There’s a good chance that the CFP® Board will ask a few questions about the differences between a Registered Investment Advisor (RIA) and Broker/Dealer (BD). The Board will likely also test your knowledge of where an Investment Advisor Representative (IAR) is licensed as opposed to a Registered Representative (RR). If you are charging clients for advice, you must pass the Series 65 exam after which time you are an IAR. If you will only be brokering financial products such as mutual funds, you need only to be a Series 6 (or Series 7 for additional capabilities) Registered Representative. What difference does this make when taking the Certified Financial Planner™ exam? The exam creators want to test your knowledge about who is legally obligated to put the interests of clients first (an IAR) vs. one who is only required to make recommendations for clients that are simply “suitable” (RR).
The legal obligation to act in your clients’ best interest in known as a fiduciary duty and RIAs (and those licensed under the RIA i.e. IARs) are fiduciaries while RRs are not. Furthermore, RIAs are either registered with their own state’s securities regulator or the Securities and Exchange Commission (SEC). Whether an RIA is registered with their state or with the SEC depends on the firm’s assets under management. Most BDs, however, are members of the Financial Industry Regulatory Authority (FINRA) and the SEC. FINRA is a self-regulatory organization and it and its members are regulated under the Securities and Exchange Act of 1934.
As far as compensation is considered, RIAs typically charge clients a percentage to manage assets. For example, an IAR (licensed under the RIA) may charge his clients a flat 1% to manager their assets. In this fashion, the advisor’s interests are aligned with his clients’ because as the clients AUM goes up, so does the advisor’s income. However, if the client’s AUM falls, so will the income of the advisor therefore it’s in the advisor’s best interest to manage client funds in a prudent (and hopefully profitable) manner. RR’s on the other hand, typically earn their income through sales commissions. While this is not necessarily a bad arrangement for the clients of RR’s, it has greater potential for abuse as opposed to a flat percentage charge.
Finally, many advisors interact with clients in both the capacity of an IAR and an RR and are registered with both the SEC and FINRA. In being registered with both entities, an advisor can offer his clients a wider range of products and services. Being dually registered may be an advantage for a client, but full disclosure should be made.
When it comes to discerning between an IAR and RR on the CFP® exam, it’s important to understand the difference between the two. Although the difference between and IAR and RR can seem like a gray area, it certainly is black and white. For the exam, just remember that an IAR (who is licensed under an RIA) is required by law to act in the best interest of the client, whereas an RR is held to a lower standard, and that standard is to act in a manner that is suitable only. To sum it up, an IAR must adhere to a fiduciary standard whereas an RR must only adhere to a suitability standard.