Why You Must Know the Difference Between Brokers and RIAs

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An ominous gray cloud continues to form overhead.

Before you get caught in a storm burst, we want you to know how to protect yourself.

In the next few paragraphs, I’ll define some valuable terms:

  • RIA vs. hybrid broker.
  • Best interests vs. suitability.
  • Fee-only vs. fee-based vs. commission.

Allow me first to explain the various (confusing) business models or channels by which our industry operates. Sophisticated investors, please excuse the 101 lesson. For others, knowledge is power.

Financial Advisor Channels

Our industry overcomplicates itself with definitions. Many models exist: Retail banks; Wirehouses (full-service brokerages) like Bank of America’s Merrill Lynch, Morgan Stanley Smith Barney, UBS and Wells Fargo; Regional firms like Raymond James or Ameriprise Financial. Boutiques like Credit Suisse; Discount brokerages like Scott Trade; Multi-family offices for intergenerational wealth.

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I want to focus on two key channels. First, Broker-Dealers (B-Ds). BD “advisors” are independent contractors and do business under their firm name or a larger BD, like LPL for back-office support.

Regulated by FINRA, the Financial Industry Regulatory Authority, B-Ds comprise members from the industry who, in effect, self-regulate. Banks own many broker-dealers, and they follow the “suitability” standard─investments made on behalf of a client must be suitable for the client at the time purchased. Further, they are fee-based, not fee-only, which means they can charge clients a fee to develop a financial plan, then charge more fees (or commissions) to implement the plan.

Registered Investment Advisors (RIAs). The RIA model came about after the Great Depression ended in 1939, presumably as a protective reaction to massive investor losses. RIAs hold a “fiduciary duty” to clients, which means they are legally obligated to always act in the “best interest” of clients, a major differentiator from B-Ds.

Under a fiduciary standard of care, your RIA must ensure the appropriateness of any risky investment under all circumstances. The Securities and Exchange Commission (SEC) or state regulatory bodies regulate RIAs under the 1940 Investment Advisors Act.

True RIAs are fee-only advisors, another major differentiator, and do not accept any fees or compensation based on product sales, which means no inherent conflicts of interest. Clients agree in advance to a fee tied to the value of the assets for management of the account, the only fee charged. No trailing commissions on mutual funds. No hidden fees on anything. Full stop.

While I admit to bias, RIAs provide more comprehensive advice, in part, because they are duty bound to clients to show transparency, impartiality, and full-disclosure of fees. Always know the compensation mechanism of your advisor.

Roush Investment Group operates as a RIA, working in your sole and best interest. RIAs give up their Series 7 securities licenses. If we fail our fiduciary duty, we can go to prison. No other business model in the industry─except the RIA─follows the higher fiduciary standard of care, signs an oath to adhere it, and faces criminal charges if it fails to meet the standard.

Enter the Grey Clouds

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Another channel has emerged in recent years: Hybrid Advisor. And here is where it gets complicated for clients. Dually registered with FINRA and the SEC, hybrids have the option to take any business, whether fee-based or commissioned, even with the same client. Yes, you have a choice on how to be charged. And, yes, you can access many products or services from a variety of firms.

But you may never know when the hybrid decides to push a “suitable” product to you for higher commission or decides instead to offer you fee-based advice because they:

  • hold a Series 7 (securities license) with their broker-dealer
  • must meet annual commission quotas by selling an amount of IBD registered shelf product
  • often work for fee-only, but conflict arises from products used in a fee-based structure
  • may even lead with RIA role; however, waters muddy quickly, and you may not know
  • face only fines and termination for bad behavior; RIAs face jail

Broker-dealers may state they support the fee side of the business; a hollow declaration because they stand to earn substantially more money if their reps sell commission products. At your expense.

Given a choice between making more money and doing the right thing? After all, there’s a reason why greed is one of the seven deadly sins.

What’s more, broker-dealers owned by banks do not want the liability exposure of a fiduciary standard of care. Suitability works fine for them. However, clients realize no benefit. In fact, the entire hybrid structure does not benefit the client, only the hybrid “advisor.”

Please understand, an ocean of difference exists between the prudent recommendations of a RIA and the suitable recommendations of a hybrid, fee-based advisor.

The impetus behind the hybrid channel is the broker-dealer. It uses the channel as a flexibility magnet to attract and hold those advisors who do not want to tether to only a broker-dealer or RIA.

I’m not saying they are “bad actors” in an industry already fraught with trust issues; I am saying caveat emptor, buyer beware.

Shelter in a Storm

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You can get out from under the gray cloud of uncertainty. You can adopt certain protective gear. No matter from whom you seek financial advice, ask the following questions and clear the air. If the person at the other end of the question hesitates at all, or succeeds in hedging an answer altogether, he or she likely has a conflict of interest and is not operating in your best interest.

 1. Are you familiar with the Fiduciary Oath from the Committee for the Fiduciary Standard?

If, yes, continue with next question. If no, walk away.

2. Describe for me your Fiduciary Oath and would you sign it for me?
If, yes, continue with next question. If no, walk away.

3. Are you affiliated with a broker-dealer? Or a bank?
If, yes, continue with next question. If no, continue to probe.

4. Can you tell me what to expect from products or services?
Listen very carefully and take notes.

5. Are there any disclosed or non-disclosed benefits or commissions which accrue to you?
Depending on the answer, reconsider working with the advisor to protect your money from fee erosion. Banks and broker-dealers hide fees.

We do not believe your interests should be subordinated to the financial interests of the industry.

We do believe anyone calling himself or herself a financial advisor or consultant should be held the fiduciary standard of conduct.

And, we believe you deserve the tools necessary to distinguish between higher-quality advisors and lower-quality advisors.

This email address is being protected from spambots. You need JavaScript enabled to view it. with a simple “I want the Fiduciary Oath,” and we will send it to you shortly to help you with questioning advisors.

In our next post, I’ll discuss the new Department of Labor Fiduciary Rule which went into partial effect June 9 and its implications for retirement plans and the investment advisory business.