Investment advisers vs. brokers: Know the difference Boomer Bucks by Barbara Whelehan Bankrate.com True or false: Financial planner, financial consultant, investment adviser, stockbroker -- these are all titles for people who provide essentially the same types of services, right? True. So there's no need to concern yourself about how they differ from one another, right? False. Actually, there's a wide chasm between brokers and investment advisers, though you can hardly tell if you just go by their titles. That's because in recent years, brokers have been recasting themselves as financial consultants, offering a slew of wealth advisory and financial planning services, on top of their usual job of buying and selling securities. "Many would claim that the brokerage industry deliberately makes this differentiation difficult for the public by using such labels as 'financial adviser' and 'financial consultant' for a role once called 'stockbroker,'" says Michael Kitces, a certified financial planner and director of financial planning for Pinnacle Advisory Group in Columbia, Md. The difference is legal Brokers are held to a different standard than registered investment advisers. The latter must abide by the rules of the Investment Advisers Act of 1940, which legally obligates them to act solely in the best interests of their clients. Brokers, meanwhile, are regulated by the National Association of Securities Dealers, which imposes a "suitability standard" rather than the stricter fiduciary standard. This simply means an investment sold by a broker must be suitable for the client. Critics say the standard is loose and allows brokers wide latitude in recommending products that often serve the brokers' interests as much as or even more than those of their clients. Proponents say the NASD rules are just as stringent as the SEC's, so brokers shouldn't be subject to duplicative regulation. Earlier this month, the Securities and Exchange Commission overwhelmingly approved a 1999 proposal that officially allows brokerage firms offering fee-based accounts to be exempt from registration and regulation as investment advisers. The controversial decision drew approval from key congressmen on the House Financial Services Committee, but the ire of financial planners who say brokers continue to have an unfair advantage by selling "lots of services with minimal liability," in Kitces' words. A bit of background The SEC's ruling that exempts brokers from registering as advisers actually upholds the law as stated in the Investment Advisers Act of 1940. Brokers were exempted 65 years ago in part because they were regulated under provisions of the Exchange Act, enacted in 1934. So why resurrect this ruling? The SEC initiated the proposal in 1999 in response to changes in the market place, in particular the introduction of fee-based brokerage programs, which changed the way in which brokers were compensated for their services. Until fee-based programs came along, transaction fees made up the bulk of brokers' businesses. Last summer, the Financial Planners Association filed suit against the SEC because even though the 1999 proposal had not been approved, the brokerage industry was conducting business as though it had. The lawsuit was put on hold while the SEC gathered public comments on its proposal. In the end, the SEC concluded that the fee-based programs were not "fundamentally different from traditional brokerage programs," and in fact afforded "important benefits to brokerage customers." The fact that the programs generated asset-based fees of between 1 percent and 2 percent rather than transaction-based fees alleviated concerns the SEC had "about the incentives that commission-based compensation provides to churn accounts, recommend unsuitable securities and engage in aggressive marketing of brokerage services." So these changes in the brokerage business represent a win-win for brokers and consumers alike, in the rose-colored analysis of those in the securities industry. It's an especially big win for brokerage firms, which have attracted nearly $269 billion of assets into fee-based accounts, double the amount five years ago, according to Boston research firm Cerulli Associates. That's not to say that the SEC is unconcerned about the trouble consumers have in distinguishing between investment advisers and brokers. To that end, the SEC will require brokerage firms to disclose in plain English that they offer brokerage accounts -- not advisory accounts -- and also the fact that brokers' interests may not be the same as those of clients. Will consumers recognize these red-flag statements and run? Probably not. In sheep's clothing My educated, intelligent friend Pam learned the hard way about how divergent such interests can be. She opened an account with a broker in the mid-1990s, during one of those downdrafts in the midst of a roaring bull market. She's a trusting soul, so she went along with her broker's recommendations. Within three months he decimated her account, shorting stocks that went up, going long on stocks that crashed, until it became a mere shadow of its former self. He was slick, came up with reasons for the failures, kept offering solutions to get the money back. She closed the account after losing 90 percent of her assets. Another friend, Tom, once worked for a small full-service brokerage firm in New Jersey. He now works for a discount broker that hires certified financial planners and does business with investment advisers, and says the difference in the way clients are treated is stark. He explains that when you see a broker, you normally fill out an application, outlining general parameters, such as your income, risk tolerance and investment goals. Armed with this information, a broker still has a wide range of flexibility with what he or she can sell you. "They can't do something egregious. If an investor is conservative, they probably wouldn't push penny stocks on him. Most wouldn't do that. But there's a lot of gray area in the middle where a disservice could be done to a customer." Pressure to sell vs. option to sue For example, brokers may be pressured to sell particular products, and whether these products are appropriate for their clients is open to interpretation. "You get better incentives, better commissions on some mutual funds than on others, and that could cloud someone's recommendations a little bit." Meanwhile, Tom says, investment advisers must be upfront about what they do. "There's a lot more two-way communication before any advice is given at all. Their guidelines are lot more strict. Brokers are held to less account. It's not necessarily their fault, just a result of their pay structure. They get focused on selling product and not seeing the bigger picture." So the main difference is that brokers are under pressure to sell (the top producers are in big demand), while advisers are obligated by law to serve your best interests. Of course, that's not to say that all brokers are ruthless, or that all investment advisers are ethical. Any financial professional can break the rules and do a disservice to the consumer. But if you get into a dispute with an adviser, you can sue. With a broker, you have no choice but to settle the matter in an arbitration hearing. Investors waive their rights to sue thanks to standard clauses in their brokerage account contracts. Brokerages in the news In recent months we've seen the SEC and the NASD take action against brokerage firms for a wide range of misconduct. Some of it had to do with cozy revenue-sharing agreements between mutual fund companies and brokers who push their funds. Some of it had to do with brokers selling inappropriate (meaning more expensive) share classes of funds to investors. Citigroup, American Express, Edward D. Jones & Co., and J.P. Morgan Chase were among firms paying fines to settle such charges. Of course, as is standard practice, none of these companies admitted or denied wrongdoing. SEC chairman William Donaldson has publicly stated that the agency continually strives to inform investors about broker conflicts and compensation. I hope that message will seep through to consumers. Longtime financial journalist Barbara Mlotek Whelehan earned a certificate of specialization in financial planning. -- Posted: April 27, 2005

