Wall Street V. Main Street Podcast – Episode 6 – The differences between brokers and investment advisors
The following is a transcription of a recent episode of Wall Street vs. Main Street, a radio show hosted by the firm’s managing partner D. Daxton White.
In this episode, Mr. White discusses the differences between brokers and investment advisors with respect to duties, registrations, and products they can sell.
Producer: Welcome to Wall Street versus Main Street, a different take on the investment show with our host Dax White. Dax White is the managing partner of the White Law Group, a national securities fraud, securities arbitration and investor protection law firm with offices in Chicago, Illinois and Vero Beach, Florida. The White Law Group has represented hundreds of investors in FINRA arbitration claims against their brokerage firms and throughout this show Mr. White will shine a light on some of the tricks of the brokerage industry while also providing valuable information for investors on how to successfully navigate the investor/financial advisor relationship
Dax: Welcome everyone; you’re listening to Wall Street v. Main Street. I’m your host Dax White and as the intro indicated, this is a different take on the investment program and I’m not going to be giving investment advice. I am not a licensed investment professional but rather a securities attorney that handles litigation cases against brokerage firms. The objective of this show is to pass along some of the information that I’ve learned in that role to sort of try to arm investors with what I think would be valuable information in evening the playing field between the investor and the broker. Give them some of the information that would allow them to have a more productive relationship with their financial advisor and sort of arm you with information that I think would be helpful to make sure that you’re not being taken advantage of. That’s the objective of the show. This week I will try to tackle the difference between a financial adviser and an investment advisor. A very nuanced language difference but there’s actually quite a big difference there and I think it’s one that most investors aren’t aware of. I think it’s worth hitting on so that you have a sense of, which one am I dealing with. Is my financial advisor – are they a broker? Or an investment advisor? Because I think it’s important in terms of understanding what are their duties to you, how are they being compensated and if something goes bad, what are the differences in terms of litigation. That’s what I will try to tackle today.
In jumping right in, the first fundamental difference between a financial advisor. A financial advisor is generally someone who works at either a wire house like a Morgan Stanley or Merrill Lynch or even some these independent firms like Raymond James, LPL, Commonwealth. There’s hundreds and hundreds of brokerage firms. But a financial advisor is someone who has a 7 license to sell securities and they’re regulated by FINRA and they usually work at a brokerage firm. An investment advisor is somebody who is regulated by the SEC and they’re compensated differently and they usually work for what’s called a registered investment advisory firm. And that affects their duties to you and how they are compensated. We are going to go into those nuances. But just broad strokes that’s what those two entities are. Those two types of professionals. The first one again has to do with regulation. Brokerage firms are self regulated by what’s called FINRA. FINRA is literally the self regulatory body of the brokerage industry; they are paid for by the brokerage industry. It’s a very overt conflict of interest in my view but it is what it is, that’s the way it is in our country. The brokerage firms pay in money to FINRA and FINRA comes out and audits them and makes sure that they are complying with FINRA and SEC rules.
So if you’re with a financial advisor, if you’re with a Morgan Stanley or Wells Fargo, those types of firms, your financial advisor is being regulated by FINRA. If you’re with an investment advisor, your investment advisor is being regulated by the SEC. The difference there, it’s nuanced, both of them have similar rules and both of them have very excellent regulators but my experience, the fundamental and largest difference there is that the SEC is spread much thinner than FINRA in terms of its supervision. And whether it’s a funding issue or just a numbers game I’m not sure, but the reality is investment advisors in my experience are not regulated as frequently or as strenuously as FINRA firms. So if you’re with an investment advisor, that’s not an indictment on them. That doesn’t suggest that they are good or bad. But it of concern to me as somebody who sees fallout, who sees outcome, and always a bad outcome. It’s a concern to me because if you have a bad investment advisor they are less likely to get caught. That doesn’t mean that FINRA is perfect or that they catch financial advisors in every context. But in my experience they are regulated more strenuously and more regularly. So that’s the first fundamental difference.
