It is not easy to get rich in Las Vegas, at Churchill Downs or at the local Merrill Lynch office.”
- Paul A. Samuelson

Nobel Prize winning Professor of Economics and Institute Professor Emeritus, Massachusetts Institute of Technology, Cambridge, Massachusetts
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How are Investment Advisors Different from Stockbrokers?

Some of these key differences follow:

  • Investment advisors have a fiduciary duty to act in the best interests of their clients at all times. Brokerage firms generally are not fiduciaries to their customers and therefore do not make decisions that are solely in their customers' best interests.
  • Investment advisors provide their clients with a Form ADV that describes exactly how the investment advisor does business and obtains the client's consent to any conflicts of interest that do exist in the investment advisor's business. Brokerage firms are not required to provide customers with any comparable type of disclosure.
  • Investment advisors cannot trade with their clients as principal except in extremely limited circumstances. Brokerage firms often earn significant undisclosed profits by trading as principal with their customers.
  • Investment advisors charge clients a fee negotiated in advance and cannot earn any other profits from their clients without the clients' prior consent. Most investment advisors are paid an asset-based fee, so their interests are aligned with their clients. Brokerage firms' revenues may increase even if the customer's assets shrink.
  • Investment advisors manage money in the best interests of their clients. They do not engage in other business activities like investment banking or underwriting, which brokerage firms do. These other businesses may cause a brokerage firm's interest or attention to focus on other areas of the firm outside of their retail brokerage business and customers.

What are the advantages of working with an independent registered advisor over a stockbroker?

Independent Registered Investment Advisors (RIAs) are held to a higher standard than stockbrokers when it comes to putting investors' interests first and doing the right thing for their clients' investments. Independent RIAs have a fiduciary duty to their clients which means they must:

  • Act in the best interest of their client
  • Identify and monitor illiquid securities
  • Employ fair market valuation procedures where appropriate
  • Observe procedures regarding the allocation of investment opportunities: including new issues and the aggregation of orders
  • Monitor for best execution of trades
  • Have policies regarding affiliated broker-dealers and maintenance of brokerage accounts
  • Disclose conflicts of interest
  • Have policies on use of brokerage commissions for the use of research
  • Have policies regarding directed brokerage, including step-out trades and payment for order flow
  • Adopt and administer a code of ethics

Stockbrokers are held to suitability obligations on the part of their broker-dealer:

  • Reasonable Basis Suitability - the broker-dealer must believe that the recommended security is suitable for any investor
  • Customer-Specific Suitability - the broker-dealer must believe that its recommendation is suitable for that particular investor

Investor confusion exists over fee-based advice offerings

At Principia, we firmly believe investors are entitled to one clear set of regulations, no matter who they turn to for their financial advice. And we're not the only ones. A recent poll* revealed that 90% of investors want Congress to set uniform standards of protection for both stockbrokers and investment advisors. We stand firmly on the side of the investor to promote a set of regulations that is fair for advisors, brokers and, most importantly, investors like you.

In the financial world today, there are basically two types of advice available to investors, brokerage accounts and advisory accounts. Unfortunately, most investors don't know the difference between these two kinds of advice. In fact, most aren't even aware a difference exists.

In a recent survey:

  • 58% of investors believed both stockbrokers and Independent Registered Investment Advisors have a responsibility to act in their best interest.*
  • 63% believed that stockbrokers and Independent Registered Investment Advisors were both required to disclose all conflicts of interest before providing financial advice.*
  • 81% were concerned that both stockbrokers and investment advisors provide fee-based advice, but offer different levels of protection.*
  • 89% said they would rather work with an investment advisor if they knew advisors provided greater investor protection than stockbrokers.*

*2004 U.S. Investor Perception Study. Commissioned by TD Waterhouse

The truth is, there's considerable confusion in the investment community regarding financial advice and the people who dispense it.

Why does this confusion exist?

Historically, brokerage firms could offer investment advice only if that advice was "solely incidental" to their brokerage business, and only if they did not receive "special compensation" for the investment advice. The SEC interpreted these provisions narrowly until 1999, when it issued a proposal allowing brokerage firms to offer fee-based accounts without registering as investment advisors. The SEC also issued a controversial "no-action" position, allowing brokerages to take advantage of the proposal even before it was finalized. In 2004, the Financial Planning Association sued the SEC for allowing the "no-action" position to continue without taking final action after hundreds of comments were submitted in opposition to the proposal. The SEC then reopened the comment process, and on April 6, 2005, it announced it was adopting a final rule generally similar to its 1999 proposal.

The new SEC rule and what it means

Starting July 22, 2005, any brokerage firm that offers fee based accounts must prominently disclose the following:

  • Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you understand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest. We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits and our salespersons' compensation may vary by product and over time.
  • Brokerage firms must include this disclosure in their brokerage account applications, and in advertisements and sales materials for fee-based accounts.
  • Brokerage firms must make available someone who can explain to potential customers the differences between brokerage accounts and investment advisory accounts.

Starting October 24, 2005:

  • Brokerage firms may not offer discretionary accounts, except in accounts regulated as investment advisory accounts.
  • Brokerage firms may not offer "financial planning" services, except in accounts regulated as investment advisory accounts.

OVERVIEW

  • Acknowledging our role as fiduciaries, Principia must always provide services and advice in the best interests of the client.
  • Brokers at large, publicly traded financial services firms are subjected to enormous pressures to serve the firm rather than the long-term best interest of the client. Their compensation is determined solely by the quantity of the products they sell rather than the quality of their advice.