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How the SEC Regulates Financial Advisors

The SEC is an agency that protects investors and maintain fair markets. We explain how they regulate the financial advisory industry.

When you hire someone to manage your money, you want them to be transparent and clear about the services they offer. And, if they break their promises, they must be held accountable by the proper authorities. In the financial advisor industry, the U.S. Securities and Exchange Commission (SEC) enforces policies and regulations to keep investment advisors in check at all times.

This article will outline how the SEC regulates financial advisors and what you should know as a client. You’ll learn how the organization defines an investment advisor and what specific policies they must adhere to. We’ll also break down how these standards impact you and how you can, if necessary, file a report.

Key Takeaways

  • The SEC’s mission is to safeguard investors, uphold “fair, orderly, and efficient markets,” and “facilitate capital formation.”
  • Both the Investment Company Act of 1940 and the Investment Advisers Act of 1940 give the SEC power to regulate the financial advisor industry.
  • Financial advisors of a certain size must register as an RIA with the SEC, subjecting them to the agency’s regulations.
  • RIA firms must act as a fiduciary when providing investment advice.
  • If you’re a current or prospective client of an RIA firm, you can use the SEC’s Investment Adviser Public Disclosure (IAPD) search tool to pull important documents and brochures, such as its Form ADV.

What Is the SEC?

The U.S. Securities and Exchange Commission (SEC) is an independent regulatory agency of the United States federal government. It was established by President Franklin D. Roosevelt on June 6th, 1934, amid the Great Depression. The organization was formed and still exists to uphold the following values:

  • Protect investors. The SEC safeguards investors by demanding public companies maintain absolute transparency. Additionally, anyone who provides investment advice or facilitates trades must uphold ethical standards at all times.
  • Maintain fair, orderly, and efficient markets. Each year, the SEC handles over $100 trillion worth of securities trading. To ensure fair trading, the agency regulates the markets through various rules and policies. Additionally, it vigilantly monitors activities to identify any wrongdoing or nefarious activity.
  • Facilitate capital formation. One of the core jobs of the SEC is to give businesses and entrepreneurs the power to grow through additional capital. Through the capital markets, investors can provide additional capital by buying a stake in the company.

As part of its mission above, the SEC requires public companies to file both annual and quarterly reports. These document a company’s financial information, as well as provide details about its upcoming strategy. Registered investment advisor firms must also file an annual Form ADV, which similarly provides vital information about their operations and any conflicts of interest.

In addition to its rules and regulations, the SEC gives investors various tools to help protect them and facilitate fair markets. One of which is the Electronic Data Gathering, Analysis, and Retrieval system, or EDGAR, for short. With EDGAR, you may access the various reports that companies must file. This includes information on specific securities, such as bonds or mutual funds, which investors often keep in their portfolios.

In the context of the financial advisor industry, the SEC is a regulatory agency that governs firms that provide investment advice in return for compensation. It does this by imposing various policies, which we’ll expand upon further in this article.

Understanding Registered Investment Advisors (RIAs)

The SEC requires any firm that provides investment advice for compensation to become a registered investment advisor (RIA) if it exceeds $100 million in assets under management (AUM). The Investment Advisers Act of 1940 binds RIA firms and their representatives to act as fiduciaries at all times when they deliver investment advice to clients.

As part of an RIA’s fiduciary duty, it may only offer services through a fee-based structure, rather than a commission. For instance, many firms offer an AUM fee structure, in which you pay a percentage of the value of the assets your advisor manages for you. Other firms may also charge for their time or per project. The purpose of these structures is to eliminate the chance for any conflict of interest through any kickbacks a professional might receive for recommending a product or investment.

RIA firms must also file annual reports with the SEC. This includes the Form ADV, which is a comprehensive document that outlines the following:

  • Identifying information
  • Corporate structure and ownership
  • Advisory business
  • Types of clients
  • AUM
  • Conflicts of interest, if any
  • Disciplinary action against the firm, if any

Regulations Advisors Must Follow

As mentioned above, the SEC imposes several regulations upon RIA firms and their representatives. These rules were initially enacted by the Investment Advisers Act of 1940. Below is an overview of the policies that RIAs must adhere to:

  1. Fiduciary Duty. The SEC requires all investment advisers to act as a fiduciary. This means that they must “avoid conflicts of interest” and refrain from taking advantage of clients. If an adviser does injure or cause monetary loss to a client, they will be held responsible.
  2. Substantive Prohibitions and Requirements. These are rules which exist to prevent fraudulent activity from advisers. For instance, an RIA may not advertise based on misleading performance. Also, an adviser may not sell a security in which they have a financial interest to a client.
  3. Contractual Requirements. The SEC states that it doesn’t require advisory contracts to exist between a client and an adviser. It does, however, impose restrictions on what a contract may include. For example, the commission allows advisers and clients to “mutually agree” to advisory fees but prohibits performance-based fees of any kind.
  4. Recordkeeping Requirements. RIAs must keep both accounting and “additional” records at all times. The latter includes documents that relate to the firm and its employees’ personal investing records, code of ethics, and power of attorney. All of which is to foster transparency between the adviser, client, and the SEC.
  5. Applicability to Non-U.S. Advisers. This aspect of the Investment Advisers Act of 1940 simply points out that the requirements in this list don’t generally apply to advisers operating outside of the U.S.
  6. Administrative Oversight. This rule indicates that an RIA and its records are subject to monitoring and examination by the SEC at any time to ensure compliance.

What Clients Should Know

The rules in the list above exist to meet the SEC’s mission of protecting investors. As a current or prospective client of an RIA firm, it’s important that you have a basic understanding of what one can or can’t do. This will help you spot any irregularities, if any.

Whenever you work with a financial advisor, especially if it’s your first time meeting them, it’s tempting to be trusting. However, it’s wise to be vigilant and pay attention to their actions. If you do spot a potential issue or cause for concern, be sure to ask the firm about it.

If need be, the SEC allows you to use its Investment Adviser Public Disclosure (IAPD) search tool to look up RIA firms and representatives. Here, you can access a company’s Form ADV, Part 2 Brochures, and Client Relationship Summary (CRS). These can give you an idea of what the firm offers, who they serve, and if there are any disciplinary issues or conflicts of interest you should be aware of.

In the case of an issue with a firm, you may also submit a complaint to the SEC through its online Investor Complaint Form. You must provide information about yourself and what occurred. However, you can choose to not send the form to the company in question.

Frequently Asked Questions

Are all financial advisors registered with the SEC?

No, only RIA firms maintain a registration with the SEC. Smaller firms, however, do register with their respective state.

How do I submit a complaint about a financial advisor?

You may submit a complaint via the SEC’s Investor Complaint Form on its website. To do so, you must outline what the issue was, who you are, and indicate whether you want to send the form to the RIA firm.

How can I tell if an advisor is registered with the SEC?

There are a couple of ways to go about this. Your best bet is to search for the firm on the SEC’s IAPD database, either with its name or SEC number. You should also visit the firm’s disclosure section on its website to see if it makes any of its documentation available to clients.

What does the Investment Advisers Act of 1940 do?

The Investment Advisers Act of 1940 imposes regulations on those who give investment advice for compensation. Primarily, it requires RIA firms to uphold a fiduciary duty at all times. It also mandates proper recordkeeping and disclosure of conflicts of interest.