Wondering who or what are the financial advisor regulators?
Well, there are several.
Today, we’ll cover:
Before we dive deep into the financial advisor regulators, let’s first distinguish between investment advisers and registered representatives.
These are the two financial professionals that are often referred to as financial advisors.
From there, we’ll get into the regulators of each.
Let’s get started straight away.
Investment Advisers vs. Registered Representatives
Investment advisers refer to financial professionals or firms that offer financial advice to clients at a fee.
They also issue in-depth reports and financial analyses of securities and investment strategies.
Investment advisers have different titles, including portfolio managers, financial planners, wealth managers, asset managers, and investment advisor representatives (IAR).
Investment advisors are regulated by the Securities and Exchange Commission (SEC).
Depending on their qualification, this category of advisors may offer financial planning services and personalized financial advice.
They also offer investment portfolio management and brokerage services or a combination of these services.
Steps to Become an Investment Adviser
There are a few steps an advisor must follow to become an investment advisor.
Familiarize with the state regulations
Different states have different requirements and exceptions.
Some states exempt advisers with certain certifications from taking the series 65 exams, which is mandatory for investment advisors.
The certifications that are often exempted include certified financial planner (CFP), chartered financial analyst (CFA), personal finance specialist (PFS), chartered financial consultant (ChFC), and chartered investment counselor (CIC)
Register for uniform investment adviser law examination (Series 65 exams)
FINRA administers this examination.
It covers a wide range of topics, including portfolio management, fiduciary standards, operating laws in the financial advisory industry, and investment strategies.
Register with SEC
With a series 65 license, investment advisors are eligible to register with SEC.
The registration process starts by creating a profile with Investment Adviser Registration Depository (IARD).
From there, an adviser goes on to file form ADV.
Steps to Become a Registered Representative
Registered representatives, also known as stockbrokers, trade on behalf of the client.
They evaluate the financial market and advice individual investors on what to buy and sell.
They equally guide investors on when to trade.
Stockbrokers work with brokerage firms.
They are registered with Financial Industry Regulatory Authority (FINRA) and often sell and buy securities such as variable annuities, mutual funds, stocks, and bonds.
The registration requirement to become a stockbroker include:
A financial advisor should first sit for the SIE exams.
The exam is an introduction to the financial advisory industry.
Therefore a potential adviser can take it before employment to jump-start their career.
Once done with SIE exams, an advisor can now seek employment with a brokerage firm.
Here, an advisor gains hands-on experience and also sponsorship to sit for the series 7 exam.
The firm books the exams on behalf of the advisor through the Central Registration Depository (CRD) system.
Once approved, the adviser has up to 120 days to take the exam.
Pass series 7 exam
It’s only by passing series 7 exams that an advisor can get a license to sell securities.
Advisors also need to take series 63 exams to sell securities across states.
Stockbrokers are held to suitability standards.
This means that they are obliged to offer recommendations that are most suitable to the client.
With the suitability standard, a stockbroker doesn’t necessarily take into account the client’s best interest.
They could recommend costly securities over cheap ones for the sole reason that they generate a high return on investment.
Now that we have a clear overview of investment adviser representatives and stockbrokers, let’s look into their regulators.
Financial Advisors Regulators
The bodies that regulate financial advisors constitute self-regulatory organizations (SROs) and federal and state regulatory commissions.
The financial regulatory authorities are in charge of discipline, registration, compliance, and examination.
These regulatory authorities are based on two acts:
- The Security Exchange Act of 1933, also known as the Securities Act, the Federal Securities Act, or the Truth in Securities Act. The act was enacted during the Great Depression to protect investors after the 1929 market crash.
- Investment Advisers Act of 1940 provides the legal framework that guides investment advisors.
With that brief overview, let’s look at the specific regulators in the financial advisory industry.
Securities and Exchange Commission (SEC)
SEC is the highest financial service regulatory authority in the United States.
At the time of its formation in 1934, SEC was majorly geared towards regulating the stock market. It was also the oversight authority for corporations that offered securities.
Years later, SEC’s primary duty is regulating the securities industries and enforcing federal securities law.
It’s an oversight authority that brings to book financial firms and financial advisors that violate the securities law, protecting investors from fraudulent financial services.
In the cases where the misconduct is criminal, SEC works with law enforcement agencies to hold wrongdoers accountable.
An investment adviser should register with SEC if they meet any of the following requirements, as stated in the Dodd-Frank act of 2010.
- Investment advisers with assets under management (AUM) worth $110 million and above must register with SEC.
- Robo advisers must register with SEC regardless of the asset under management.
- Advisers or advisory firms offering financial advice to investment companies.
