A Publication of WTVP

Why it matters whether your investment professional is a fiduciary…

A large percentage of Americans seek the services of a financial professional to assist them with the management of their financial assets. While some select a Registered Representative, or broker, others seek assistance from a Registered Investment Advisor. Industry surveys suggest the average investor doesn’t understand the difference between the two, but there are many—a few of which might surprise you.

To make matters even more confusing, financial service professionals can (and do) use a variety of titles without holding any professional designation. For example, financial analyst, financial advisor, financial consultant, financial planner, investment consultant and wealth manager are all generic terms or job titles that can be used by anyone.

Requirements for Brokers
Registered Representatives, or brokers, are employed by a parent company known as a broker-dealer, the largest of which include Morgan Stanley, Wells Fargo, UBS Financial Services and Bank of America Merrill Lynch. Broker-dealers are organizations that are in the business of buying and selling securities and other investment products on behalf of customers, on an agency basis as a broker, or for their own account as a dealer.

A broker must obtain various licenses in order for them to legally sell the products offered through their broker-dealer. For example, a broker who has passed the Series 6 exam is licensed to sell mutual funds and variable annuities, while a Series 7 licensed broker can sell a much wider variety of securities, including common stocks and bonds. In addition, a broker must obtain a separate license to do business in a particular state. In most cases, broker-dealers must register with the Securities and Exchange Commission (SEC), and their brokers are required to register with the Financial Industry Regulatory Agency. FINRA is the regulatory organization that was formed in 2007 when the National Association of Securities Dealers merged with the regulation committee of the New York Stock Exchange.

Brokers are expected to have a comprehensive understanding of their client’s investment experience, income, financial circumstances and risk tolerance, and may only recommend securities that are deemed to be suitable (remember this point). Investment recommendations are seldom provided on a discretionary basis, which means brokers must seek their client’s approval before taking any investment action, such as placing a stock trade or acquiring a fixed income security. As compensation for their efforts, brokers are paid commissions in varying amounts based upon the product sold and the dollar amount invested. It is customary for the broker-dealer to retain a portion of the commission to cover expenses and pay the remainder to the broker based upon a number of criteria, including their level of sales production.

The Registered Investment Advisor
A Registered Investment Advisor (RIA) differs from a broker in a number of ways: their independence, the method by which they serve clients, how they are paid, and most importantly, their fiduciary duty. While a small percentage of RIAs are employed by broker-dealers, most investment adviser representatives are employed by RIA firms owned and operated by the investment advisers who run them. In 2013, more than half of all RIAs consisted of 10 or fewer employees, and 88.3 percent reported having fewer than 50 employees, according to the Investment Adviser Association and National Regulatory Services.

Because of their independent status, it is necessary for RIAs to engage a corporate custodian and/or a broker-dealer to hold client assets, provide trading platforms, issue monthly account statements, and assist with compliance and numerous other back office services. The largest custodians providing services to the RIA community include Schwab Institutional, TD Ameritrade and Fidelity Investments. Using an independent custodian provides a system of checks and balances, as a client’s funds are not held by the same entity that is providing investment advice. Since the RIA is not an employee of their chosen custodian(s), they are free from any pressures to promote proprietary investments and are compensated via an asset-based fee rather than by sales commission.

Unlike the service structure of a broker, most advisors manage client assets under a discretionary contractual arrangement. Thus, it’s important for investors to understand the RIA’s investment philosophy and process. This information is detailed in a registration document, known as the Uniform Application for Investment Advisor Registration (or Form ADV), which is required to be filed with the SEC and is distributed to clients annually. Form ADV also provides information on an advisor’s ownership structure, fee schedules, compliance history, information about key staff members, and other information deemed relevant to a client’s decision to hire the advisor. (Visit to access this information about any RIA.)

Registered Investment Advisors with assets under management in excess of $110 million are required to register with the SEC and are governed by the Investment Advisors Act of 1940. Advisors with assets under $110 million follow their state’s statutes, rules and regulations. RIAs are required to pass the FINRA Series 65 exam, or the Series 7 exam in conjunction with the Series 66, unless they have successfully earned and maintained the Charted Financial Analyst (CFA) or Certified Financial Planner (CFP) designations, in which case they are exempt from this requirement. The Advisors Act defines an investment advisor as any individual or entity that provides advice by making recommendations regarding securities or securities markets for compensation and who regularly engages in the business of providing advice regarding securities.

Highest Duty of Care
The most significant difference between a broker and an RIA is the requirement set forth by the Investment Advisors Act that defines an RIA as a fiduciary. (Recall that a broker is only required to make “suitable” investment recommendations based upon their client’s financial circumstances). As a fiduciary, RIAs are legally obligated to act in the best interest of their clients, even if that runs counter to the RIA’s own self-interests. A fiduciary duty is the highest duty of care recognized by the U.S. legal system, requiring an individual to act with both honesty and full disclosure. Therefore, RIAs operate under a higher standard of responsibility to their clients than any ¬other financial service provider.

All indications appear to reflect that investors appreciate the fee transparency, flexibility and accountability associated with the service model of an RIA. According to a report by Cerulli Associates, client assets managed by independent RIAs grew by 45 percent from 2005 through 2011, compared to just five percent within the broker-dealer community. Before hiring any investment professional, it’s important to look beyond an individual title to gain a true understanding of the caliber, soundness and thoroughness of their financial advice. One should research their credentials, obtain a comfortable understanding of their investment philosophy and process, and review their firm’s audited historical rates of return. Lastly, make absolutely certain that you understand their economic motivation and that they are fully transparent with their fee disclosures. iBi

Patrick J. Smarjesse, CEBS is vice president at David Vaughan Investments, Inc. For more information, visit