Investment adviser

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Investment Advisers (IA)[note 1] are individuals or firms that receive compensation for giving advice on investing in securities such as stocks, bonds, mutual funds, or exchange-traded funds. IA's are subject to regulatory authority depending on their classification. An Investment Adviser who registers with the Securities and Exchange Commission (SEC) must adhere to a fiduciary standard which acts in the client's best interest. An adviser registered with the SEC is known as a Registered Investment Adviser (RIA).

Although many individuals who are employed by advisers fall within the definition of “investment adviser,” the SEC generally does not require those individuals to register as advisers with the SEC. Instead, the advisory firm must register with the SEC. The adviser’s registration covers its employees and other persons under its control, provided that their advisory activities are undertaken on the adviser’s behalf.[1] Therefore, only firms can be Registered Investment Advisers (RIA), while its employees can only be Investment Adviser Representatives (IAR).[2]

Registered Investment Advisers are not permitted to use the term “registered investment adviser” unless they are registered, nor should this term be used to imply a level of professional competence, education or special training. The term “RIA” should not be used after a person’s name because using initials after a name usually indicates a degree or a licensed professional position for which there are certain qualifications; however, there are no federal qualifications for becoming an SEC-registered adviser.[3] For example, it is not permitted to use "RIA" on a business card.[4]

Investment advisers who manage less than $100 million in assets must be registered with the state securities agency in the state where they have their principal place of business.[5]

Anyone registered with the FINRA typically makes commissions and fees from the products they sell (brokerage or mutual fund company). They must provide to their clients products that are "suitable" (the suitability standard), but not necessarily the cheapest or the best.[6]

Regulations

Section 202(a)(11)(C) of the Investment Advisers Act of 1940 exempts from the definition of an Investment Adviser (and therefore the associated fiduciary standard) "any broker or dealer whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor."[5]

In Release 34-51523; the Financial Industry Regulatory Authority (FINRA), the US Securities Self Regulatory Organization (SRO) having authority over Brokers and Dealers, determined that Broker-Dealers are "not to be deemed investment advisers" and therefore are not subject to the same fiduciary standards as Investment Advisers when recommending investments to clients, as are Registered Investment Advisers (RIA).

Registered Representatives (RRs) affiliated with a Broker Dealer are therefore required to recommend securities that are deemed "suitable" for non-institutional clients.[7]

Suitability

Suitability means that a broker can sell any fund or any investment as long as it fits the purpose. For example, if stocks are suitable for an investor, then it doesn't matter if a broker advises an 8% load stock fund that has 3% in annual fees because it's agreed that stocks in general are a suitable, thus any diversified stock mutual fund will do.[8]

Suitability is quite different than fiduciary standard. Under a fiduciary standard, not only does an investment adviser have to recommend suitable investments, the adviser must recommend funds that are in the best interest of the client. Clearly, a fund with an 8% load and 3% in fees is not in the best interest of investors. Low-cost index funds are in the best interest of clients.[8]

This is the difference between investment recommendations of brokers under a suitability standard and those of investment advisers under a fiduciary standard.[8]

Fiduciary standard

On April 8, 2016, the Department of Labor issued revised regulations which widens the definition of a fiduciary for advisers who have control over retirement plans. The intent is to avoid a conflict of interest between an adviser (including a broker-dealer) and the client. The rules go into effect June 1, 2016, but do not apply until April 10, 2017.[9]

Background checks

Those considering a business relationship with an investment adviser (financial adviser, broker, or investment firm) should perform due diligence to validate background credentials and complaints on file. The SEC and FINRA provide free tools to help consumers with this process.

Investors should use both tools. If a financial adviser cannot be found in SEC's Investment Adviser Public Disclosure (IARD) database, but is found in FINRA's Broker Check, then this adviser should be considered as a product salesperson.[6]

SEC Investment Adviser Public Disclosure

The SEC's Investment Adviser Public Disclosure (IAPD) database provides information about current and former Investment Adviser Representatives (IARs) and Investment Adviser firms registered with the SEC and/or state securities regulators.[10]

Choose either Individual or Firm to start. Be sure browser cookies are enabled. The results will contain links to "Investment Adviser Firm" or "Brokerage Firm" as applicable.

Brokerage firm

The Brokerage Firm link will launch into the FINRA's BrokerCheck (below) which provides additional information such as a state-by-state breakdown where a broker is licensed to practice, or if any complaints have been filed.

Investment adviser firm

The "Investment Adviser Firm" link goes to Form ADV (Uniform Application for Investment Adviser Registration), each section appearing in a menu on the left-hand side. Among other items, Form ADV can be used to determine if a firm does financial planning as opposed to providing investment advice.[11]

Go to "Item 5 Information About Your Advisory Business" in the ADV and look for:[11]

  • 5F(1): Do you provide continuous and regular supervisory or management services to securities portfolios?

If the answer to 5F(1) is No, this firm is not in the investment advisory business. It might give investment advice and sell investment products, but that doesn’t make it an investment adviser you want to manage your money.[11]

Critically important is "Item 11 Disclosure Information." Every “No” box on this page should be checked because a “Yes” indicates that the firm has violated some of the laws and regulations governing registered investment advisers.[11]

Where a “Yes” has been checked, the firm must detail on the ADV the date and nature of the infraction, and how it was settled. A minor infraction, perhaps from some administrative error involving small amounts of money, may be forgiven, but any “Yes” on this page should be scrutinized closely.[11]

FINRA BrokerCheck

The Financial Industry Regulatory Authority, known as FINRA, is the largest non-governmental regulator for all securities firms doing business with the United States public—more than 5,000 firms employing more than 660,000 registered representatives. FINRA was created in 2007 through the consolidation of NASD and NYSE Member Regulation.[12]

FINRA BrokerCheck is a free tool to help investors check the professional background of current and former FINRA-registered securities firms and brokers. It should be the first resource investors turn to when choosing whether to do business with a particular broker or brokerage firm. Note that financial advisers can also be registered brokers.[13]

Enable browser cookies. At the report summary, select "View Full PDF Report" (upper right corner) to get the full details. If applicable, the FINRA report will contain complaints filed against the adviser.

See also

Notes

  1. U.S. financial law spelling uses adviser, while elsewhere the spelling is advisor

References

  1. The Regulation of Investment Advisers, from the SEC.
  2. A Firm is an RIA, Not a Person., forum discussion, direct link to post.
  3. Information for Newly-Registered Investment Advisers, from the SEC.
  4. A Firm is an RIA, Not a Person., forum discussion.
  5. 5.0 5.1 Registered Investment Advisor, from Wikipedia
  6. 6.0 6.1 Investment Advisor or do it ourselves, forum discussion, direct link to post.
  7. Broker-dealer, from Wikipedia: A natural person, a company or other organization that trades securities for its own account or on behalf of its customers.
  8. 8.0 8.1 8.2 Ameriprise employees sue firm for lousy 401k choices, forum discussion, direct link to post, from Rick Ferri.
  9. Bogleheads® forum post: [DOL Rule on Fiduciary Standard is Released]
  10. Investment Advisor or do it ourselves, forum discussion, direct link to post.
  11. 11.0 11.1 11.2 11.3 11.4 How to select an investment adviser, by Simple Smart Investing (forum member ihckennedy).
  12. About the Financial Industry Regulatory Authority
  13. FINRA BrokerCheck

Further reading

External links