When seeking professional financial guidance, there are two main options: brokers and investment advisors. There are several similarities, as both brokers and financial advisors offer professional financial advice. While these jobs may seem indistinguishable at first, in reality, there are significant fundamental differences between the two.
Investors should be aware of these differences and their implications before hiring a financial professional. Additionally, while most financial professionals are honest, investors will also need to be aware of how these differences pertain to their legal rights if they become victims of investment fraud or misconduct. You can learn more about these legal rights in a free consultation with the securities lawyers at McCarthy, Lebit, Crystal & Liffman Co., LPA.
What Does a Broker Do?
The emergence of online trading as the dominant form of investment has changed the role of the broker significantly. Previously, brokers were generally a luxury that only the rich could afford, as investors did not have direct market access and were required to place their orders through a licensed broker. However, low-cost online brokerages have allowed investors to make their own buy and sell orders.
Brokers do still handle these orders for some clients, but most have expanded their professional role to encompass additional services, such as personal investment management. Many brokers are also registered as investment advisers. This expansion of services is often used as a justification to charge higher rates, as brokers are unable to compete with the affordable rates of low-cost online markets if they only offer buy-and-sell services.
Modern brokers also sometimes work on sales teams and with the corporate finance team at their firm, selling deals to clients to help earn profits for the firm. In exchange for these sales, brokers usually receive additional compensation in the form of commissions, shares, or warrants.
What Services Does an Investment Advisor Provide?
Rather than relying on commissions, investment advisors charge their clients a fee in exchange for ongoing and personalized investment advice. This fee is often based on the size or performance of the client’s assets.
In many cases, an investment advisor will manage the client’s entire investment portfolio and help them develop a comprehensive wealth management plan. These services may also include assistance with taxes, estate planning, and mortgage planning.
An investment advisor is not the same as a financial advisor. “Financial advisor” is a relatively generic term that may apply to different types of financial professionals, but it often refers to brokers. Conversely, “investment advisor” is a legal term with a more rigid definition, with specific regulatory and fiduciary requirements.
What Are the Regulatory Differences Between a Broker and Advisor?
Investment advisors and brokers are bound by different regulatory and legal standards. An investment adviser is required to abide by the fiduciary duty under the Investment Advisers Act of 1940. Brokers, on the other hand, are required to register with the Securities and Exchange Commission (SEC) and a self-regulatory organization working under the SEC, the Financial Industry Regulatory Authority (FINRA).
The Fiduciary Standard
While some brokers are also fiduciaries, there is no legal requirement for a broker to follow this standard. (And here we have to insert the typical lawyer caveat: the SEC’s relatively new Regulation Best Interest does impose a form of fiduciary duty upon brokers, though the regulation is so new there is not a well-established body of case decisions interpreting it.) However, all investment advisors are required to be fiduciaries. The fiduciary standard requires investment advisors to only make recommendations that are in the best interests of their clients. According to this standard, an advisor must place their own interests below those of their clients.
The fiduciary standard is regulated by the SEC and state securities regulators. Investment advisors and fiduciary brokers are prohibited from making transactions that are not in the client’s best interests, such as buying securities for their own portfolios before purchasing them for clients. Additionally, fiduciaries may not make trades with the primary intention of earning higher commissions for the fiduciary or their investment firm.
Advisors also have a legal obligation to conduct thorough research and analysis before offering investment advice to their clients. Trades must also be made under the standard of “best execution”, which means that the advisor must attempt to make trades with the best combination of low cost and effective execution.
The Suitability Standard
Before Regulation Best Interest (“Reg BI”) went into effect in mid-2020, brokers were obligated to follow the suitability standard, which is more loosely defined than the fiduciary standard. According to the suitability standard, the broker only needs to make recommendations that are suitable to the client’s needs, such as their financial goals and risk profile.
The suitability standard is defined and enforced by FINRA. Non-fiduciary brokers are required to meet the following three general requirements of the suitability standard:
- Reasonable basis – An advisor must have a reasonable basis to believe that a financial recommendation or strategy is suitable for at least some investors. The client must also be made aware of the possible benefits and risks of the recommendation.
- Customer-specific – All recommendations must be suitable to the individual client based on their unique investment profile. The advisor must consider various client-specific variables, including their risk tolerance and investment timeline.
- Quantitative – Advisors who control their client’s accounts must have a strong reason to make recommended transactions, either as part of a long-term strategy or an isolated transaction. Transactions must not be excessive or unsuitable for the client’s needs.
