Our Thoughts

Registered Investment Advisers vs. Stockbrokers

“It is not easy to get rich in Las Vegas, at Churchill Downs or at the local Merrill Lynch office.”

– Paul A. Samuelson, Noble Prize-winning economist

Before choosing a professional to help you plan and achieve your long-term financial goals, it’s important that you understand the differences between a registered investment adviser (RIA) and a stockbroker. The roles and responsibilities of each should be clear with a strong line drawn between individuals who call themselves advisers and those who call themselves stockbrokers. So, what are these differences? Let’s take a look.

Regulatory Differences

An RIA is an independent adviser registered under the Investment Advisers Act of 1940. The Act was passed to monitor persons who, for a fee, advise individuals, pensions and companies (among others) on financial matters.

The Act defines an adviser as, “Any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.”

A stockbroker is typically regulated by the Financial Industry Regulatory Authority (FINRA) through his or her employment with a securities firm. FINRA licenses over 629,000 registered securities representatives doing business in the U.S.

The Act defines a (stock)broker as, “Any person engaged in the business of effecting transactions in securities for the account of others…” It’s interesting to note that many of today’s brokers work for “broker-dealers,” meaning they effect trades and they sell financial products to customers for a fee or commission (this is especially true when the broker-dealer is owned by a bank holding company).

Standards of Care

Advisers have a fiduciary duty to act in the best interest of their clients at all times and are therefore held to a higher standard than a stockbroker. Advisers provide their clients with a Form ADV that describes exactly how the adviser does business and spells out any potential conflicts of interest that may exist in the adviser’s business.

In addition to the Form ADV, advisers provide their clients with an Investment Policy Statement (IPS) which outlines the client’s needs, goals and objectives; and defines the level of risk the client is willing to accept. Perhaps, more importantly, the IPS establishes a recommended asset allocation, defines the investment methodology to be used, and establishes a strategic implementation plan.

Advisers charge their clients a fee—usually based on assets under management—negotiated in advance and do not charge any other fees to their clients without the clients’ prior consent. Advisers cannot trade with their clients as a principal (trading on the adviser’s accounts at the adviser’s own risk) except in extremely limited circumstances.

Advisers do not engage in other business activities such as investment banking or securities underwriting. These things together help ensure that an advisers’ interests are aligned with their clients.

Stockbrokers represent their firms and generally do not act as fiduciaries with their customers. Instead, stockbrokers are held to suitability obligations (Reasonable Basis Suitability and Customer-Specific Suitability) on the part of their firm. Simply put, this means that stockbrokers must believe that securities they recommend are merely suitable for, but not necessarily in the best long-term interest of, the client at the time the recommendation is made. Additionally, stockbrokers are not required to provide clients with any type of disclosure that is comparable to a Form ADV or an IPS.

NOTE:  Broker-dealers often earn significant undisclosed profits by trading as a principal with their clients and also engage in other business activities such as investment banking and securities underwriting. This may cause the stockbroker’s interest or attention to focus on areas outside of the best long-term interests of their clients.

Summary

Advisers must act in their client’s best interest at all times (the fiduciary standard) and brokers must understand their client’s complete financial picture and direct them towards appropriate products (the suitability requirement). Not to say that one is right and one is wrong, but investors need to understand the differences between an adviser and a stockbroker before seeking professional financial advice.