For many individuals, working with a financial professional can prove beneficial. Especially, if one lacks the knowledge, interest, and/or time (collectively, “KIT”), to manage his or her financial life on his or her own. However, if you want to work with a financial adviser, deciding who to work with is hard. After all, it can be difficult to not only find someone with the right qualifications and experience but also to find someone you are comfortable working with on both a personal and professional level.
The decision is made even more challenging because different types of professionals are held to different standards when it comes to providing advice or recommending products or investments. The related regulations are also in flux, complicating matters even more. Credentials also vary from individual to individual and firm to firm.
The SEC’s Top Tips for Selecting a Financial Professional is a good guide. Read on for more helpful information.
The Fiduciary Standard
At a minimum, it would be prudent to work with a financial adviser who is regulated by the SEC. For decades, such individuals have been held to a fiduciary standard. Fiduciaries are required to put their clients’ best interests ahead of their own. This requirement’s roots go back to the stock market’s crash of 1929 and the Depression that followed, as Congress, in part, blamed the crash on abuses in the securities industry.
The rules are largely laid out in the Investment Company Act of 1940 (The 40 Act). The 40 Act was created to establish and integrate a more stable financial market regulatory framework following the market crash. It was preceded by the Securities Act of 1933, which focused on greater transparency for investors. The 40 Act focuses primarily on the regulatory framework for retail investment products. These rules were put in place in an effort to crack down on much of the investment advising abuses that occurred during the booming 1920s. These rules were instituted to create a distinction between salespeople who were brokers, and those who formally provided ongoing investment advice for compensation.
On the other hand, brokers are regulated by the Financial Industry Regulatory Authority (FINRA), which is the securities industry’s self-regulatory body. Brokers must provide what the agency characterizes as “suitable” investment advice. The suitability standard is much less stringent than the fiduciary standard. A broker only needs to recommend investments that are suitable for his clients. A broker can recommend a financial product that compensates him the best as long as it is suitable for the client.
Things get even trickier if you consider that some financial professionals can be dually registered. Others may have professional designations trumping the required regulatory standards. For example, if a broker is also a certified financial planner, he must serve as a fiduciary when doing financial planning, to maintain the designation.
What About an Advisor’s Title?
Unfortunately, titles have changed over the years. Most brokers are no longer called brokers. Instead, they have titles that imply more trust such as Financial Advisor, Wealth Manager, Financial Coach, Comprehensive Wealth Manager,” or Vice President. Those who achiever great success may even be referred to as Managing Directors. (The SEC provides some guidance on evaluating financial titles here.)
However, within the firms for which they work, these individuals are typically called something more closely associated with their activities: Producers.
Producers strive to maximize the sales revenue they generate for their firm. “Managing Directors” generate significant revenues and focus on maximizing the revenue they produce relative to the time they spend with clients.
Working in a brokerage firm does not mean the person providing the advice is not a good person. There may be individuals working inside these organizations who view their role as a trusted advisor. The issue is that it is hard to imagine how a fiduciary relationship can exist inside of or next to a broker-dealer business model. The two are incompatible.
The Role of an Investment Professional’s Place of Employment
Advisers who are held to a fiduciary standard must choose products that are in their clients’ best interest. However, what products an advisor picks can change depending on where they work.
For example, stand-alone Registered Investment Advisers such as Apprise Wealth Management are not connected to a bank or brokerage. This typically leaves them with access to the universe of investment products, including the cheapest index funds. Sometimes, but not always, brokers at firms associated with banks have similar access. However, because some firms have house funds and lucrative partnerships with fund companies, their brokers are often left with more limited menus of investment choices from which to choose.
How This Can Affect You
Let’s review an example showing how this might impact you.
Adviser A, who operates as a fiduciary, wants to allocate 20% of your portfolio to an S&P 500 Index Fund or ETF. As can be seen here, you can pay as little as three basis points (0.03%) when investing in an S&P 500 Index Fund. It is expected that someone operating under the fiduciary standard would choose one of these low-cost funds or another fund with similar characteristics for the investment.
On the other hand, Broker B, who is operating under the suitability standard, could place your investment in what may be the worst index fund in the world instead.
How can that be?
The Rydex S&P 500 Fund – Class C (RYSYX), which is marketed by Guggenheim Investments, pays the salesperson for placing your investment in that fund. The charges on these Class C shares include a 0.75 percent management fee (for an S&P 500 Index Fund!!), a 1.00% 12b-1 fee (the marketing or distributiuon fee which compensates advisors for selling the fund), and a deferred sales load (another bonus for the seller that may or may not be collected based on how long you hold the fund.) Total annual expenses are currently 2.33%. (This information is summarized in the prospectus found on Morningstar’s website.) (For a more detailed description of the types of fees you can pay and fee transparency, in general, please see this blog post.)
