BD vs. RIA: Navigating compliance requirements

BD vs. RIA: Navigating compliance requirements
Transitioning from a BD to an RIA firm requires navigating several compliance regulations
As more advisors transition to RIA firms, compliance can be a stumbling block. This guide explores the different layers of BD vs RIA in terms of compliance
DEC 01, 2024

A growing number of financial advisors have been leaving their broker-dealer (BD) firms to start or join a registered investment advisor (RIA), an annual industry analysis has found. The study noted that among the biggest factors driving the trend is the RIA model’s client-centric approach to wealth management.  

In this article, we will delve deeper into the key differences between a broker-dealer and an RIA. We will discuss how the two roles differ and what compliance challenges those transitioning need to navigate. An industry expert also shared advice on how BDs can ensure compliance as they make the shift.  

This guide can prove handy for BDs who may be wondering whether transitioning to an RIA is the best move. Keep reading as we dig deeper into the different layers of BD vs. RIA.  

BD vs. RIA: What’s the difference?  


Broker-dealers and RIAs are key figures in the financial advising space. Both play an important role in helping investors shape their investment strategies. However, they differ in several aspects, including how they operate, the regulations they need to meet, and their payment structures. Here’s a more detailed comparison of BD vs. RIA.  

Roles and functions 


BD: Broker-dealers act as intermediaries in the purchase and sale of securities. As the name suggests, they serve dual functions. As a broker, they facilitate investment transactions by connecting buyers and sellers. They may also work with advisors to help clients decide which assets to buy or sell. As a dealer, BDs trade securities from their inventory, acting as the principal of the deal.   

RIA: RIAs provide clients with financial advice and manage assets on their behalf. Compared to a BD, an RIA can offer a broader range of services. These can include retirement, estate, and tax planning. Some RIAs target a particular client base, such as retirees or high-net-worth (HNW) individuals. This holistic approach to their service makes them a good option for clients needing extensive financial guidance.  

Regulatory standards 


BD: The Financial Industry Regulatory Authority (FINRA) is the main regulatory body for broker-dealers. FINRA is regulated under the Securities and Exchange Act of 1934. BDs must meet specific rules involving trades and customer accounts. They are also subject to a suitability standard. This requires them to recommend only investments that suit their clients’ needs. 

RIA: RIAs are regulated under the Investment Advisers Act of 1940. Depending on the firm’s size, they may need to register with the Securities and Exchange Commission (SEC) or their state’s securities commissions. Unlike BDs, RIAs are subject to a fiduciary standard. This requires them to always act in their clients’ best interests, ensuring the highest possible standard of care.  

Licensing requirements  


BD: Firms must have at least two general securities principals and a financial and operations principal (FINOP) to get a broker-dealer license. For sole proprietorships, only one general securities principal is required. Industry professionals must pass the Series 24 exam to qualify as a general securities principal. The Series 24 exam, however, has prerequisites, including the Securities Industry Essentials (SIE) and Series 7 exams.  

RIA: Industry professionals must pass the Series 65 exam to qualify as an investment advisor representative (IAR) and work for an RIA firm. To progress in their careers, they will need additional qualifications, such as the Series 6 or Series 7 exam, and credentials, including the CFP or CFA designations.  

Compensation structure 


BD: Broker-dealers often receive commissions for their services. This means that they earn income for each transaction they facilitate.  

RIA: RIAs are paid through fees. These can be based on a percentage of assets under management (AUM), an hourly rate, or a flat fee.  

Here’s a summary of the key differences between a BD and an RIA. 

BD vs. RIA – comparison table 

BD vs. RIA – comparison table

This guide provides more details on how to become a registered investment advisor.  

BD vs. RIA: A shift towards registered investment advisors 


An annual analysis of the investment advisor industry has revealed a notable trend that has emerged in the past few years – a growing number of financial advisors are leaving their FINRA-member firms and opting to start or join an RIA. 

The latest industry snapshot from the Investment Adviser Association (IIA) identifies some of the factors driving the shift. These include: 

Regulatory disparity 


FINRA-member broker-dealers have traditionally operated under a suitability standard. This makes it obligatory for BDs to ensure that any investments they recommend suit their clients’ needs. Suitability can be based on various factors, including the client’s risk tolerance, financial situation, and investment goals.  

The recommendations, however, don’t need to be in the client’s best interests. This means that nothing is prohibiting BDs from recommending investments that may earn them a higher commission, as long as these meet the suitability standard.   

RIAs, on the other hand, adhere to a fiduciary standard. This demands that they act in their clients’ best interests. RIAs are held to a higher standard of ethics and transparency, which resonates with advisors who want a more client-centric approach.  

Autonomy and flexibility 


Registered representatives working for FINRA-member BDs work within a structured framework. This restricts their ability to choose investment products and strategies.  

By contrast, RIAs hold more control over their business. They can personalize their offerings to meet a client’s unique needs. They can also provide a wider range of investment options, allowing them to capitalize on emerging opportunities in a rapidly changing market. The independence and flexibility that come with the RIA model make it an appealing option for many financial advisors.  

Client-centric model 

RIAs are legally required to act in their clients’ best interests. This allows them to build a relationship based on trust and transparency. This can be a major selling point for financial advisors who want to differentiate themselves in a highly competitive market.  

This chart reveals a strong growth in the number of IARs in the three-year period ending in 2022, according to the report.  

 

The rising number of investors seeing the value of the fiduciary advice provided by RIA firms and representatives was the main factor driving the shift, the industry report adds.  

BD vs. RIA: Compliance requirements 


But despite the uptrend, the transition from a BD to an RIA firm is far from straightforward, with compliance potentially turning into a major stumbling block.   

