Phone: 503-565-2100 
RIA vs. Broker-Dealer
Submitted by Headwater Investment Consulting on April 20th, 2016By Kevin Chambers
Investors seeking professional advice have two main types of financial services firms from which to choose: Registered Investment Advisor (RIA) and Broker Dealer. Headwater Investment Consulting is an independent investment management firm, classifying us as a Registered Investment Advisor (RIA). Our business model is slightly different than the traditional stockbroker structure.
Regulation:
The various securities regulatory agencies ensure the compliance with State and Federal laws that govern securities markets and protect investors.
|
Registered Investment Advisor (RIA) |
Broker-Dealer |
|
Regulation of an RIA is dependent on the firm’s level of assets under management. Firms with assets under management of less than $100 million are regulated by their state’s securities agency. Firms with assets under management of more than $100 million are regulated by the Securities and Exchange Commission (SEC). Headwater Investments is regulated by the SEC. |
Stocker-Brokers are overseen by the SEC but are regulated by a self-regulatory organization called the Financial Industry Regulatory Authority (FINRA). |
Compensation:
An important aspect to consider is how the investment professional you choose is compensated.
|
Registered Investment Advisor (RIA) |
Broker-Dealer |
|
RIAs typically charge a management fee for their service on either an hourly basis or as a percentage of the assets that they manage. Headwater Investments charges an asset-based fee. We do not charge an hourly fee, trade fees, account opening or closing fees, or other miscellaneous administrative fees. NOTE: Fidelity does charge fees, paid directly to the custodian, not to our firm. |
Brokers are compensated by charging a commission on the products they sell. Commissions can be flat fees charged for making trades or can be based on the amount of the trade, often called a “load.” Sometimes clients are charged both of the fees for a single transaction. |
Standards of Investment Advice:
We have all heard the phrase, “Past performance is no guarantee of future results.” Investors also need to be aware that investment advice given can be based on two different standards.
|
Registered Investment Advisor (RIA) |
Broker-Dealer |
|
RIAs are subject to a “fiduciary” standard when servicing their clients. This means that their investment recommendations have to be in the best interest of their clients and that their clients’ interests must come first. The fiduciary standard is defined by the Investment Advisors Act of 1940. Advisors are prohibited from making trades in their own accounts before their clients’ accounts and are not allowed to trade products that would result in higher commissions for them or their firm (Fuhrmann, 2013). |
Brokers are held to a “suitability” standard, which is slightly less diligent. The suitability standard means that brokers make investment recommendations that are reasonably suitable for their clients’ financial objectives and needs. Furthermore, a broker’s duty is first to their broker-dealer firm and not necessarily the client served (Fuhrmann, 2013). |
A way to understand the difference between suitability and fiduciary standards is to think of a car dealership. First, let’s look at an example of “suitability” service: If I go to the Subaru dealership to buy a new car, the salesman that I talk to is going to try and do everything he can to sell me a Subaru. The Subaru that he recommends will probably suit my needs very well. But, it is hard for me to know if the Subaru is actually the best possible option for me in terms of price and quality. The Subaru salesman has an incentive for me to buy a Subaru, regardless if it is the best car for me because he gets a commission and he makes his parent company happy. On the other hand is an example of “fiduciary” service: I could hire someone to help me find the best possible car for me. Although I need to pay this person for their service, their advice is going to be unbiased because they do not benefit if I buy a Subaru over a Ford (Schweiss, 2011).
The details between the two standards in the financial services sector are particularly contrasting. RIAs get paid a service fee, but they give unconflicted advice on investment products, and they are required to find products that fit their client’s needs. RIAs are usually independent and don’t have a parent company that puts pressure on them to push clients into different products or meet sales goals. They often can get their clients price breaks on mutual funds because of their size, so investing with them may even be cheaper than going it alone. Suitability standards of brokers can end up causing a conflict of interest between the client and the broker. RIAs are prohibited from choosing a product that would result in getting them a commission or higher fee. Brokers are not held to this standard. As long as the product is suitable for the client, a broker can sell a product to a client that results in a higher commission, even if there are cheaper competing products.
New Department of Labor Ruling
Earlier this month, the Department of Labor (DOL) announced a new rule set to take effect next year that directly concerns the difference between RIAs and Brokers. The ruling requires all financial professionals, when consulting, managing, or advising on tax-deferred retirement accounts (IRAs), and employer-sponsored plans (401(k)’s, 403(b)’s etc.), must act as fiduciaries. The “fiduciary rule” eliminates an inherent conflict of interest for some brokers who can make large commissions by selling certain products to individuals in their retirement accounts. This new ruling has no effect on RIAs like Headwater Investments. We already act as fiduciaries for all of our clients, and always act in their best interest.
Deciding on the Right Investment Professional for You:
When trying to find an investment professional to work with, it is important to choose the best fit for you and your situation. Both brokers and RIAs have their own place in helping investors reach their goals. Fees can eat into investment returns, and understanding the fees that are being charged on your account is an important consideration when investing. In the end, selecting a financial professional is about trust and service. It is important to find a company that you can trust and offers you the best service at a reasonable price.
Fuhrmann, R. (2013). Choosing A Financial Advisor: Suitability Vs. Fiduciary Standards. Investopedia.
Schweiss, S. (2011). Understanding the Differences between RIAs and Brokers, Suitability and Fiduciary. TD Ameritrade.
