Hector Rojas, Spring 2017 Student Intern
In part one of this series, we defined the term broker. There we learned that there are two general classification of brokers, what each one does, and why that matters for investors. In part two of this series, we will discuss the role of the broker generally. We will discuss who has authority over brokers and the standard broker conduct or recommendations are judge by.
What is the role of the broker?
The role of the broker is to execute orders to buy or sell a stock on behalf of their clients. Typically, brokers do this by handling two main types of accounts: discretionary and non-discretionary accounts. Under an advisory or non-discretionary account, a broker conducts transactions on the specific orders of his client. Under a discretionary account, however, the client authorizes the broker to conduct transactions on behalf of the client without prior consultation or their permission. Learn more about this important distinction in our prior post on this topic.
Who governs brokers?
Brokers are registered with the Financial Industry Regulatory Authority (FINRA). In regulating brokers, as a self-regulating organization, FINRA writes and enforces its own rules, with oversight from the SEC (See here).
Suitability standard of care
Brokers must only recommend products and services to their clients, which are “suitable” to the specific needs of the client (i.e., investor). This means that a broker must have a reasonable basis for recommending a specific product or investment strategy to the client only after he has obtained information through reasonable diligence of the customer’s investment profile. The investment profile of the customer includes: the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs and risk tolerance (See FINRA Rule 2111; see here also).
Now that you understand who a broker is, who governs them, and the standard of care their recommendations are judged by, in part three of this series we will tie together all of these concepts and discuss why this matters to you when selecting your financial broker. Stay tuned.