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[Although most of my posts here on The North Carolina Business & Banking Law Blog are intended to be read by professionals, I sometimes explain basic concepts for the general public. This is one of those posts in which my aim is to inform everyone...including the uninitiated.]
Brokers vs. Investment Adviser
Let's begin by being clear about the terminology. People often use the terms "broker" and "investment adviser" interchangeably, but they do not mean the same thing. At the most basic level, investment advisers provide advice about investments, while brokers handle transactions in securities. (You can read a bit more about the differences here.)
A "broker" is defined by Section 3(a)(4)(A) of the Securities Exchange Act as "any person engaged in the business of effecting transactions in securities for the account of others." Often, it is easy to determine whether a person or entity is a broker. For instance, one who regularly executes transactions for others on a stock exchange clearly is a broker. (For purposes of this article, I am not going to explain the meaning of the term "dealer" and how it differs from the term "broker." Furthermore, I am not going to address the complex questions around the various service providers whose status as a broker is ambiguous. For purposes of this article, I am referring simply to people and businesses that execute trades in stocks and bonds for other people and businesses.) The individuals who work for a broker are called "associated persons" or "registered representatives." This is the case whether they are employees or independent contractors. Although associated persons usually do not have to register separately with the Securities and Exchange Commission (SEC), they must be supervised by a registered broker, registered with FINRA, and, usually, licensed by a state securities regulator.
A broker is required to comply with a number of requirements. Brokers register with the SEC through the Central Registration Depository (CRD), operated by the Financial Industry Regulatory Authority (FINRA). A broker must also be a member of at least one self-regulatory organization (SRO): FINRA, a national securities exchange, or both. "Associated persons" of brokers, including salespeople, must also register with a SRO. In addition, each state in which a broker wants to operate may have its own registration requirements. Brokers must also be members of the Securities Investor Protection Corporation (SIPC), an organization that assists investors when their brokerage firms fail.
The best source of information about a registered broker is the FINRA BrokerCheck database, available here. Brokerage firms are required to disclose certain criminal matters, regulatory actions, civil judicial proceedings, and financial matters in which the firm or one of its affiliates has been involved. The information about brokers and brokerage firms available through BrokerCheck comes from the CRD, the securities industry online registration and licensing database. Information on approximately 1.3 million current and former registered brokers is accessible through BrokerCheck. To check the registration status and background of an individual "associated person" in North Carolina, you must call the Securities Division of the North Carolina Department of the Secretary of State (1-800-688-4507) and ask to speak with a staff employee responsible for "broker-dealer registration."
People and companies who are paid to give advice about investing in securities generally must register with either the SEC or the state securities agency where they have their principal place of business. In 2010, the Dodd-Frank Act amended certain provisions of the Investment Advisers Act of 1940 by shifting responsibility over certain mid-sized investment advisers (those that have between $25 million and $100 million of assets under management) to state-level securities regulators.
To find out about an investment adviser, read the adviser's registration form, called a "Form ADV." Form ADV has two parts: Part 1 contains information about the adviser's business and whether the adviser has had problems with regulators or clients. Part 2, which is often called the “brochure,” describes the adviser’s business practices, fees, conflicts of interest, and disciplinary information. Before you hire an investment adviser, always read both parts of the adviser's Form ADV. Brochures are also sometimes required to be accompanied by a “brochure supplement” that includes information about the specific individuals who actually provide investment advice to the client. (An adviser is required to deliver a brochure supplement to the client before or at the time that the adviser begins to provide investment advice.) You can view an adviser's most recent Form ADV online by visiting the Investment Adviser Public Disclosure (IAPD) website. The IAPD database contains background information on approximately 441,000 current and former investment adviser representatives and 45,700 current and former investment adviser firms. (You can also find information about investment advisers through FINRA's BrokerCheck.)
If an investment adviser provides advice with respect to less than $25 million in assets, it may not be required to register with the SEC. In that case, you should check with your state's securities regulator to obtain information about the adviser. In North Carolina, you must call the Securities Division of the North Carolina Department of the Secretary of State (1-800-688-4507) and ask to speak with a staff member responsible for or "investment adviser registration". The Securities Division staff can tell you if an adviser has a disciplinary record. Unfortunately, there is not currently a more convenient method for these sorts of inquiries.
Further Due Diligence
It is important to recognize that the information identified above is merely intended to tell you whether a broker or investment adviser is properly licensed and has a disciplinary history or a record of formal customer complaints. This may give you an indication of basic competency, but is no guarantee of solid performance. These steps are just the beginning of the inquiry. You should ask for, and check, references, and consult with others, including professionals, familiar with the broker's or investment adviser's work before beginning a financial relationship. A little effort on the front end may save a lot of heartache down the road.