Do You Know the Difference Between an Investment Advisor and a Broker?

Copyright (c) 2010 Tome Tomaj
White River Capital Management LLC

As an fee-only investment advisor I come across clients from all
walks of life. Lately I have noticed something in common with
many of these investors. Many do not know the difference between
an investment advisor and a broker who manages and/or makes
securities recommendations for their clients' investment
portfolios. With the almost unprecedented volatility in the
securities markets, you cannot afford to dig your head in the
sand when it comes to whom is managing your assets.

In short, an investment advisor has a fiduciary obligation to act
in the best interest of its clients. Investment advisors are
required to register either with the Securities and Exchange
Commission (SEC) or the states in which they operate in and are
regulated under the Investment Advisors Act of 1940. According to
Rule 206 of the Investment Advisors Act of 1940, investment
advisors are considered fiduciaries, and as such, owe their
clients a higher fiduciary duty. What this means in layman's
terms is that advisors must operate in a way that avoids
conflicts of interest, puts their clients' interests ahead of
their own and make a full disclosure of their fees.

On the other hand, brokers (which are registered representatives
of a brokerage firm [or in industry lingo a "broker-dealer"])
are salespeople whose primary responsibility is to help clients
buy and sell securities for their accounts. While there is
nothing wrong with this, investors should be made fully aware
that broker-dealers are subject to the Securities Exchange Act of
1934, a different regulatory rule than for investment advisors.
As such, their principal obligation is to make suitable
recommendations (emphasis ours) to their clients and as such, do
not necessarily owe their clients a fiduciary duty.

I decided to write this piece because the differences between an
investment advisor and a broker-dealer have become quite blurred
over the years. Many broker dealers market themselves as offering
financial advisor or investment consultant services. I think it
is quite critical for the general investing public to know these
differences. Many investors may have a false sense of security
that their "advisor" may be continually managing and acting in
the best interest of their clients, when in reality this may not
be the case. In addition, be aware that just because your broker
may be recommending a suitable security for you, their primary
goal may not be to act in your best interest, but rather to
generate a commission for their employer's brokerage arm.