The second one has to do with their duty to you. In the brokerage firm context while most clients think my financial advisor has to look out for my best interests, the reality is that the standard that the brokerage firm believes that it has to you is what’s called the suitability standard. Their obligation to you is to make an investment recommendation that is suitable for you and what is suitable for you is not necessarily always in your best interests. And I’ll explain that in an example. Let’s say that there is a mutual fund that would be suitable for you. You want growth and it provides growth and you want large stocks making up the mutual fund and that’s what this one has. So this particular mutual fund might be suitable for you. But let’s say this mutual fund pays 4% and there’s another one with virtually identical investments that pays 1%. The broker in that context doesn’t have an obligation to pick the one that pays 1%, which would clearly be in your best interest. They can pick the one that pays 4% because it’s suitable. So that’s a very important distinction in terms of their duty to you and why, we touched on it last week, in terms of vetting your financial advisor, why it is always important to ask them how they are being compensated and whether or not they consider themselves to have a fiduciary duty to a client. Because this is an industry thing, industry standard in terms of the brokerage industry, but that doesn’t mean that you don’t have financial advisors out there who think that they do have fiduciary duties and that’s how they operate their business and they would therefore pick the mutual fund that pays 1%. It’s important to ask them that question. But in terms of the accepted industry standard, the standard suitability for a financial advisor, for somebody who is regulated by FINRA.
An investment advisor on the other hand, does generally have a fiduciary duty to you. So that is something that would be a pro for an investment advisor because generally speaking, that’s their obligation to you. When they’re making a recommendation, not only does it have to be suitable but it’s also got to be in your best interest. And in that same example, an investment advisor would be required to make the recommendation of the mutual fund that fits your needs and has the lower commission. The next big difference is how they are generally compensated. In the brokerage firm context, the ones that are regulated by FINRA, again, your Morgan Stanley, your Merrill Lynch, your Smith Barney, etc., in that context, there are two models. There is commission based, which is transactional base, they make a recommendation, you agree, you buy it, and you pay them a commission for the recommendation. Or there is the assets under management model which is you have a portfolio of $1 million and you pay your broker 1% and so they take 1% of the average of the portfolio. The theory behind that one is that gives your financial advisor a motivation to sort of be on the same team with you. Let’s grow this portfolio because if you grow it you’ll get paid more. But in the brokerage firm context, you could get either and you have to have a conversation with your advisor to figure out which one you’re getting.
In the investment advisor relationship it is generally an assets under management model, it’s not typically commission based. Again, in terms of what’s better for you it really depends on the type of portfolio that you’re constructing. If you’re a retired investor who doesn’t trade much and just buys and holds and is looking for some income, maybe the commission based approach would be better because maybe you’re only doing two or three trades a year and you don’t want to be paying 1% for talking to your broker two or three times. If you’re more involved, more active, maybe the assets under management approach is better for you because if you were paying commissions every time you traded, that would add up to far more than the 1%. So in terms of which is more appropriate, that really depends on you. But in terms of who you’re dealing with, whether it is a financial advisor or investment advisor, that’s the two differences that you’ll typically see in terms of what you’re probably getting. If you are with an investment advisor you’re probably getting some sort of number based on your assets and if you’re with a financial advisor it may be more of a commission based model. So you need ask that question.
The other differences and this to me is perhaps more significant because whether it’s a financial advisor or investment advisor is not going to be an initial indicator of good or bad. There are good financial advisors, bad financial advisors and there’s good investment advisors and bad ones. Which they are is really not an indicator of, okay this is a good one, this is a financial advisor, and this is the one I want. But where you do get into perhaps a meaningful difference is in the litigation context. The financial advisor is registered through FINRA and because of that they are beholden to some of the FINRA rules which include litigation. If you have a dispute with your financial advisor, typically in the agreement somewhere there is language that says you agree to waive your right to sue us in court and instead you have to sue us through what used to be called the NASD, which is now called FINRA. If you have a relationship with a financial advisor regulated by FINRA, that’s where your disputes will be heard. It will be heard through FINRA and there some advantages to that relative to investment advisers. Number one, it’s obligatory. You can’t be with a financial advisor who doesn’t respond to the FINRA dispute and throws up his hands and says, “Ha ha, you can’t get to me.” FINRA has protections in place for investors that if you get an award against the financial advisor or brokerage firm and they don’t pay it within 30 days they lose their license. They are out of the business.
That is a huge protection and a huge hammer that requires these guys or girls to show up and defend themselves because if they don’t they know they can lose their license. That is, in my view, a very huge protection and a pro in terms of the financial advisor versus investment advisor.
