The Difference Between Brokers and RIAs

The financial advisory industry uses different business models to compensate industry professionals. The difference in compensation determines a lot about how they interact with clients. Three of the more common industry models are broker-dealers, Registered Investment Advisors (RIAs) and hybrid advisors.

Broker-Dealers

Broker-dealers are independent contractors and do business under their firm name or a larger broker-dealer firm for back-office support. Broker-dealers are regulated by the Financial Industry Regulatory Authority (FINRA) and the groups' members, in effect, self regulate.

Big banks own many broker-dealer firms and their employees follow the suitability standard, meaning investments made on behalf of a client must be suitable for the client at the time purchased. They are also fee based, rather than fee only, meaning they can charge clients a fee to develop a financial plan and then charge more fees to implement the plan. (For more, see: RIAs and Independent Broker-Dealers: A Comparison.)

Registered Investment Advisors

The RIA model came about after the Great Depression ended in 1939, presumably as a protective reaction to massive investor losses. RIAs hold a fiduciary duty to clients, which means they are legally obligated to act in the best interest of clients. Under a fiduciary standard of care, an RIA must ensure the appropriateness of any risky investment, under all circumstances. The Securities and Exchange Commission (SEC), or state regulatory bodies, have regulated RIAs since the Investment Advisors Act of 1940.

RIAs are fee-only advisors and do not accept any fees or compensation based on product sales, which reduces the potential for conflicts of interest. Clients agree in advance to a fee tied to the value of the assets under management of the account, the only fee charged. There are no trailing commissions on mutual funds, for example. 

While I am biased, I believe RIAs provide more comprehensive advice because they are bound by law to show transparency, impartiality and full disclosure of fees to their clients. RIA firms work in your sole and best interest and if they fail in their fiduciary duty, they can go to prison. No other business model in the industry follows the higher fiduciary standard of care, signs an oath to adhere to it and faces criminal charges if it fails to meet the standard.

Hybrid Advisors

Another model has emerged in recent years called a hybrid advisor. A hybrid advisor is dually registered with FINRA and the SEC and they have the option to take any business, whether fee-based or commissioned, even with the same client. (For more, see: Fee-Only Financial Advisors: What You Need to Know.)

Clients have a choice of how they want to be charged and have access to products or services from a variety of firms. But they may never know when that advisor offers a "suitable” product for a higher commission or decides to offer fee-based advice. They may do this for sereval reasons:

  • They hold a Series 7 (securities license) with their broker-dealer.
  • Must meet annual commission quotas for selling certain products.
  • Work for fee only, but conflict arises from products used in a fee-based structure.
  • Only face fines and termination for bad behavior.

Broker-dealers may state that they support the fee side of the business but they stand to earn substantially more money if their representatives sell commission products. In addition, broker-dealers owned by banks often want to avoid the liability exposure of a fiduciary standard of care, so suitability is in their best interest. However, clients do not realize the benefit. The same is true for the hybrid structure: it does not benefit the client, only the hybrid “advisor.”

The difference between the the prudent recommendations of an RIA and the suitable recommendations of a hybrid, fee-based advisor is huge. The impetus behind adopting the hybrid channel are the advantages of being a broker-dealer. It uses the channel as a flexibility magnet to attract and hold advisors who do not want to tether to only a broker-dealer or RIA. 

Questions to Ask

The financial industry is already fraught with trust issues. It is a buyer beware market.

No matter from whom you seek financial advice, ask the following questions and clear the air. If the person at the other end of the question hesitates at all or succeeds in hedging an answer altogether, he or she likely has a conflict of interest and is not operating in your best interest.

1. Are you familiar with the Fiduciary Oath from the Committee for the Fiduciary Standard?

2. Describe for me your Fiduciary Oath and would you sign it for me?

3. Are you affiliated with a broker-dealer or bank? 

4. Can you tell me what to expect from products or services?

5. Are there any disclosed or non-disclosed benefits or commissions which accrue to you?

Depending on the answer, reconsider working with the advisor to protect your money from fee erosion because banks and broker-dealers hide fees. Your interests should not be subordinated to the financial interests of the industry. You deserve the tools necessary to distinguish between higher-quality advisors and lower-quality advisors. (For related reading, see: (For more, see: Choosing a Financial Advisor: Suitability vs. Fiduciary Standards.)

 

Disclosure: Advisory Services offered through The Roush Group (TRG), a State of California registered investment adviser. For information pertaining to the registration status of TRG, please contact TRG or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). No Individual should assume that any information presented or made available on or through this website should be construed as personalized financial planning or investment advice. Personalized financial planning and investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Please contact the firm for further information. Be sure to consult with a TRG adviser and/or a tax professional before implementing any strategy discussed herein.