What Investors Need to Know When Selecting Advisors

In broad terms, there are three type of financial advisors:  investment advisors; broker-dealers, and insurance agents.

• Investment advisors give advice about securities.  They are regulated by the Investment Advisers Act of 1940, rules from SEC, and state securities laws.   And, they have a fiduciary duty to render services solely in the best interest of clients and to disclose conflicts of interest.
• Broker-Dealers recommend, purchase, and sell securities.  These professionals are regulated by the Securities and Exchange Act of 1934, rules of SEC, FINRA, and state securities laws. Broker-Dealers are subject to suitability rules requiring that recommendations are suitable for customers.
• Insurance Agents recommend and sell insurance products and are regulated by state insurance laws.  They, too, are subject to suitability rules that vary by product and state insurance law.

Without experience or a significant amount of time spent studying how various investment vehicles work, chances are you, the average investor, will need to locate a financial advisor who can help direct and manage your investment. [Editor’s Note: If you’re interested in learning more about investment advisors, read “The Doctor and the Drug Dealer: A Parable About Registered Investment Advisors and Broker-Dealers”]

CNBC recently reported that, “a 2012 study by Cerulli Associates and Phoenix Marketing International found more than 60 percent of investors either did not know how their advisors got paid or thought that the service they offered was free.” Additionally, Barbara Roper, Director of Investor Protection for the Consumer Federation of America told CNBC, “Investors are very sensitive to the fees they pay directly to their advisors, and all but oblivious to the fees they pay indirectly.”

Advice from CNBC includes 5 questions to ask a financial advisor before choosing to use their services:

This is good advice.  In addition, because we are fans of the expression “take it from the horse’s mouth,”, we think when selecting an investment professional the best place to start and to refer back to often is the Securities and Exchange Commission. While the SEC oversees all things public (i.e. publicly traded securities), much of its advice and admonishments are certainly transferable to any types of investments.

Financial professionals, be they investment advisors, financial planners or stock brokers, want to earn fees from you. They want to guide your liquid assets as an accredited investor into various investment vehicles.

What you must do is fully educate yourself on an individual advisor prior to choosing him or her to take charge of your money. The SEC’s excellent piece “Investment Advisors: What You Need To Know Before Choosing One“ provides a Q&A format designed to walk an investor through the research needed to pick an adviser.

As explained by the U.S. Government Accountability Office:

[T]here is no specific, direct regulation of “financial planners” per se at the federal or state level, but various laws and regulations apply to most of the services they provide.

Financial planners are primarily regulated as investment advisers by the Securities and Exchange Commission (SEC) and the states, and are subject to laws and regulation governing broker-dealers and insurance agents when they act in those capacities. Federal and state agencies have regulations on marketing and the use of titles and designations that also can apply to financial planners.

The regulatory structure applicable to financial planners covers the great majority of their services, but the attention paid to enforcing existing regulation can vary and certain consumer protection issues remain.

First, consumers may be unclear about when a financial planner is required to serve the client’s best interest, particularly when the same financial planner provides multiple services associated with different standards of care. SEC is studying these issues with regard to securities transactions, but no complementary review is under way by the National Association of Insurance Commissioners (NAIC) related to the sale of high-risk insurance products.

Second, financial planners can adopt numerous titles and designations, which vary greatly in the expertise or training that they signify, but consumers may not understand or be able to distinguish among them. SEC has a mandated review under way on financial literacy among investors and incorporating this issue into that review could assist in assessing further changes that may be needed.

Finally, the extent of problems related to financial planners is not fully known because SEC generally does not track data on complaints, examination results, and enforcement activities associated with financial planners specifically, and distinct from investment advisers as a whole. A regulatory system should have data to identify risks and problem areas, and given that financial planning is a growing industry that has raised certain consumer protection issues, regulators could benefit from better information on the extent of problems specifically involving financial planning services. 

The result need not be a cautionary tale if AIs are thorough with their due diligence—getting in writing the fee structures, background, license and education credentials– of potential advisors.

Published 9/5/2013; Updated 11/1/2013