If you’re talking about bad outcome, if you’re talking about, “Hey, this could go bad, I want to be protected you are typically better off with a financial advisor. Because you’ve got more protection there. In the investment advisor context, the ones who are regulated by the SEC, they don’t have that same default; this is where the case is going to be heard. Instead what I’ve seen is the investment advisor draws up an agreement and the litigation forum. They are usually going to get you to waive your right to court particularly if they’re smart, and if they’re really smart, they’re going to put in some sort of arbitration agreement that is extremely onerous on you. And by that I mean they are going to pick a forum that’s very expensive. They will often pick a venue that’s difficult for you to get into. I’ve seen these agreements for investment advisory firms where the process that’s selected is what’s called JAMS. JAMS is a very expensive arbitration forum mostly because the arbitrators in that forum are retired judges. You are paying them by the hour, their hourly rate. So you can have arbitration in JAMS that could cost $50,000 just in arbitration fees and investment advisors, if they are savvy enough, know that. They know the threshold of cases that will be brought through JAMS is very high. You’re not going to bring a $100,000 loss in a forum where the fees might be $50,000. The other thing that they’ll do in those types of agreements is they’ll pick a venue that’s not where you live. They’ll say that it’s mandatory that you file in Los Angeles and maybe you live in Atlanta. Making it that much more difficult for you to bring the claim. That to me is a very fundamental difference between the two and certainly if you’re talking to an investment advisor pay very close attention to their agreement, in total. But certainly the litigation aspect of it in terms of where the claim can be brought because, hopefully the relationship goes fine, but if it goes bad you don’t want to be stuck in a situation where your Colorado lawyers and no one will bring the case because the fees are too expensive and the arbitration forum that’s required per the agreement. So that’s a very fundamental difference.
The other difference between the two and this again goes more into the litigation context but in my experience, for brokerage firms, it’s a lot easier for lawyers like myself to figure out collectability with brokerage firms. Generally speaking, if you’re FINRA registered broker, still registered, you’re going to have an incentive to try to resolve the case and it’s for the same reason I mentioned before. If you don’t resolve the case FINRA will take your license within 30 days and so if you’re still operating as a brokerage firm, still making revenue in the industry, that’s not something you want. So you are typically going to respond to the FINRA complaint, try to either resolve it or if you lose, you’re generally going to pay unless it’s just reached that point that you just don’t have the money to do so.
In the investment advisory context it’s more complicated. You don’t have that same hammer. The SEC doesn’t step in and shut them down if they don’t pay an award and so it’s more difficult, number one, to force them to pay. It’s also more difficult for lawyers to sort of vet them and figure out whether or not there is an ability to pay. So you end up in situations at least with respect to my firm, where I am much more apt to bring a claim against a FINRA registered broker-dealer than I’m not. I’m looking worst case scenario, the reality is worst-case scenario might be one to maybe even 5% of the time are you going to be in a situation where you even need to sue your financial advisor or your investment advisor. But if you’re vetting somebody and that’s what we talked about last week. Let’s vet our financial advisor. Let’s pick the right one, then that is something that you probably should be considering. What is the likelihood of this going bad and if it does, how am I protected? And to me that’s a big difference between financial advisors and investment advisors. Generally speaking, if you’re involved with a financial advisor and it goes bad your ability to find remuneration through a lawsuit is much better than if you’re dealing with an investment advisor. So certainly something to consider, that some of the differences. We are going to a break soon, but when we get back, we’ll talk about how there’s another wrinkle and there’s another type of person out there who might be selling you investments that’s neither a financial advisor or investment advisor making it that much more complex. But I’ll try to bring some clarity to it.
Welcome back to Wall Street versus Main Street. I’m your host Dax White. Before the break we talked about some of the differences between financial advisors and investment advisers and there are some nuanced but significant differences between the two. To add to that complexity is another wrinkle which is the insurance salesperson. They are not necessarily a financial advisor or investment advisor. It depends on the product and it’s another just a wrinkle in terms of finding out who I’m dealing with. I want to make sure I understand who they are regulated by and in most importantly make sure they are being regulated in a way that protects you. In terms of this insurance salesperson it depends on the type of product that they are offering to you. If we’re talking term insurance or whole insurance or things like that, that’s just a straight insurance person. There’s not an investment component to that and so they’re going to be regulated by the state agency that regulates insurance people. But the context I’m talking about has to do more with annuities. There are a lot of people out there who sell annuities and put themselves out there as insurance but if they’re selling a certain type of annuity they’re selling an investment. So that’s where it becomes more important in terms of whose regulating that person now. The big difference has to do with are they selling a fixed annuity or variable annuity.
