Key Takeaways

Investment advisors and broker-dealers operate under different regulations

Broker-dealers typically must get your approval before buying securities

Investment advisors can buy and sell on your behalf without approval for each transaction

New regulation coming soon from the Securities and Exchange Commission

Broker-dealers and investment advisors can both play a crucial role in their clients’ financial lives, serving each investor’s specific situation and needs.

Although the terms sound similar, the two financial professionals actually operate under different rules and for different reasons. Everyday investors should understand the difference between broker-dealers and investment advisors, as well as several other common terms connected to these roles, so they can decide with confidence how their portfolio is handled.

Standards for Investment Advisors vs. Broker Dealers

Investment advisors, sometimes known wealth managers, are a person or firm that is engaged in the business of providing advice, making recommendations, issuing reports or furnishing analyses on securities for compensation. 

The compensation is generally in the form of an advisory fee assessed as a percentage of the assets under management.  For example, investment advisers work with clients to develop strategies and allocate investment portfolios to help clients purse their goals. Investment advisors may be ideal for investors who want someone else to manage their investments, or for investors who want assistance with planning for taxes, an estate, or a mortgage.   

In contrast, a broker-dealers is a person or a firm that can buy and sell securities on its own account as well as on behalf of clients. They can recommend products that net them a commission, but an investor must approve each transaction. Technically, a broker is in the business of buying and selling securities on behalf of its clients, and a dealer buys and sells securities for its own account. A broker-dealer does both. Broker-dealers may appeal to investors who want to be more proactive in managing their own portfolios.

As a result of the different ways these professionals work, they abide by different legal standards. Investment advisors follow a “fiduciary standard,” while broker-dealers follow a “suitability standard” or “best interest standard.” Let’s take a look at these terms.

Fiduciary Standard. Investment advisors must put their clients’ interests above their own and owe their client’s undivided loyalty, any may not engage in activity that conflicts with a client’s best interest without the client’s consent. The fiduciary standard is regulated by the Securities and Exchange Commission (SEC) or state securities regulators.Suitability/Best Interest. Broker-dealers aren’t required to put their clients’ interests before their own. The suitability standard does require that broker-dealer recommendations be “suitable” for their clients. For example, they must make sure their recommendations fit clients’ financial needs and goals, and that the transaction costs are not excessive.

Other Key Terms

The following terms are used in these rules and may be important for investors to understand.

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Conflict of Interest. When a financial professional may benefit from recommending a particular product or trade, that situation is considered a conflict of interest. While the phrase may seem to have a negative connotation, it’s not necessarily a bad thing when a financial professional has a conflict of interest, but it is something to be aware of so that investors can form their own opinions about any recommendations.Recommendation. This is when a financial professional suggests that a client buy, sell or hold a security. Both investment advisors and broker-dealers can make recommendations, but recommending investments is a common job of broker-dealers. Some broker-dealers may offer blanket recommendations, or the same recommendations to all their clients. Others may offer a recommendation specific to a portfolio. Broker-dealer representatives may be required to provide background information on themselves, such as accreditations and certifications, when making a recommendation.

Where These Terms Might Apply

You may have seen these terms in recent financial news because the SEC has been revising the code of conduct for broker-dealers through new rules called Regulation Best Interest (Reg BI).

Beginning on June 30, 2020, brokers will be required to comply with the requirements of Reg BI when making recommendations to retail customers, including requiring a broker-dealer to act in the best interest of the customer when making a recommendation of any securities transaction or investment strategy involving securities.  

In addition to adopting Reg BI, the SEC also clarified regulations on the conduct of investment advisors to “help retail investors better understand and compare the services offered and make an informed choice of the relationship best suited to their needs and circumstances.” Essentially, the idea is to add protection for consumers who are receiving recommendations.

The Bottom Line

With your own portfolio, you may find that you’d prefer to work with a broker-dealer over an investment advisor, or vice versa.

No matter which type of professional has a role in your financial life, it’s good to be aware of how they work and the rules they must follow as they buy securities for you. That way, you can be aware of any potential risks that could end up costing you extra money.