Brokers and Advisors Have Different Standards of Care

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• Suitability
• Fiduciary

Individuals and businesses often require advice when they wish to make investments in securities, and finding the right source for that advice is important. Regardless of the source’s job title, it’s important investors understand first and foremost that there are two different levels of care of investment advisers and brokers must provide. These levels are tied to the function of the financial professional—generally, either a broker or advisor. A registered investment advisor (RIA) is an advisor registered with the Securities and Exchange Commission (SEC) or the Texas State Securities Board. Federal securities law defines the advisor or firm as one engaged in the investment advisory business. A broker, or broker-dealer, is a person or company that is in the business of buying and selling securities. Brokers must also register with the SEC or with the state of Texas, as well as register with a self-regulatory organization—typically, the Financial Industry Regulatory Authority (FINRA). There are many similarities between the professions, but the one significant difference is standard of care owed by each.

Suitability

Brokers are held to the suitability standard of care, which requires that the brokerage have a reasonable basis to believe that a recommended securities transaction or investment strategy is suitable for the customer. A broad range of investments may be suitable for any investor. The broker bases that suitability decision on information obtained through reasonable diligence to ascertain the client’s investment profile, which includes factors like:

• client’s other investments
• financial situation and needs
• tax status
• investment objectives
• investment experience
• investment time horizon
• liquidity needs
• risk tolerance
• any other information the client may disclose to the broker in connection with such recommendation

The suitability rule (FINRA Rule 2111) requires that brokers meet certain obligations as part of their determination of whether or not the investment is suitable. Brokers meet those obligations by demonstrating that the investment is suitable for at least some investors, that the broker has analyzed the client’s investment profile, and that the investment is not financially excessive and unsuitable. Brokers and financial advisors are also distinguished by whether they sell financial products; brokers often do sell financial products, advisors do not. Brokers will receive commissions from the sale of certain investments which puts their interests in conflict with their clients.

Fiduciary

Federal securities law regulates advisors who, for compensation, give advice to others as to the value of securities, or as to the advisability of investing in, purchasing, or selling securities. A fiduciary—the advisor—is given the power to act on behalf of another on the condition that the fiduciary puts the other’s interests first. The law establishes principles for how advisors should treat their clients. The advisor, as a fiduciary, owes the client a duty of loyalty, which means the advisor must act in the best interest of the client. If a conflict of interest exists, the advisor must make full and fair disclosure of all material facts so the client can make an informed decision whether to proceed with a transaction. Additionally, the advisor owes the client a duty of care, which means the advice—based on a reasonable inquiry of the client’s financial situation, investment experience, and investment objectives—is in the client’s best interest. This is a far higher standard than just being suitable. These duties will not apply to a broker. For example, a broker is under no duty to disclose conflicts of interest to a client. If a broker is earning a commission from putting a client in a certain investment, the broker need not disclose that to the client. Whether issues arise with a broker or investment advisor, you should seek out an experienced Texas securities attorney to determine your options. For more information about this area, read our securities and corporate finance law overview.