RIA
What is a Registered Investment Advisor?
Legal Definition. “Investment adviser” is a legal term that appears in the Investment Advisers Act of 1940, the federal law that governs investment advisers. Generally, this law defines an investment adviser as someone who, for pay, is in the business of advising others on investing in stocks, bonds, and other securities.
What Investment Advisers Do. Investment advisers provide professional advice to their clients regarding investments in securities. Investment advisers typically have the authority to make investment decisions on behalf of their clients, including which securities to buy or sell (referred to as “discretionary authority”) consistent with each client’s objectives and guidelines. The adviser’s authority may also extend to deciding which additional investment advisers to retain on behalf of their client to manage all or a portion of the client’s investments.
Spelling and Titles. The word “adviser” is often spelled “advisor.” There is no difference in meaning between the two terms. The Investment Adviser Association prefers to use the spelling Congress used when it passed the Investment Advisers Act. “Investment adviser” is a broad legal term that encompasses a wide range of businesses. Other terms that investment advisers frequently use to describe themselves include “investment counsel,” “investment manager,” “asset manager,” “wealth manager,” “money manager,” or “portfolio manager.”
Clients. There are a wide variety of clients that employ the services of investment advisers. Clients fall into two broad categories: individuals and institutions. The first category includes: individuals, trusts, families, and groups of families. The second category includes: corporations, private pension plans, public pension plans, educational institutions, endowments, foundations, mutual funds, hedge funds, investment partnerships and other pooled accounts, banking institutions, and state and local governments.
Investment Strategy and Style. Investment advisers use a number of different investment styles and strategies, such as growth or value. Some specialize in investments in stocks (also called “equities”), some specialize in bonds (also called “fixed income”), while others manage portfolios that consist of investments in stocks, bonds, and cash. Some advisers tailor investment portfolios for each client. Other advisers strictly adhere to one or more centrally managed portfolios that reflect a specific investment strategy, style, or model. Clients sometimes retain several advisers with different investment strategies and styles to diversify their portfolios.
Size of Firm. Investment advisers range from small businesses to large corporations. Most investment advisers are small businesses that offer more discrete services and cater to a certain type of individual or institutional client. Some investment advisers are global businesses that employ thousands of people, serving both individual and institutional clients and offering a very broad range of services and products. The popular press often equates investment advisers with mutual funds. While some investment advisers manage mutual funds, statistics indicate that the vast majority of investment advisers are small businesses that have nothing to do with mutual funds.
Advisory Contract. Investment advisers enter into a written agreement with each client that outlines the adviser’s responsibilities. The advisory contract typically identifies the services the adviser will provide, the assets or accounts it will manage, a description of the adviser’s fees, and various other terms and disclosures.
Fees. Investment advisers are usually compensated based on a percentage of assets under management, not on a transactional basis. This structure promotes a long-term relationship between client and adviser and helps to align the interests of the adviser with each client. Investment advisers, however, may employ a variety of other compensation arrangements, including hourly or flat/fixed fees for selected services, or performance fees based on the performance of the assets in the client’s account. The adviser’s fee generally is separate from and does not include brokerage commissions, dealer spreads, and other costs associated with the purchase or sale of securities; custodian fees; interest; taxes; and other account expenses.
Custody of Client Assets and/or Securities. Investment advisers, unlike most brokers, typically do not maintain custody of client assets or securities. Instead, the client specifies a particular custodian (such as a bank, broker-dealer, or other financial institution) where the client’s assets will be held. The client will receive periodic written statements from the custodian listing all holdings and recent transaction activity. In addition, an investment adviser will generally provide periodic account statements and supplementary reports to each client.
Registration. If an investment adviser has at least $25 million in assets under management, manages a mutual fund, or meets certain other requirements, it must register with the SEC by filing a document called Form ADV, Part 1. Investors can review the information that investment advisers file with the SEC by visiting: www.adviserinfo.sec.gov. Form ADV, Part 1 includes useful information about the adviser, including its address, phone number, number of employees, types of clients, assets under management, ownership information, key executives, and disciplinary information (if any). An investment adviser is also required to maintain and deliver to clients and prospective clients Form ADV, Part 2, a narrative document that includes additional information about the investment adviser, its employees, and its business practices.
SEC Oversight. SEC-registered investment advisers are subject to inspections (also referred to as examinations) by the SEC. This means the SEC will periodically meet with the adviser and will request and examine documents that relate to how the adviser discloses risks and potential conflicts of interest, trading activities, and other business practices, including communications with clients.
Regulation. The Investment Advisers Act is a law Congress passed in 1940 that authorizes the SEC to register and regulate investment adviser firms. Investment advisers are subject to rigorous regulatory requirements. For example, all SEC-registered investment advisers are required to have a written policy in place relating to the following subjects: insider trading, privacy, proxy voting (if the adviser has the authority to vote client proxies), and code of ethics. In addition, all SEC-registered investment advisers must develop and implement other written policies and procedures that are reasonably designed to prevent violations of the Investment Advisers Act. All investment advisers are required to appoint a Chief Compliance Officer (CCO).
Disclosures and Qualifications. Advisers are required to provide certain disclosures in Form ADV, including information about their qualifications, ownership of the firm, services they provide, fee rates, potential conflicts of interest, and disciplinary actions. Unlike some other professions, there is no qualification examination for investment advisers. However, many investment advisers have completed rigorous programs of study thereby earning professional designations such as Certified Financial Analyst (CFA) and Certified Financial Planner (CFP). Investment advisers are required to outline the educational and work experience of their investment professionals in Form ADV, Part 2. This form is not yet available on the SEC’s web site; therefore, clients and prospective clients should ask advisers for this document and for any other details of their investment professionals’ educational, investment, and work experience.
Fiduciary Duty. Investment advisers owe a fiduciary duty to their clients. As such, an investment adviser stands in a special relationship of trust and confidence with its clients. As a fiduciary, an investment adviser has an affirmative duty of care, loyalty, honesty, and good faith to act in the best interests of its clients. The parameters of an investment adviser’s fiduciary duty depend on the scope of the advisory relationship and generally include the following duties: (1) to place the interests of clients first at all times; (2) to have a reasonable basis for its investment advice; (3) to seek best execution for client securities transactions where the adviser directs such transactions; (4) to make investment decisions consistent with any mutually agreed upon client objectives, strategies, policies, guidelines, and restrictions; (5) to treat clients fairly; (6) to make full and fair disclosure to clients of all material facts about the advisory relationship, particularly regarding conflicts of interest; and (7) to respect the confidentiality of client information. This fiduciary duty differs from the suitability obligations that govern brokers.
Public Disclosure. In recent years, much more information has become widely accessible to the public regarding investment advisers. As noted above, the SEC maintains a public web site that allows anyone to review information the adviser has filed with the SEC (Form ADV, Part 1). The web site is located at: www.adviserinfo.sec.gov.