- Firms and individual advisers with a place of business in Newyork or Wyoming with $25,000 and above AUM.
- Firms and advisers operating in over 15 states.
Investment advisors enjoy a buffer period when the AUM is between $90 million and 110 million.
They may choose to register with SEC once AUM hits $100 million, though mandatory registration is $110 million.
Advisers are also allowed to withdraw their registration if the asset under management drops to $90 million and below.
Advisors managing $100 million and below must register with state regulatory authority.
How to Register With SEC
To register with SEC, an investment adviser files form ADV.
The form has two parts and several schedules for the advisor to fill.
Part I requires an investment adviser to fill in basic information about the business, types of clients, affiliation parties (if any), education background, number of employees, total AUM, and any disciplinary actions.
Part I of form ADV is basically checking in boxes and filling in blank spaces.
This first section is submitted electronically once completed.
The information on part I is to ascertain an advisor’s eligibility.
Additionally, this information comes in handy in the regulation of the commission’s exam programs.
Part II of the form contains a full disclosure statement about the advisory services, fees structure, typical clients, code of ethics, conflicts of interest, and terms and conditions.
This part is in prose, and it’s commonly referred to as the brochure rule.
The rule stipulates that advisers must provide investors with written disclosure about their business, the same information in part II on the form ADV.
An adviser should issue all the required information at least 48 hours before signing an advisory agreement with a client.
There are exceptions to this rule; investment advisers who offer impersonal investment advice don’t need to give clients a brochure.
In addition, if the advisor earns less than $500 per year from a client, they are exempt from issuing a brochure.
Investment advisers also don’t need to give a brochure to clients who are employees of the investment firm.
Apart from Part I and II, advisors must file the form ADV schedules.
SEC requires financial advisors to file schedule I annually, whether there are any changes in the details first filed or not.
In case there are changes, then the same should reflect on schedule I annually.
The form ADV indicates the information that an adviser should update immediately and the ones that are updated 90 days after the end of an investment adviser fiscal year.
Once an advisor has filled in all the information required and the schedules, they submit the ADV registration application.
SEC will either grant or deny their registration within 45 days from the day of applying.
Firms or advisers may receive a response within 30 days, but often the process is delayed with the back-and-forth requests for additional information and clarifications.
The commission returns any incomplete forms, in which case a financial advisor will have to complete their application, resubmit and wait for another 45 days.
In regards to transparency, SEC requires registered investment advisors to submit annual and quarterly financial reports.
Advisers must maintain up-to-date, accurate books of record.
But then again, not all advisers are required to submit financial reports. Advisers that are eligible include:
- Those who have custody of investors’ securities and funds.
- Advisers who require prior payment of over $500 from individual clients six months or more in advance.
In such cases, an independent public accountant must audit the firm’s balance sheet before submission.
On the other hand, an impromptu audit from an independent accountant is mandatory for advisory firms or individual advisers managing investor’s securities and funds.
Important to note is that if an advisor wants to pull out from SEC registration, they must file their registration withdrawal within 180 days after the end of their fiscal year.
On the contrary, prospect broker-dealers must file form BD to register with the SEC.
The form is filed through Financial Industry Regulatory Authority (FINRA) and includes information such as account holdings, names of executives, management policies, past securities violations, and legal proceedings if any.
SEC has a new rule that reinforces the fiduciary standards among investment advisers and holds broker-dealers to higher standards.
SEC’s Standards of Conduct for Financial Advisors
Many financial professionals refer to themselves as financial advisors, including RIAs, broker-dealers, and insurance agents.
To be a RIA, one must register with SEC.
RIAs offer comprehensive financial planning services and investment advice.
They also manage investor’s investment portfolios and charge an asset under management (AUM) fee for service rendered.
They can charge an hourly rate or a flat rate for one-off services.
SEC requires registered investment advisers to comply with the fiduciary standards.
As fiduciaries, RIAs are obliged by law to act in the client’s best interest at all times.
This entails informing clients of all the service offers, fee structure, and any conflicts of interest.
Broker-dealers, on the other hand, are registered with FINRA.
They sell different securities, depending on their licenses.
Brokers can offer financial advice to clients.
They are not held to fiduciary standards.
Thus, their recommendations are based on what will work best for the client, not necessarily what’s in their best interest.
Since they earn commissions for the product sold, conflicts of interest are inevitable.
For this reason, SEC’s new rule, the famous Regulation Best Interest (Reg BI) that took effect on 30th June 2020, seeks to clear this confusion.
The new rule ruling also includes other factors, including investment adviser fiduciary duty, which we’ve talked about, client relationship summary (CRS), and interpretation of “solely incidental.”
Regulation Best Interest
Reg BI requires brokers to make their recommendations with the client’s interest at heart.