behaviorK - funny you mention a teacher getting into an annuity as part of her retirement planning. Just last week on Suze Orman, a teacher in CA called about this very thing. She was told the 403b was her only option and the caller didn't feel right about it. Suze told her not to contribute to it. At what age does this annuity mature? In the caller's case, it was at 85 YO, which is ridiculous. You may want to get your GF to suck up the 10% or just leave it and stop contributing to that 403b altogether. In the caller's case, she had not started contributing and Suze advised her not to. If she sucks the 10%, you should help her try to find a bit more aggressive fund in which to replace it and try to earn back some of the funds she lost in the surrender. Depending on her age, she can still invest in ROTH, traditional IRA's and have a nice nestegg. That is what Suze recco'd to the caller - to divert the money she would have allocated to this annuity to much more reasonable retirement savings. Whatever you do, she needs to stop the contributions to the annuity pronto and find another avenue - be it Vanguard or whatever else. I think the episode ran last Saturday, which means it repeats tonight with the new episode. If you have TIVO, record all SUze Orman shows and see if the ep with the specific question aired again. Like you, I"m surprised that the employer has such a crappy retirement plan.

Thanks jose and steve for the confirmation and advice! I like the idea of VanGuard or Fidelity and will check out both more thoroughly. I actually have about 25 years to retirement and will be increasing my retirement savings each year. Would love to save 25% but my income is low and I'm already living rather frugally (not a shopper, no vacations, no credit card debt, 3 month emergency fund)! For the last 4 years I have been saving (IRA/Roth) just over 10% of my gross income. My income is low enough that I have qualified for the maximum Saver's Credit (which is why some savings is in an IRA and some in a Roth). In the next year I will be re-entering the regular world of work (after being self-employed for 15 years). And while I have earned a living and loved being self-employed I have decided to do this so that I have better health insurance plan and work for a company that offers a 401K with a company match. My total saved is about $10,000 and the split is actually about $4000 in a regular IRA and $6000 in a Roth IRA. My thoughts are that I should invest the $4000 IRA in something that is relatively stable and I should invest the $6000 Roth in something that offers the opportunity for a greater return (especially since there is no tax on Roth earnings at withdrawl once I retire). At this time I am not looking to convert the regular IRA into a Roth IRA. Knowing the split ... $4000 IRA and $6000 Roth what the best option for each?

I like using a credit union, also. The people's bank. When they make money - it's the users who profit. (Spoken as one who, for 39 years, has been a shareholder in a bank - shares bought for $4.25 or so, worth $96.00 last week, and paid about 3 - 3.5% dividend throughout). Kelton, If you'd like all of your accounts in one location/institution, make sure that the institution is covered by CDIC and that the total amount is under the CDIC covered amount. And that each one of those assets is of the type covered by CDIC. Otherwise, if they die/disappear/move offshore speedily - you may be left crying the blues. In fact - if the situation is internet-based, what assurance have you that they have a U.S. presence, so you might have some comeback in case they might fade away? ole joyful