Most people look toward registered investment advisors (RIAs) or brokers when looking for financial advice, but they may not be aware of the differences in loyalties between the two. While RIAs must always do what’s in the best interest of clients, investment brokers are only required to ensure an investment is suitable for a client, creating a potential source of conflicts of interest when it comes to commissions and fees. In this article, we’ll take a closer look at the differences between investment advisors and brokers and explore their legal duties to their clients in greater detail.

Advisors’ Fiduciary Duty

Financial advisors – also referred to as portfolio managers, asset managers, or wealth managers – are investment professionals that directly or indirectly advise others as to whether or not they should buy, sell or exchange securities. In order to become an advisor, they must complete the Series 65 or Series 66 exams and may hold additional certifications, such as the certified financial planner (CFP) certification. (For more, see: Choosing a Financial Advisor: Suitability vs. Fiduciary Standards.)

The Investment Advisers Act of 1940 requires an investment advisor to act in the best interest of clients by putting clients’ best interests above their own at all times and adhering to the duties to loyalty and care. Under these rules, advisors must disclose their qualifications, services provided, compensation, fees, methods of analysis, disciplinary actions, and any conflicts of interest before any contracts are signed to provide investment advice.

For example, an advisor may be offered a higher commission by referring a specific fund, but since the fund has a higher expense ratio, the advisor may be legally obligated to recommend a lower cost fund to their client. The Department of Labor’s latest requirements could even mandate some customer education requirements designed to ensure that clients understand exactly what they are getting when it comes to their asset management. (For more, see: Get Your House in Order By Choosing a Financial Advisor.)

Brokers’ Suitability Requirements

Investment brokers – also referred to as wealth managers, financial advisors, financial consultants and registered representatives – are investment professionals that effect transactions for client accounts. In order to become a broker, these professionals must obtain Series 7 and other licenses depending on the products being sold. These licensing exams are usually focused on knowing the product and suitability to clients.

The Investment Advisers Act of 1940 specifies that brokers whose performance of advisory services is solely incidental to the conduct of their business as a broker are exempted from the fiduciary responsibilities, so long as they receive no special compensation. Instead, brokers must follow a lower standard known as suitability, which requires a broker to recommend investments that are suitable for a client, but not necessarily in their best interest. (For more, see: Paying Your Investment Advisor - Fees or Commissions?)

For example, a broker could sell a client the investment that pays them the highest commission, as long as the investment is deemed suitable for the client. The broker could even be incentivized to sell the investment in other ways, but wouldn’t be required to disclose those potential conflicts of interest with the client by law. Insurance products are especially prone to these types of problems given their large commissions and potentials for conflicts of interest.

Dual Standards & Other Gotchas

According to the Financial Industry Regulatory Authority (FINRA), 88% of investment advisors serve both as an advisor and a broker, which complicates the situation. These investment advisors may sell “fee-based” advisory services, while executing transactions in another account where they receive broker commissions. Clients may be unsure of whether the advisor is subject to the fiduciary duties of an advisor or just the suitability requirements associated with a broker. (For more, see: FINRA: How it Protects Investors.)

Clients can take several precautions to protect against these problems:

  • Ask whether or not the financial advisor is acting as a fiduciary and check whether they have a Series 7 license that may suggest they are a stock broker.
  • Request Form ADV to see fees, conflicts of interest, disciplinary information, types of clients, and other information to help make informed decisions.
  • Determine if the financial advisor is “fee-only” or “fee-based”, where “fee-only” means they are acting as fiduciaries and “fee-based” being a little less clear.

The key in any of these scenarios is determining whether the advisor is acting as a fiduciary instead of just acting based on suitability standards. (For more, see: Shopping for a Financial Advisor.)

The Bottom Line

Financial advisors directly or indirectly advise clients about whether to buy, sell, or exchange securities to generate the best returns. Since they are bound by fiduciary standards, they act in the best interest of the client at all times. Stock brokers effect transactions on behalf of clients, but aren’t bound by fiduciary duties like advisors. Rather, they are bound only by suitability requirements, which are far less stringent than fiduciary standards. Dual registered brokers and advisors can be confusing to clients, since it can be unclear as to what rules the advisor is acting under. There are a number of ways that clients can determine the difference by asking some key questions. (For more, see: Brokers and RIAs: Are They the Same?)

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