How Registered Investment Advisors Are Different

There are about 285,000 financial advisors nationwide. Quick question… how many of them do you think are legally required to put your interests ahead of their own? One would assume the number would be close to 100%. The reality is that only around 10% of all financial advisors in the United States work under the fiduciary standard. This standard legally requires financial advisors to put client needs first.

As a fiduciary, an investment adviser owes its clients undivided loyalty, and may not engage in activity that conflicts with a client’s interest without the client’s consent. There are organizations such as the Financial Planning Association or the Certified Financial Planner Board of Standards that require members to work under this standard. These members, however, are not required by law to act as a fiduciary and are only subject to discipline by the organization if they are not compliant.

Registered Investment Advisors (RIA), on the other hand, are subject to the legal standards set by the Investment Advisers Act of 1940. These financial advisors are regulated either the Securities and Exchange Commission or their state securities division. The 1963 Supreme Court case of SEC vs Capital Gains Research Bureau required that RIAs cannot act in a way that is deceptive, fraudulent, or manipulative. This ruling set the fiduciary standard for RIAs and RIA firms.

Wall Street Polices Itself

FINRA Broker Check Madoff

At this point, you have to be asking yourself a question. “Why aren’t financial advisors required to put their client’s interests first?” The short answer is Wall Street. The long answer is Financial Industry Regulatory Authority, or FINRA. FINRA is a multi-billion-dollar organization that acts like a government watchdog while being basically unaccountable to the industry or public. This is a literal case of the foxes guarding the hen house.

FINRA started out as the National Association of Dealers (NASD) back in 1939. It’s a ‘self-regulatory’ organization the investment industry created as a response to the improprieties that led to the Great Depression. The Maloney Act of 1938 was the compromise Wall Street made with the government to prevent actual oversight of the banks. Since the banks ‘police’ themselves, they’re not required to act as a fiduciary.

This self-regulatory body works as well as you would expect. The banks use FINRA to block investigations of unscrupulous tactics. When Wells Fargo was caught making up fake accounts, investigations discovered the bank had been sabotaging the careers of whistle blowers though FINRA. This was also done to Merrill Lynch employees as well. FIRNA’s arbitration clause lead to expensive legal fights for former employees after managers made up false accusations to justify employee dismissal.

Allowing the banks to regulate themselves is why so many financial advisors can put profits first. As long as investments firms are policing themselves, they have no reason to act in your best interest. In 2016, the Department of Labor attempted to enact an Obama Administration rule that would have required the retirement accounts be placed under the fiduciary standard. As you might have guessed, Wall Street fought back. The banks know that it’s more profitable to lie to clients and place them in high cost investments. The Trump Administration agreed.  

Finance obviously attracts some employees who prioritize money above all else. Investment firms also reward employees that generate the most profit. These facts reinforce the culture greed stereotyped in the movies. People that move up the corporate ranks are the ones who shape the culture, after all.

How to Find a Good Cop

Registered Investment Advisor Certified Financial Planner fee-only

It can be hard to find someone to trust with your money. Not everyone who works with these large broker-dealer firms are dishonest. And not everyone who claims to act under the fiduciary standard will work in your best interest. I’ve met some great financial advisors working for unethical firms. I’ve also met CFP certificate holders that charged high commissions and fees when better alternatives were available.

There are a few ways to improve the odds you’ll find an advisor you can trust. The first thing to do is look for a local Registered Investment Advisor. This is the only way to currently ensure that your advisor is, and always has been, under the fiduciary standard. The hard part about this is that a simple google search won’t return many results. You’ll need to do some research on anyone you find in order to ensure they’re a RIA.

Choosing a RIA that holds the CFP designation helps as well. Registered Investment Advisors need to pass either FINRA’s Uniform Investment Adviser Law exam or the CFP exam to become registered with the state or SEC. As someone who has taken and passed both exams, I can vouch for how difficult the CFP exam was (the board reduced the difficulty in 2014, though it’s still the most comprehensive exam in the industry). Working with a Certified Financial Planner ensures that your advisor is highly trained and up to date with continuing education requirements. This also means that they have taken a fiduciary oath.

Working with a fee-only practice will help ensure that your financial advisor doesn’t have any of the inherent conflicts of interest that arise under a commission based pay structure. Again, a simple google search isn’t going to help much here. In fact, 9 out of CNBC’s top 10 “fee-only” firms wouldn’t qualify as fee-only under the CFP Board’s guidelines.

The reason many firms fail to meet the definition of fee-only is because they offer commission based insurance products. Insurance is a vital component of any financial plan, but I have set my own firm up to avoid this conflict of interest. While I hold an Arizona Producers Life Accident and Health or Sickness license, I’ve opted to forgo potential income that comes from selling insurance products.

And that leads me to what I believe to be the most important factor when selecting an advisor. Their character. Are they willing to pass on profit to do what’s right? How involved are they in the community? Are they focused on building a business or making the world a better place? Character might not be as tangible a quality as the rest, but it plays a big part finding the right person to work with.

If you find someone you like, make sure to be involved in the process. A good advisor may, at times, disclose conflicts of interest to you if they feel a product is in your best interest.  There’s nothing wrong with this as long as your advisor provides clarity and can prove what they propose is in your best interest. If you’re not comfortable with what they propose, or if you have concerns your current advisor doesn’t always act in your best interest, perhaps it’s time to change firms.

 

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