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Broker Vs. Investment Advisor

Securities Lawyer Jonathan Kurta
By: Jonathan Kurta Author

Is your financial professional a broker, an investment advisor, or both? Investors may not realize that the SEC and FINRA regulate these terms and that different investment professionals have different obligations to their clients.

Brokers execute securities transactions and recommend investments. Investment advisors or financial advisors offer more holistic investing advice that may involve retirement planning and insurance policies. In the securities industry, investment advisors who register with the SEC are also referred to as Registered Investment Advisors (RIAs). Many investment professionals register as both brokers and RIAs so that they can provide their clients with both types of services.

Investment advisors and brokers have similar roles, but there are a few important differences, including:

  1. Their obligations to customers,
  2. How they are paid,
  3. How they settle investor disputes and allegations of securities fraud, and
  4. The regulatory bodies that oversee their work and ensure compliance with securities laws.

Other Types of Professionals in the Financial Industry

Brokers and investment advisers are just two types of professionals within the wealth management sphere. For instance, wealth management brokers also offer accounting and tax services, whereas financial planners specialize in budget advice, and they may or may not be registered as financial advisors or brokers.

What is a Broker?

A broker is an investment professional who executes securities transactions. With the advent of online trading platforms, many investors manage their investment portfolios themselves. Before online trading, investors would call their brokers and tell them what shares they wanted to buy and sell. Brokers still execute trades, although they typically offer more bells and whistles, including advice about how to invest.

Investors who rely on their brokers for recommendations are vulnerable to broker fraud. They may not have the experience or willingness to examine an investment’s prospectus to assess its level of risk.

Brokers execute transactions either via a stock exchange or over-the-counter (“OTC”). OTC securities are not listed on the public stock exchange and are sold by smaller companies.

Brokers register with the Financial Industry Regulatory Authority (FINRA). They must obtain a FINRA license and register with a broker-dealer before they can legally buy and sell securities.

What is an Independent Stock Broker?

Independent stock brokers work with independent broker-dealers, allowing them to work without the supervision of an external employer. These types of brokers typically work with high-net-worth individuals. In addition to registering with regulators like the SEC and FINRA, the broker-dealer must also register with the Securities Investor Protection Corporation (SIPC) which serves as federal insurance for clients. Brokers may want to work independently to earn higher commissions than they would while working for a broker-dealer.

What is a Broker Dealer?

“Broker-dealer” is the term for the financial institution that investors use to place trades. Brokers are representatives who place the trades, and the dealers operate a platform that enables the sale of securities. A dealer may also buy and sell securities from its own account, either on behalf of customers or for itself. Registered broker-dealers are also regulated by FINRA.

What Does a Broker-Dealer Do?

Broker-dealer services include providing investment research to financial professionals so they can make informed investing choices for their clients. IPOs offered through broker-dealers provide companies with the essential opportunity to raise capital.

Brokers execute transactions for a fee, which is typically a small percentage of the total share price.

  • Full-service brokers recommend investments.
  • Discount brokers, like E*Trade, only offer the ability to buy and sell securities, without any guidance from a registered representative.

What is an Investment Advisor?

Investment advisors register with the Securities and Exchange Commission (SEC). These investment professionals are fiduciaries, which means that they are required by law to act in their client’s best interests. Investors can search their investment advisor’s name on the SEC’s Investment Adviser Public Disclosure database (IAPD) to review any possible history of misconduct or regulatory actions.

What Does an Investment Advisor Do?

As their title suggests, investment advisors provide investors with advice on how best to invest and manage their wealth. They may also advise their clients on estate planning and retirement. Investment advisors might recommend a certain type of insurance or offer advice on how and when to withdraw for the best tax advantages.

To learn more about your Registered Investment Adviser’s duties and obligations, ask to review their Form ADV. This form includes information about the advisor’s fees, conflicts of interest, and information about any disciplinary history they might have.

Dually Registered Financial Institutions

Just as an individual can be both a broker and a registered investment adviser, a financial institution may be both a broker-dealer and investment advisor. Big-name firms like Merrill Lynch, J.P. Morgan, and Morgan Stanley are all registered as both.

Brokers vs. Investment Advisor: Payment

RIAs may provide portfolio management and execute securities transactions on behalf of their client without their client’s approval of each transaction. Typically, investors are paid a fee based on the dollar amount of the assets under management (“AUM”).

Brokers are paid a commission per securities transaction. Investor disputes often arise because a broker values their commission more highly than their customer’s financial well-being.

Broker vs. Investment Advisor: Regulations

It may alarm investors to learn that brokers are not fiduciaries. They are, however, required to adhere to industry rules and regulations when recommending investments.

FINRA Rule 2111 – The Suitability Rule

FINRA Rule 2111 requires brokers to exclusively recommend investments that match the criteria set out by the investor’s profile. The investor’s profile provides details on their age, investing goals, investing experience, tax status, other investments, liquidity needs, and overall risk tolerance. Investment recommendations that do not consider these factors – for instance, long-term or risky investments for elderly investors with conservative risk tolerance – are often the subject of investor disputes. The investor may also disclose information to their investor about their investing goals that the broker must factor into their recommendations.

Regulation Best Interest

In 2019, the Securities and Exchange Commission adopted Regulation Best Interest, which expands on the requirements of Rule 2111. This regulation added requirements and obligations for brokerage firms and their registered representatives.

Customer Relationship Summary

Under Regulation Best Interest, Brokers must provide investors with a Form CRS, or the Customer Relationship Summary. This disclosure will inform investors whether the broker-dealer or associated representatives have disciplinary histories. For details on these disclosures, investors typically have to look up the broker’s CRD number on BrokerCheck themselves.

Disclosure Obligation

Broker-dealers and associated representatives must disclose the following:  

  • All material facts relating to the scope of the relationship with the retail customer, and
  • All material facts relating to conflicts of interest that are associated with the recommendation.

These disclosures must be “full and fair,” meaning that they include all the information an investor would need to make an informed decision.

Material facts include information about the fees and costs associated with transactions and accounts, as well as any limitations related to the type of security at issue.

Conflicts of Interest

This includes information about any compensation or commissions associated with proprietary products that might affect the broker’s decision to recommend a security. The broker-dealer is also required to identify and mitigate any conflicts of interest.

Duty of Care

Brokers are required to make a good-faith effort to understand the products they recommend. They must also have a reasonable basis to believe that their recommendations will benefit their investor. This also applies to a series of transactions, which must not be excessive. Transactions can be excessive when they incur so many fees that the investor’s portfolio struggles to generate a return.

Broker vs. Investment Advisor: Investor Disputes

The difference between these two designations matters when you go to pursue a complaint against your financial professional.

If your registered representative is solely registered as an investment advisor with the SEC, you can file a complaint with the SEC and your state securities regulator.

Investors who work with FINRA-registered brokers will probably be required to use FINRA arbitration to settle the dispute. Typically, an investment contract will come with a “pre-dispute arbitration” clause that requires them to settle disputes using FINRA arbitration. FINRA arbitration is different from a civil trial, and a securities attorney’s expertise can help instill confidence in the proceedings.

What if I Have a Dispute with My Advisor or Broker?

If you lost money with a FINRA-registered broker, your FINRA arbitration case may benefit from the assistance of a securities attorney. Not sure if you have a case for FINRA arbitration? Kurta Law investment fraud attorneys will evaluate your case for free.

Securities Lawyer Jonathan Kurta
Written by: Jonathan Kurta

Jonathan Kurta is an accomplished securities attorney and a founding partner at Kurta Law.