Reg BI does not discard the requirements of the former suitability standard, and arguably makes the requirements more stringent, calling for brokers to put clients’ interests first and avoiding conflicts of interest where possible, and disclosing those conflicts where they are unavoidable. One feature of Reg BI is the requirement that, if two investment products are substantially identical, the broker must offer their client the less expensive option.
Do Brokers and Advisors Have Different Testing and Licensing Requirements?
There are key differences in the testing and licensing requirements of brokers and investment advisors. Brokers are required to pass the General Securities Representative Exam, also known as the Series 7. Aspiring investment advisors must pass the Series 65 exam before they can offer professional financial services.
In the United States, brokers must pass the Series 7 exam to obtain their trading license. Candidates must be sponsored by a FINRA member firm or other applicable self-regulatory organization member firm before they can take the exam.
This exam covers the following financial services and investment topics:
- Investment risk
- Debt instruments
- Packaged securities
- Retirement plans
- How to effectively interact with clients
The exam assesses the broker’s competency as a registered financial representative or stockbroker in the securities industry and tests the candidate’s knowledge of basic, fundamental securities information and concepts.
Those who pass the Series 7 exam will be entitled to sell all types of securities products, except for commodities and futures. In some states, registered representatives must pass both the Series 7 and Series 63 exam.
The Series 65 exam is also administered by FINRA, but unlike the Series 7, applicants do not need to be sponsored by a FINRA member firm to take the exam. Also known as the Uniform Investment Adviser Law Examination, this exam covers a wide range of relevant topics important to working as an investment advisor – including laws, regulations, ethics, and other relevant topics.
Applicants who pass the Series 65 exam are qualified to act as investment professionals and to serve as Investment Adviser Representatives in certain states.
Here is a brief overview of the content of the Series 65:
- Economic factors and business administration – Accounts for 15 percent of the exam and covers monetary and fiscal policy, financial reporting, economic indicators, basic risk concepts, and quantitative methods.
- Investment vehicle characteristics – Worth 25 percent of the exam, this section covers cash and cash equivalents, fixed income securities, methods of fixed income valuation, equities and equity valuation methods, derivative securities, insurance-based products, and pooled investments.
- Client investment recommendations and strategies – Accounts for 30 percent of the exam, and addresses recommendations and strategies for individuals, business entities and trusts, client profiles, capital market theory, portfolio management styles, tax considerations, retirement planning, strategies and techniques, ERISA issues, special account types, trading securities, performance measurement, and exchanges and markets.
- Laws, regulations, and guidelines – The final 30 percent of the exam covers state and federal securities laws; rules and regulations for investment advisors, investment advisor representatives, broker-dealers, and agents; ethical practices; and fiduciary obligations, such as communicating with clients, client funds, conflicts of interest, and compensation.
Liability Differences: Suing a Broker vs. an Investment Advisor
If a client loses money because of negligent or fraudulent actions by their broker or investment advisor, the client may have legal grounds to recoup these losses. Claims against brokers almost invariable proceed in a FINRA-sponsored arbitration, where claims against RIAs will be resolved in whatever forums are identified in the clients’ agreements with their RIAs (or in court if the opening account agreement does not specify a forum).
Claims brought in arbitration are often different than those brought in court. FINRA, for example, does not require that an investor plead a particular cause of action like negligence, fraud, or breach of fiduciary duty. Other arbitration forums, like the American Arbitration Association or JAMS do often require that claims be plead as they would in court. The manner in which the claim is pled often has a material effect on the investor’s likelihood of recovery.
A successful claim requires a number of steps to start:
- A determination of whether someone acted wrongfully and is therefore liable;
- A calculation of the likely range of damages that could be recovered;
- A determination of the forum in which the claim will proceed; and,
- An estimation of the costs to be incurred prosecuting the claim and a comparison of those expenses against the likely recovery.
Contact Our Securities Fraud Lawyers to Learn More
Suffering unjust investment losses due to misconduct by a broker or investment advisor can be extremely stressful, as it may feel like you have no recourse. However, victims of investment fraud and negligence have legal options to recoup their losses. Contact McCarthy, Lebit, Crystal & Liffman Co., LPA to learn more about your legal rights.
Hugh Berkson is a Securities Attorney with McCarthy, Lebit, Crystal & Liffman, Co. LPA. Hugh is rated AV® Preeminent™ by Martindale-Hubbell®.
He obtained a business degree in Finance from the University of Texas at Austin in 1989, and is a 1994 graduate of Case Western Reserve University School of Law, where he was a member of the Order of the Barristers and received both the American Jurisprudence Award, (National Mock Trial) in 1993 and the Jonathan M. Ault Mock Trial Prize for 1993-1994.