FINRA's Suitability Standard vs the SEC's "Best Interest" Standard

The chairman of the United State Securities and Exchange Commission (SEC), Jay Clayton, has made no secret about the fact that he wants to make adopting the proposed “best interest” regulation a key priority in 2019.

Over much of last year, heated debate raged within the securities industry and among some politicians about the “best interest” standard and how it should be applied to registered financial advisors and stock brokers alike. Right now, two different standard apply to the industry. Bringing them all under one standard would unify a fractured industry and give greater clarity and increased protection to investors who may be unaware of which standard they are subject to.

What is the Best Interest Standard?

Registered investment advisors or RIAs must uphold the “best interest” standard in managing client accounts. This standard means that, when making decisions on behalf of a client or fiduciary, they must put the best interest of the fiduciary ahead of their own self-interest, period. This is the highest fiduciary standard available in the securities industry.

What is FINRA’s Suitability Standard?

By contrast, FINRA’s “suitability” standard for broker-dealers and registered brokers is more lenient. Brokers must only ensure that the investments and strategies they choose for fiduciaries are suitable for all investors and suitable for the individual investor on an ongoing basis. It mentions nothing about best interest. Indeed, it is theoretically possible for brokers to violate the “best interest” standard while still upholding the “suitability” standard simply by finding an investor an opportunity that is at once suitable for the investor while not in his or her best interest, yet that is also in the broker’s own self interest. This happens often with products which are nominally suitable for investors but which contain hidden or inflated fees. The broker choses the products with higher fees even when another investment with lower fees would be equally suitable for the investor.

What Is the Impact on Investors of the Fiduciary Standards?

The SEC and other regulators have been discussing imposing the more rigorous best interest standard on broker-dealers. They believe it would not only bring the standards in line with each other, but it would protect investors from the very situation described above — privileging high fee investments over low fee ones when they are equally suitable. The result could save retail investors many millions of dollars in unnecessary fees.

Or course, the broker-dealer industry has been reluctant to adopt these changes. Citing all kinds of reasons, but mostly balking at the expense of supervising the high standard, what it boils down to is that broker-dealers don’t want to lose those excess fees either. While SEC continues to fight for the higher standard, it seems unlikely to happen any time soon. Time will tell.

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