial situation
  • Be aware of a client’s investment experience
  • Know a client’s investment objectives
  • Recommend products and give advice suitable to a client’s circumstances

The best interest standard institutes a new definition of fiduciary as anyone who receives compensation for providing individualized recommendations or guidance within a retirement account: Fiduciaries must:

  • Put their client's best interest first
  • Act with prudence
  • Provide full disclosure
  • Avoid conflicts of interest
  • Fully disclose and fairly manage, in the client's favor, unavoidable conflicts

Tips for Addressing Client Confusion or Concern About Suitability Versus Best Interest

While advisors may be crystal-clear on the how the suitability standard and best interest standards differ, investors, prospects and even existing clients may be confused. For example, many consumers are surprised to learn that RIAs are held to a different standard than broker-dealers. Questions about differing advisory standards may arise more frequently in discussions with prospective clients as your clients are likely operating under the assumption that an advisor is in fact acting in their best interest.   

Tip: One of the best ways for advisors to showcase their commitment to the enhanced fiduciary standard is to anticipate client questions before they are asked. Doing so shows you’ve internalized a client’s unique situation and are critically thinking about ways to best serve their needs.  

 Tip: Address reverse-churn head on with your clients, discussing how and how often you’ll monitor their investments and analyze their portfolio. One issue targeted by the Securities and Exchange Commission (SEC) is the practice of “reverse churning” — placing investors into accounts that pay fixed fees, but generate little or no activity and may often go unmonitored. Reverse churn is symptomatic of a larger issue: many times investors use a financial advisor because they don’t have the time (or knowledge) to manage their investments. Educating your clients on how often you’ll monitor and analyze their investments — even if they don’t ask — is an excellent way to demonstrate your fiduciary status. A good rule of thumb for advisors is to analyze client portfolios quarterly, using the opportunity to discuss the services offered and how they align with the annual fee.  

Tip: Use language that reinforces your fiduciary status. In addition to having the proper disclosures on your website and marketing materials, it’s important to reinforce your fiduciary status with clients verbally. Use affirming language like, “In my fiduciary role I will ensure that your investments best meet your long-term needs,” and “Although annuity companies pay me, I am still a fiduciary and bound by law to act in your best interest, not my own.”

Tip: Encourage a team mentality in client-advisor interactions. Creating a financial plan is a team effort between an advisor and their client. It isn’t rare for investors to hide assets from their primary advisor. Research found that 15 percent of investors who had been working with their advisors for an average of 7.5 years concealed on average 40 percent of their total wealth. Trust is a two-way street and vital for maintaining a long and fruitful client-advisor relationship. Try to use “we” instead of “I” and keep conversations centered on client issues, not your obligations as an advisor. Clients who don’t trust their advisors run the risk of making seemingly small decisions on their own, like collecting Social Security early, decisions that can severely disrupt a comprehensive financial plan.

As the profession continues to move toward a single, enhanced fiduciary standard, financial services professionals will need ways to distinguish themselves from other financial advisors. Illustrating your commitment to the best interest standard and proactively educating prospects and clients about the differences between “best interest” and “suitable” will help you differentiate your value from your competition. However, the new fiduciary rule is not in the free and clear yet, as a Trump Administration could, and is likely to reconsider the rule, perhaps shelving it completely.  

Learn more about how the DOL’s fiduciary rule is changing the financial services landscape in 5 Things You Didn’t Know About the DOL Conflict of Interest Rule But Should.