Brokers must fully disclose the investment products or strategies they recommend and why the recommendations best fit the client’s needs.
Additionally, brokers should reveal any conflict of interest to the client when offering their recommendations.
This information must be provided to the client during the recommendation, specifically before signing the advisory contract.
Reg BI also bars independent broker-dealers from referring to themselves as “advisers” or “advisors.”
The only professionals who should refer to themselves as advisors are RIAs and advisory firms dually registered as broker-dealers and RIA.
Moreover, the SEC’s new rule requires broker-dealers to tread carefully when marketing their services to avoid giving a false impression to investors.
Customer Relationship Summary (CRS)
The form CRS is a document that outlines the services of the broker-dealer firm, the fees and any other costs, any legal and disciplinary actions, and conflicts of interest.
Brokers and investment advisers must provide customers with the form CRS at the beginning of their working relationship.
But since investment advisers are already providing full disclosure on the form ADV, the ball is in the brokers’ court.
Interpretation of “Solely Incidental”
SEC exempts broker-dealers whose investment advice is solely incidental to the brokerage firm services from the investment adviser fiduciary duty.
These broker-dealers are not held to fiduciary standards as long as they don’t receive special compensation for the financial advice offered.
Financial Industry Regulatory Authority (FINRA)
FINRA is a not-for-profit self-regulatory authority that was formed in 2007.
FINRA resulted from a merger between the North Association of Securities Dealers (NASD) and the enforcement division of the New York Stock Exchange (NYSE).
The regulatory authority works under SEC.
Its primary responsibility is to supervise brokerage firms, exchange markets, and other institutions that offer professional securities training and testing.
Besides that, the authority work hand in hand with SEC and the North American Securities Administrators Association (NASAA) to:
- Administer licensing exams for broker-dealers and investment advisers.
- Uphold the highest continuing educations standards for financial professionals.
- Maintain the database for financial advisors.
Additionally, the Financial Industry Regulatory Authority is the oversight authority for licensing broker-dealers, investment advisors, and their registered representatives.
Lastly, FINRA developed an electronic system that collects and stores the federal and state registration data of financial professions and financial service firms.
So, part of its duty is to maintain the electronic system.
Firms registered with FINRA are required to:
- Register any new securities offerings in their advisory services.
- Submit audit reports annually.
- Ensure their employees are up to speed with continuing education.
The continuing education training is split into two: the Firm Element and the Regulatory Element.
The advisory firm implements the Firm Element annually, which constitutes training programs to keep its registered financial professionals up-to-date on financial services and product-related subjects.
On the other hand, FINRA offers the Regulatory Element every three years.
For the Regulatory Element, an investment adviser should show competency in sales practice, regulatory, ethical, and compliance standards.
Finally, FINRA has sanction guidelines that guide the regulatory authority on disciplinary procedures.
Investment advisers and firms that violate the federal securities law and FINRA’s law and regulation are subject to disciplinary action.
Depending on the offense, the advisor firm or the individual could be barred from practice or suspended.
Other times, violations could lead to criminal penalties or fines.
The North American Securities Administrators Association (NASAA)
NASAA was formed in 1919.
The association comprises state securities administrators from three countries, United States, Canada, and Mexico.
NASAA works in collaboration with the state’s security regulators that make up the association and FINRA.
Its primary mandate is to protect individuals interested in purchasing investment advice and securities.
NASAA also educates, investigates consumer complaints against advisory firms, and registers certain state securities.
Particularly, NASAA is the brain behind the series 63 exams, also known as the Uniform Securities State Law Examination, which is administered with FINRA.
Investment advisers firm with less than $100 million assets under management (AUM) registers with the state securities regulators which are part of NASAA.
Every state in the United States requires Investment Advisors Representatives (IAR) and Registered Investment Advisers (RIA) to register with the state securities regulators in the state they are conducting business.
The registration process is complex.
Thus it’s recommended to seek the help of an attorney in case a RIA is not conversant with the process.
Moreover, the requirements vary depending on the state.
So, it will help to confirm with the specific state regulatory agency for the registration requirement.
RIAs register through IARD.
Hence, it’s paramount for an advisor to read and understand the instructions on the form ADV before completing it.
Additionally, advisors should update the form over time as stipulated in the instructions.
Apart from form ADV, IARs should fill form U4.
The form has its own instructions that an advisor must heed.
Form U4 shows whether an advisor has successfully completed the licensing exams or has an active certification.
Besides filling the forms, IAR is required to pay a registration fee through IARD.
Apart from registrations, the state security regulators are also in charge of enforcing the state securities law in their states.
The security agencies take legal action against investment advisers found in fraudulent activities or sales malpractice.