Broker-Dealers and Investment Advisers--Who's Who and What's What?

Remember that a broker-dealer is in the TRANSACTION business. As the Uniform Securities Act states, a broker-dealer is "any person engaged in the business of effecting transactions in securities for the account of others or for his own account." If the firm acts as a broker, they arrange a transaction for the accounts of others. If the firm acts as a dealer, they effect a transaction for their own account in which they buy from or sell to a customer. They work the secondary market, either arranging or participating in trades, and they work the primary market as investment bankers, bringing new issues to market in order to raise capital for government and corporate issuers. On the other hand, an investment adviser is not paid to complete securities transactions. An investment adviser, believe it or not, is compensated for providing advice on securities. This advice could be delivered in person or through reports and analyses. It could involve managing portfolios for a % of the assets, or charging a fee to act as a consultant or financial planner. The big financial services firms work both sides of the business, but they still register the broker-dealer as one entity and the investment adviser as another. For example, at Wells-Fargo, the structure is explained in their Form ADV 2 like this: Wells Capital Management Incorporated (“WellsCap”) is a registered investment adviser and a wholly owned subsidiary of Wells Fargo Bank, N.A. (“Wells Fargo"), which is wholly owned by Wells Fargo & Company, a diversified financial services company. If we go to the broker-dealer's website, we see that: Brokerage is offered through Wells Fargo Investments, LLC (member SIPC), a non-bank affiliate of Wells Fargo & Company. Now we see why the Uniform Securities Act exludes "banks, savings institutions, and trusts" from the definition of both broker-dealer and investment adviser. A bank may be related to a broker-dealer and /or investment adviser because they have the same parent, but they are only siblings. WellsCap is the adviser. Wells Fargo Investments, LLC is a broker-dealer. They are both siblings of Wells Fargo Bank, N.A., and all three have the same parent, known as Wells Fargo & Company. Three kids, all related, yet all distinct entities.
Yesterday, a young man came in for some Series 6 tutoring and was trying to figure out what some of the senior reps at NMFN are doing under "wealth management" and how it differs from what he'll be doing when he passes his Series 6 and 63. His question was prompted by my overview of the same mutual fund prospectuses he'll be handing out very soon to investors. As I explained to him, he will be selling investment securities products called open-end mutual funds to investors. He will be trying to "effect transactions in securities" on behalf of his broker-dealer, NMIS, who has a sales agreement with another broker-dealer called American Funds Distributors. After customers buy these investment products, money will be regularly deducted to cover management fees, which go to the investment adviser known as Capital Research and Management Company. As always, the broker-dealers get paid to effect sales of securities; the adviser gets paid a % of assets to manage the portfolio. The senior reps at NMFN, who get their Series 7 & 66, can work both sides of the business. They can sell mutual funds and annuities as securities agents of a broker-dealer. Or, when they work the wealth management/investment advisory side, they basically bypass the little product known as a "mutual fund" and simply put their clients' assets under management with a team of investment advisers. Average Joe and Joann, with maybe $100,000 to invest, are probably best served buying mutual fund products, in which their registered rep (of a broker-dealer) makes part of the sales charge and the ongoing 12b-1 fees. Big-Time Charlie and Charleene, with maybe $5 million to invest, are often best served by getting their own investment adviser/portfolio manager, who will charge a percentage of assets as opposed to calling them up twice a week to try and sell them something.
So, if the firm is selling securities to customers, they are acting as a broker-dealer. If the firm is managing the client's account for a % of assets, they are acting as an investment adviser. The big financial services firms work both sides of the business, but there are many firms that act only as broker-dealers or as advisers. For example, if I wanted to get directly into the financial services industry, I could easily become an investment adviser. All that would take is filling out Form ADV, paying $400 to the Secretary of State's office, and keeping better records than I've ever kept in my life. To become a broker-dealer, I would have to take a bunch of principal-level exams, become accepted as a member firm of FINRA, and somehow overcome the fact that I have no idea how a broker-dealer is actually run. It's a very unique and peculiar business model that requires all kinds of infrastructure. An "adviser" is really just anyone who can pass the Series 65, afford the licensing fees, and find enough clients willing to pay for the so-called "advisory" services. I could be your adviser without ever executing a trade--just charge you $1,000 a year to send you quarterly reports that tell you specifically what to do with your stocks, bonds, and real estate investments. If I were your broker-dealer, I'd be holding custody of your assets like a bank, and taking commissions every time you placed an online trade or told one of my rep's to buy or sell securities for you.
I was actually trying to keep this more concise. Sorry about that; I would have made it shorter if I'd had more time.