Chances are, if you are reading this you have an advisor. Someone who is making decisions on your investment portfolio and in whom you have placed a significant amount of trust. After all, we are talking about your future financial security, right?
Well, my question to you is, how well do you really know your advisor? Is your advisor a registered investment advisor? Is your advisor a broker? Putting aside any personal connection or common social circles, how well do you know their decision-making process in choosing the right investments for you? How are they compensated to manage your portfolio? Whose interests are they considering first? Keep reading and you will learn what you need to know and what you should be on the lookout for.
Brokers and advisors are licensed professionals who assist investors with their financial goals and objectives. Brokers are regulated by the Financial Industry Regulatory Authority (FINRA) while advisors are regulated by either the Securities and Exchange Commission (SEC) or their home state regulatory body, depending on the advisor’s level of assets under management. Although their roles might seem similar to an outsider, investment advisors and brokers perform very different roles and provide very different types of services in the delivery of financial services to investors.
A broker is defined as any person engaged in the business of effecting transactions (buying and selling securities) for the account of others.(1) Despite having many different titles (ie. wealth manager, wealth advisor, investment consultant, financial advisor, financial consultant, and registered representative), brokers are generally not considered to have a fiduciary duty to their clients.(2) Instead of being required to put their client’s best interests ahead of their own, brokers are expected to deal fairly with their clients and adhere to a lower standard of legal care known as the suitability standard.(3) This standard requires a broker to know his/her customer’s financial situation only well enough to recommend investments that are considered ‘suitable’ for that particular client.(4) In addition, brokers are not required to provide upfront disclosures like the ones required for investment advisors.
An investment advisor operates quite differently from a broker and adheres to a stricter set of rules. An investment advisor is required to act in the best interest of his/her clients, putting the client’s interests ahead of his/her own at all times.(5) This operating philosophy and legal requirement is called the fiduciary standard.(6) Under the fiduciary standard, an investment advisor must provide advice and investment recommendations that he/she views as being the best for the client. Being considered ‘suitable’ for the client is not enough. Further, an investment advisor subject to the fiduciary standard is required to disclose all potential conflicts of interest to the client before entering into a contract for advisory services with that client.(7) As such, an investment advisor is legally prohibited from giving investment advice that may conflict with their client’s needs.
There are significant differences regarding industry rules, regulations and legal requirements in the way in which a broker delivers financial services to clients via the ‘suitability standard ’ and the way in which an investment advisor delivers financial services to clients via the ‘fiduciary standard ’.
Additional Investor Confusion: Dual Registration & Hybrid Model
We just reviewed the major differences between the investment advisory (fiduciary) model and the brokerage (suitability) model. To clarify an additional area of confusion, you should also know how ‘dual registration’ or ‘hybrid model’ firms differ from the broker and investment advisor models. Today, many financial professionals serve as both advisors and brokers. One of the biggest potential issues for investors using either a ‘dually registered’ or ‘hybrid’ model is that most often the lower legal standard of ‘suitability’, not the higher standard of ‘fiduciary duty’, applies to the relationship. This potential issue exists because the brokers at the major brokerage firms and/or at the independent broker/dealer firms can function as both an investment advisor and a broker in either the ‘dually registered’ or ‘hybrid’ models. As a result, determining if the financial professional is wearing the ‘advisor hat’ or the ‘broker hat’ is oftentimes very confusing for the investor.
Investment advisors that operate on a fee-only basis (not ‘fee-based’) are compensated either by a fixed fee for their time or a percentage of the assets under management.
Brokers are compensated through commissions for the trades they place on behalf of their clients or the products they sell to their clients.
As described above, brokers who operate under a fee-based compensation arrangement within a ‘dual-registration’ or ‘hybrid’ structure can potentially earn compensation from fees paid directly by clients (similar to fee-only advisors) plus fees which they receive in the form of commissions from products they are licensed to sell.
Unlike advisors operating under a fiduciary standard, brokers are not required to inform their clients in detail how their compensation is earned. As such, the fee-based model may create significant potential conflicts of interest because the advisor’s income is directly affected by the financial products he/she sells to the client.
Below is a table summarizing the key factors by which RIAs differ from Broker-dealers or other kinds of firms.
Where Does Round Table Wealth Management Stand?
Since the founding of Round Table Wealth Management in 1999, the firm has always operated in a fiduciary capacity. Our client-centric approach to helping families and individuals achieve their financial goals has always put the client’s interests ahead of our own. We strongly believe that as a Registered Investment Advisor. We believe that by acting as a fiduciary we are in a better position to more effectively meet our client’s needs.
Over the last several years the investing public has become much more aware of the distinct differences between the broker/sales model and the advisor/fiduciary model. The investing public has been ‘voting with their wallets’ as they continue to choose the advisor model over the broker model. As a result, the independent advisors have been steadily gaining market share from U.S.’s largest brokerage firms.
Seeking out an investment advisor who will act as your fiduciary can help to potentially eliminate many of the problems associated with the commission-driven, product-focused broker model. Because a fiduciary is required, by law, to give full and complete disclosure of how they are compensated as well as any potential conflicts of interest that may exist before doing business with any prospective client, the investing public is in a better position to make a more informed decision.
So now that you are aware of the differences in the kinds of advisors in the marketplace, where does your advisor fall? Whose best interest is in the forefront of their mind? Wouldn’t you feel better knowing that your advisor has your best interests in mind from an ethical as well as legal perspective? Ask the questions, get the answers and protect yourself. After all, it is your future financial security at risk. Protect it.
• Securities Exchange Act of 1934, Sec. 3 (a) (4) (A)
• SEC Study on Investment Advisers & Broker-Dealers, January 2011, page iv
• SEC Study on Investment Advisers & Broker-Dealers, January 2011, page iv
• FINRA Rule 2111, Suitabilty (a)
• Investment Advisors Act of 1940, Sec. 211 (g) (1)
• SEC Study on Investment Advisers & Broker-Dealers, January 2011, page iii
SEC Study on Investment Advisers & Broker-Dealers, January 2011, page iii