A fixed annuity is where you invest $100,000 in a product. It pays a fixed amount in terms of a return. It’s got some death benefits and some other features to the investment but there is no variability to it in terms of investment performance. It’s fixed. It tells you, here’s the schedule, here’s what it’s going to pay. That’s not an investment, that’s an insurance product that has certain protections and guarantees for you that they will pay that set amount. A variable annuity on the other hand, has some sub-accounts which are invested, typically in mutual funds and is very much an investment. And so if you are working with somebody who is selling you a variable annuity they need to be registered either with FINRA or with the SEC. But if they are offering you an investment so it is not enough for them to have to just have an insurance license regulated by the state. If you are dealing with somebody who’s offering that type of product you need to ask the question to make sure they got the proper registration because again in those worst-case scenarios, where it goes bad you want to have recourse. You want to have the ability to do something about it. It’s much more difficult if you have somebody who’s offering an investment they are not registered for. You are not going to have that same protection or the same oversight. In terms of the insurance salesperson that’s where the nuanced difference comes in and if you’re talking about a variable annuity that has any kind of investment component that’s the question you need ask him. If you’re not, if you’re talking term or whole or even a fixed annuity and then there’s no investment component and there is no worst-case scenario. The market corrects and we lose all of our money in an annuity. It’s just you pay a premium and you get the features of the insurance products that’s being offered. That’s the difference. That’s the third wrinkle.
The reality is some of these professionals are registered for all of them. They are registered to sell insurance, they’re registered as an investment advisor through the SEC and they’re registered as a financial advisor through FINRA. I don’t know if that makes that type of person the best for you but certainly you got more oversight there. Now they’re being regulated by state agencies on insurance, they’re being regulated by the SEC and they’re being regulated by FINRA. So in terms of regulation, in terms of oversight, maybe that is the best but it is important to understand the differences and to ask those questions so that you know who you’re getting involved with. Make sure that you know that they’re registered the way that they say they are. If they are selling you an investment make sure they’re registered to do so and make sure that they’re getting the right oversight.
Some parting thoughts on all of this. Again, there’s upsides and downsides to these various nuances. Certainly an investment advisor who has a fiduciary duty to you is a significant thing. Frankly, most investors who are working with a professional assume that they have this fiduciary duty when unfortunately they don’t always have one. With an investment advisor you are getting that. That’s an important question to ask regardless, but that’s certainly a pro in my view for investment advisors. But there’s some cons too. When you get into the agreement, the litigation forum, the difficulty in bringing claims, the collectability. There’s just a lot of really small investment advisory firms out there. There are some huge ones too, but there’s some teeny tiny ones where if you sue them they go under. And in my view, if my mom calls and says “who should I invest with” the first thing you want to do is make sure you’re investing with the right person. But behind that you have the right company and what you want is a company that is going to be there even when things go bad. If they’ve got someone who’s working for them who does the wrong thing you want to be able to sue a firm that’s going to have the ability to make good. To come into that situation and say you know what, we screwed up and we’re going to own up to it. And so you know those are things to consider again when you’re when you’re looking at who to go with. Those are my parting thoughts.
If you’ve got questions I’d love to hear from you. Visit our website at WallStreetVMainStreet.com. You can also visit us on Twitter or Facebook or you can even visit our firm website which is whitesecuritieslaw.com. On Wall StreetVMainStreet you are going to see a ton of resources that I think are important for investors. So please check those out and tune in next week, Wednesdays, at four.
Producer: You have been listening to Wall Street versus Main Street. The views expressed by the participants of the program are their own and do not represent the views of nor or they endorsed by The White Law Group, its officers, directors, employees, agents, representatives, shareholders, nor any of its subsidiaries and the content should be considered legal advice. As always consult a lawyer.
This transcription has been created by Dragon Software.Tags: brokers, dax white radio show, financial advisor duties, financial advisor duties podcast, financial advisor podcast, financial advisor responsibilities, insurance salesman podcast, investment advisor podcast, investment fraud podcast, investment fraud radio show, investment podcast, securities attorney podcast, securities fraud podcast, securities fraud radio show, securities lawyer podcast, securities lawyer radio show, series 7 podcast, stockbroker duties, stockbroker registration podcast, stockbroker responsibilities, wall street versus main street podcast, wall street versus main street radio show by D. Daxton White Last modified: December 7, 2022
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