“Transitioning from a broker-dealer (BD) to a registered investment advisor (RIA) firm is a shift that goes beyond simply changing business cards,” said Alisha P. Dowell, fractional chief compliance officer at Knight's Shield Compliance Consulting. “It requires changes in mindset, compliance, and client interactions.  

Read more: What does a CCO do?

“Unlike BDs under FINRA's ‘suitability’ standard, RIAs operate under a fiduciary duty, prioritizing clients' best interests and focusing on transparency. This involves disclosing conflicts, communicating openly, and documenting interactions to maintain compliance.” 

Dowell highlighted some compliance requirements that advisors transitioning to an RIA firm must meet. 

“On the compliance side, RIAs regulated by the SEC or state agencies must file Form ADV and create a tailored compliance program,” she said. “The SEC’s updated marketing rule also allows more flexibility in advertising – hello, honest client testimonials! But be prepared for strict guidelines on truthfulness and disclosures. Organized recordkeeping of client communications and other documentation is also essential.” 

In this section, we will provide a brief overview of the different compliance requirements for both BD and RIA firms.  

FINRA compliance requirements 


FINRA requires broker-dealers to meet a stringent set of regulations involving customer accounts, trade execution, and asset protection. Here are some of the essential compliance requirements BDs must meet: 

  • Licensing and registration: BD firms and representatives must register with FINRA. They must also maintain the required licenses and qualifications to continue to operate.
      
  • Sales practices: FINRA-members are subject to the suitability rule. This rule applies when making recommendations and selling securities.
      
  • Customer protection: FINRA requires broker-dealers to implement account safeguards for client funds and securities.
      
  • Record-keeping: Broker-dealers must maintain accurate and up-to-date records. These include customer account information, trade transactions, and all forms of communication.
      
  • Broker-dealer audits: BD firms must undergo annual independent audits to show compliance with FINRA rules and federal securities laws. The deadline for the yearly audits is 60 days after the end of the fiscal year. Extensions can only be granted by the SEC.
     
  • Anti-money laundering (AML): FINRA requires broker-dealer firms to implement an AML program that will help them detect and report suspicious transactions, including money laundering.
     
  • Market integrity: Broker-dealers must only engage in fair and equitable practices. This means not getting involved in any form of market manipulation and insider trading.
      
  • Financial integrity: BD firms must meet their financial obligations. These include meeting capital adequacy standards.  

Non-compliance with FINRA regulations can lead to disciplinary actions. Penalties can include fines and suspensions. Serious violations can result in revocation of licenses or even bans.  

RIA compliance requirements 


RIAs with at least $110 million in AUM are required to register with the SEC, unless they are granted an exemption. Smaller RIA firms may register with the SEC or their state regulatory commissions, depending on their AUM.  

The Investment Advisers Act requires RIAs to meet compliance obligations. This provision is meant to ensure that they uphold their fiduciary responsibilities. Here are some of the most important rules that RIAs must comply with:  

  • Form ADV: RIAs are required to register with the SEC and state regulatory agencies using Form ADV. They will need to provide key business information, including their business structure, AUM, and fee structure.
      
  • SEC Rule 204-1: This outlines the requirements for updating Form ADV. Updated forms must be filed within 90 days after the end of the fiscal year through the Investment Advisers Registration Depository (IARD) website.
     
  • SEC Rule 204A-1: This requires RIAs to create and implement a written code of ethics. All supervised persons must receive a copy of the code.
      
  • SEC Rule 204-2: This governs bookkeeping and recordkeeping requirements. Under the rule, all RIAs must maintain accurate and complete records for their businesses. Firms must ensure that records are protected against alterations, loss, or destruction. They must also control who can access these documents. Recently, the SEC has revised rules to allow RIAs to maintain records electronically as long as certain requirements are met.
     
  • SEC Rule 206(4)-1: Also called the SEC marketing rule, this prohibits the use of testimonials, endorsements, or third-party ratings for advertising purposes unless certain requirements are met. Firms are also required to disclose their marketing strategy in Form ADV.
     
  • SEC Rule 206(4)-2: Also referred to as the SEC custody rule, this requires RIAs to maintain clients’ securities and assets with a qualified custodian. Clients must also be informed about who the custodian is and how their assets are being maintained. The rule also allows surprise inspections of firm records by a certified public accountant.
      
  • SEC Rule 206(4)-4: This requires RIAs to disclose any disciplinary proceedings involving the firm. These include criminal or civil actions against an advisor.
      
  • SEC Rule 206(4)-7: This outlines the three requirements that RIAs must meet to be fully compliant, namely: establish written policies and procedures for compliance, conduct an annual review of these procedures, and appoint a CCO to develop and enforce these policies.
     
  • SEC cybersecurity disclosure rule: This requires RIAs to disclose cybersecurity incidents. They must also submit annual disclosures detailing their cyber risk management strategies and policies.  

Read more: What is RIA compliance software?

Navigating compliance requirements 


Compliance requirements are set out to protect investors and mitigate the risk of fraudulent activities. That’s why it is crucial for every firm to develop a solid compliance plan. It is also important that the plan is reviewed regularly to ensure that all areas of the business remain compliant.  

“If joining an existing RIA, familiarize yourself with its compliance policies on client communication, conflicts, and documentation,” Dowell said. “The compliance team, whether in-house or outsourced, will be key as you adjust to this client-first model. 

“Despite new responsibilities, your core mission – helping clients achieve their financial goals – remains. Whether in a BD or RIA, guiding clients with strategies aligned to their best interests is at the heart of the work.” 

Visit our goRIA section for the latest updates on compliance regulations. Don’t forget to bookmark this page for easy access to breaking news and the latest industry developments. 

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