Lesson 1: Company Structure

Understanding the key concepts of this section will put you well on your way to making more informed decisions. Most investors aren’t aware that these differences even exist, much less the enormous impact they have on the advice you receive.

Key Concepts:
1. The difference between Broker-Dealers (BD) and Registered Investment Advisers (RIA).
2. The impact of suitability standards to which your adviser is held – Suitability vs. Fiduciary
3. “Independent” does not necessarily mean “Autonomous”.

1. BD vs. RIA
There are two main types of companies in the financial industry, that of the Broker-Dealer and Registered Investment Adviser. A Broker-Dealer, by definition is in the business of buying and selling securities for itself and others. When acting as a broker, they execute orders on behalf of their clients. When acting as a dealer, they trade for the firm’s own account. The securities they buy for their own account may then be sold to clients or other firms. In other words, they play both sides. This is not the case with RIA firms. RIA’s also manage securities for their clients, the difference is the standard of accountability to which they are held. Which transitions us nicely to key concept #2.

2. Accountability standards – “Fiduciary” vs. “Suitability.
RIA’s and their representatives owe their clients undivided loyalty, and may not engage in any activity that conflicts with a client’s interest. In addition, they have an obligation of utmost good faith and full and fair disclosure of all material facts to their clients, as well as a duty to avoid misleading them. That is the fiduciary standard, which is generally considered to be the highest legal duty that one party can have to another.

Broker-Dealers are held to the “suitability” standard. Under this standard, brokers need only have reasonable grounds for believing the recommendation is appropriate for the client.

3. “Independent” vs. “Autonomous”.
It has become quite popular for companies to advertise that they are “independent”. The securities industry defines “independent” as a company that does not “manufacture” proprietary products (mutual funds, annuities, insurance, ETF’s). What you will likely discover when you read the fine print is most of these so called independent companies have selling agreements with groups of “preferred” product providers (manufacturers). These preferred providers pay for access to the independent company’s clients through subsidizing the cost of annual meetings, special reward trips for top producers, and profit sharing arrangements. That is why some companies limit your investment choices to only certain mutual funds, etc. Be careful not confuse the word independent with autonomous.