A Registered Investment Advisor (RIA) is a firm engaged in the investment advisory business that is also registered with the Securities and Exchange Commission (SEC). By definition, RIAs are the only true source of independent investment advice, charging fees strictly for advice rather than commissions for the sale of investment products. As RIAs, they are obligated by law to act in the best interests of their clients.
RIAs operate independently without influence from securities firms, broker-dealers, shareholders, or any other element that might prevent them from offering unbiased advice. They are the only type of financial advisor that is allowed to charge a fee for investment advice, and they are compensated directly by their clients. As such, they are the only type of financial advisor that can hold claim to a strict adherence to the fiduciary standard of care.
That’s a very critical distinction because, of the nearly 650,000 financial professionals registered to sell investment products in the U.S., just over 50,000 are RIAs. That means the vast majority of financial advisors whom you are likely to meet are non-fiduciaries with no legal obligation to put your interests before their own.
Throughout time, the fiduciary status has been conferred on professionals in various fields who have specialized knowledge and provide confidential services. As such, the individuals who entrust fiduciaries with certain authority or powers are vulnerable to their possible misuse. That’s why lawyers and doctors are fiduciaries, as are Certified Public Accountants. They are held accountable by the laws and regulations that govern their conduct. RIAs are governed by the Investment Advisers Act of 1940 with the SEC as the governing body. Under the Act, the fiduciary standard was established to ensure investment advisors operate with the highest standards of care, including
As a result, clients should expect the highest level of integrity and honesty in their dealings with an RIA.
RIAs are the only type of financial advisor legally required to uphold the fiduciary standard in their dealings with clients. All other financial advisors are non-fiduciaries registered with the Financial Industry Regulatory Authority (FINRA) as registered representatives, which allows them to earn commissions from the sale of investment products. Any advice they are permitted to provide must come in the form of a product recommendation where the advice is incidental to the sale of the product.
Financial advisors come in many forms with many different titles. Such terms as “financial advisor,” “financial consultant,” and “wealth manager” are used almost interchangeably throughout the industry by stockbrokers, insurance agents, bank reps, and independent registered reps operating through broker-dealers. What all these other types of advisors have in common is that they are all captive representatives employed by their companies to sell only the products that are available on their product platform. Not only are they not legally required to meet a fiduciary standard of care in their dealing with clients, but their employers also prevent them from doing so.
Although their ranks have been shrinking over the last decade, brokers are still the most common form of financial advisor you might encounter. Before the industry abandoned the term due to bad connotations, they were called “stockbrokers.” They have since been rebranded under other names, such as “financial consultant.” But they essentially operate the same as they have for decades.
Brokers are hired by securities firms, wirehouses, and independent broker-dealers who train and compensate them for selling investment products. Their only prerequisite for the job is to pass a test and become registered with FINRA as a Series 6 or Series 7 registered representative. Because their employer compensates them through commissions, they answer only to their employers.
For the better part of the last five decades, brokers have been subject to the “suitability rule,” which has always served as a point of comparison with the RIA fiduciary standard. Essentially, the rule requires brokers to have “reasonable grounds” for recommending a specific product or investment, regardless of whether it’s in their clients’ best interest. Brokers could still recommend products that were more expensive, paid better commissions, or were inferior to other options, as long as they made a “reasonable effort” to conduct due diligence on their clients’ financial circumstances. Brokers were not required to demonstrate that the recommendation was in the clients’ best interest.
In 2020, the SEC instituted a new rule, called Regulation Best Interest (Reg BI), with the intent of raising the standard of care for brokers by requiring more in-depth disclosures, avoidance or mitigation of conflicts of interest, and more thorough due diligence to ascertain whether a recommendation is genuinely in the best interest of a client.
While Reg BI is undoubtedly an upgrade to the suitability rule, it falls short in several critical aspects. First, these obligations are not ongoing as they are in an RIA/client relationship. They are only owed at the time a particular recommendation is made. Second, the disclosures of conflict of interest, which include compensation-related conflicts, won’t necessarily reveal the depths of third-party compensation or revenue-sharing on certain investment products. Brokers can still recommend expensive products that benefit them or their firm over their clients’ interests for low-cost products.
The bottom line is that, while Reg BI attempts to raise the standard of care among brokers, it still doesn’t make them a fiduciary, which also requires their undivided loyalty to their clients.
Fortunately, you do have options when choosing a financial advisor. The challenge is finding the right one from among hundreds or thousands that work in your area (though many clients are happy to work virtually with an advisor from any part of the country). If you prefer to work with an advisor who will only serve your best interests, you need to work with a fiduciary. More specifically, you need to work with an RIA. If you want unbiased, conflict-free advice, you just need to get the answers to a few questions when interviewing a prospective advisor.
It can only be a yes or no answer. If the answer is ‘yes,’ request a copy of the advisor’s Form ADV. Form ADV is a standard form investment advisors must file with the SEC to register as an RIA. In ADV Part I, you will find disclosures about the advisor’s operation, including forms of compensations and possible conflicts of interest.
If the advisor answers ‘no’ or won’t provide you with a copy of Form ADV, you are most likely not talking to a fiduciary RIA.
Fiduciary advisors are typically compensated by their clients through fees. That way, they only answer to their clients. Fees are structured as a percentage of the amount of assets invested – generally around 1 percent. Fee-only advisors may also charge a flat dollar amount for advice, and some may charge an hourly fee.
RIAs, who also charge commissions for investment product sales, are operating as “hybrid” RIAs. If that is the case, the RIA must disclose that, when they do sell an investment product, they are not operating as a fiduciary, and they must fully disclose any potential conflicts of interest. All information on an RIAs compensation can be verified in their Form ADV.
Finding out whether an advisor is a fiduciary is essential for narrowing your choices. But there’s more to building a trusted advisory relationship. It’s important to determine if the advisor services and philosophy are compatible with your particular needs and values. So you need to ask two more questions:
It’s important to know whether the advisor can deliver the type of service you need to feel comfortable in the relationship. You need to know what services the advisor provides, the frequency of client meetings, how and when the advisor will communicate with you, how promptly your calls will be returned and whether you can expect to hear from the advisor or a staff person.
It’s critical to work with an advisor whose values and principles are compatible with your own. Ask the advisor for a copy of his written investment policy statement and ask to see a client profile to see if the advisor works with people like you.
In addition to getting the answers to these critical questions, you should conduct your own due diligence into the advisor’s experience, education, credentials, and disciplinary record. Industry sources, such as FINRA’s BrokerCheck.com, provide an easy way to research advisors’ backgrounds.