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Brokers, Advisors and Planners! Oh My!

BLOG, EDUCATION  |  15 Dec 2009

I spend a lot of time explaining what we do here at Focus. I suspect that most other fee-only financial advisors do the same. It’s not that the folks we are explaining ourselves to are simpletons. They most clearly are not. They are people of above-average intelligence, just like all of our clients here at Focus. It’s just that the subject matter is confusing, and it doesn’t need to be. Part of the problem lies with the sheer number of professional designations that are used in the investment and finance field. There are stockbrokers, investment advisors, financial advisors, financial planners, registered representatives, and investment advisor representatives. Some of these terms have strict legal definitions restricting who can claim the designation, while one of the terms is completely unregulated. In the middle are titles whose legal restrictions allow them to be used by more than one type of financial professional. It is this latter class of designation that causes most of the confusion. I’ll try to clear the air with some brief explanations of what each of these titles actually mean.

Broker (or Stockbroker): We are going to kill two birds with one stone on this one. Many people use the word “broker” generically to describe someone who handles stock transactions, but a broker is actually the company that that person works for. Sales personnel who work for broker-dealers are technically known as registered representatives (bird #2). So your friend from the club, Sven, who you thought was a stockbroker working for Stable Rock, is really a registered representative, and Stable Rock (that’s what I would name my brokerage) is the broker.

Financial Planner: This title is almost completely unregulated. My children could set up a stand in front of my house today with a hand-painted sign identifying them as Financial Planners, and the only governmental entities that could take action against them would be the zoning board and perhaps the Department of Children and Family Services, who would come after me, not the kids. Financial Planners are not required to have any financial credentials, and they do not have their own regulatory agency monitoring their activities. However, many people holding themselves out as financial planners are engaged in related professions. They could be accountants, insurance agents, registered representatives, or investment advisors, all of whom are subject to professional regulation.

Financial Advisor: Here again, we have a commonly used designation that does little to inform consumers as to what it means. Most people calling themselves financial advisors are either registered representatives working for brokers, or investment advisor representatives working for registered investment advisors. Like the title financial planner, you could probably get away with calling yourself this without any industry credentials, as long as you avoid giving advice and selling product related to investments or any of the other regulated areas.

Investment Advisor: Now, this is a title that is regulated. An investment advisor is “any person who, for compensation, engages in the business of advising others as to the value of securities or the advisability of investing in securities or, as part of a regular business, issues analyses or reports concerning securities.” Because a big part of what we do at Focus involves investments, we are considered investment advisors. As such, we are required to be registered with the Securities and Exchange Commission. Smaller investment advisors (those with less than $25 million under management) are required to register with state regulatory agencies. Once an investment advisor registers with the SEC or a state regulatory agency, the firm, or the firm’s owner is known as a Registered Investment Advisor. Anyone working for a registered investment advisor who advises clients regarding investments or manages client accounts is called an Investment Advisor Representative.

After reading the definition of Investment Advisor, you might come to the conclusion that stockbrokers (registered representatives) are investment advisors. After all, they certainly give advice about investing in securities. But alas, they are not. In fact, stockbrokers are specifically excluded from the definition of investment advisor. Why is that important? It’s important because those of us who are required to register as investment advisors are also required to act as fiduciaries with respect our clients, placing their interests before our own. In contrast, a stockbroker’s first duty of loyalty is to the brokerage itself. This distinction arises from the fact that stockbrokers make a living by selling investments, and the advice they provide is “merely incidental” to the sale. Investment advisors, on the other hand, are compensated for the advice they give, and are therefore held to the much higher fiduciary standard. Investment recommendations made by brokers are only required to be “suitable” to the client.

So if stockbrokers are not investment advisors required to work under the fiduciary standard, surely they cannot call themselves investment advisors! Or can they? The unfortunate answer is yes they can, and they often do.

I’m sure this is all as clear as mud to you by now. So how do you know which standard of care an investment advisor is working under? Ask questions. Is my account a brokerage account or an advisory account? Is your firm a registered investment advisor or are you a broker/dealer. These are questions you must have answered, as it is absolutely critical to you to know if your investment professional is acting in your best interest or merely the best interest of his employer.

Next time, an equally stimulating discussion on the riveting topic of the differences between commission-based, fee-based, and fee-only accounts.