In case you are wondering, there are investors in RYSYX. The fund’s net assets currently exceed $200 million.
In both cases, allocating some of your portfolio to an S&P 500 Index fund is appropriate for the investor. However, it could cost a lot more if the person making the recommendation is following the suitability standard. In fact, when it proposed the fiduciary rule, the White House’s Council of Economic Advisors estimated that fees and payments associated with conflicted financial advice cost working and middle-class families roughly $17 billion annually. Paying such expenses (often unknowingly), will result in your portfolio generating lower returns than a comparable portfolio with lower fees.
Whistleblowers at Wells Fargo Wealth Management reported of the difficulties sales incentives created between the firm’s high net worth clients and their brokers. A recent article in the Wall Street Journal highlights a few of them:
Wells Fargo financial advisers pushed clients into products that generated additional fees and often moved client assets between different products or investing platforms to generate more revenue and bigger bonuses.
Advisers frequently targeted wealthy clients in Wells Fargo’s private bank, sometimes steering them into alternative-investment funds of which Wells Fargo was the majority owner—allowing the San Francisco bank to collect another helping of fees.
Advisers across the wealth management business sometimes shifted client assets between products such as certificates of deposit and structured notes, or put clients into products that earned the bank higher fees.
For years, managers pressured advisers to funnel clients with assets of more than $2 million into a higher-fee platform known as Investment Fiduciary Services.
Wells Fargo often mandated client quotas for riskier alternative investments, such as private equity and hedge funds, regardless of whether they were appropriate.
While the products, services, and sales incentives may be different, these types of practices are likely happening at countless brokerage firms across the country.
An Appeals Court Ruling
There have been some attempts to change the rules. However, earlier this summer, a federal appeals court struck down the fiduciary rule. While the rule did not cover all types of accounts, it did require financial professionals to put their clients’ financial interests ahead of their own. Although the SEC is considering a “best interest” standard for brokers in its place, the blurring of the lines between sales and advice in financial services has worsened.
At one point, investors knew that a broker-dealer’s function was only to facilitate financial products transactions. It was known that the broker was a salesperson whose business revolved around earning a commission, which might or might not be in the client’s best interest. Today, this is no longer the case.
The Current SEC Alternative
One can easily argue that having the SEC establish the standards in this area would be more appropriate – the Department of Labor proposed the Fiduciary Rule. In fact, the SEC proposed a “Best Interest” Standard earlier this year. Its intent is to establish a “best interest” standard of conduct for broker-dealers and those associated with broker-dealer firms when they are making recommendations related to the sale of any security or providing any investment advice to a retail customer. The public commentary period for this standard closed on August 7th.
Unfortunately, the SEC’s proposal does not define the term “best interest” leading to confusion about how the regulation will be enforced. The SEC’s proposal states: “…we preliminarily believe that whether a broker-dealer acted in the bestinterest of the retail customer when making a recommendation will turn on the facts and circumstances of the particular recommendation and the particular retail customer.” Clear as mud, right?
How Did This Happen?
Over time, the number of employer-funded pension plans has fallen as companies have switched their retirement benefits from defined benefit plans to defined contribution plans. While this has made it easier for companies to manage the cost of providing retirement benefits to their employees, it has made it harder for Americans to save and plan for their own retirement.
Unfortunately, our schools do not provide much in the way of financial education. People have been put in charge of their retirement without fully understanding the consequences of their actions.
Brokers no longer serve as order takers for stocks and bonds. Their customers desire different products and services. Brokers now create financial plans and place client money into “fee-based” accounts. It sounds like advice.
Unfortunately, it is not.
Fees and “Best Interest”
Many investment advisers who act as fiduciaries charge investors a percentage of their assets under management. This structure eliminates commissions, which can cause conflicts of interest that can lead an advisor to recommend one product over another, even if it is to the client’s detriment.
The SEC regulates fee accounts, so if you pay your adviser a fee instead of commissions, the adviser needs to act as a fiduciary. However, a conflict of interest can still exist.
Generally, conflicts of interest can arise when advice related to transactions that have the potential to reduce a client’s assets under management is given. For example, here are some potential conflicts of interest that Apprise Wealth Management shares with clients:
· Advising whether to rollover a pension plan or leave it with a former employer
· Advising about charitable contributions
· Advising about gifts to children to avoid estate taxes
· Advising about annuities, including charitable annuities
· Advising about purchasing a larger home and investing generally in real estate
· Paying off a mortgage vs. investing in the market
· Purchasing more life insurance
How Do I Know If My Advisor Is a Fiduciary?
It is a bit easier than you might think to determine if an advisor is a fiduciary.
Here are some ways you can answer this question:
· Does the advisor hold any professional designations? For example, Chartered Financial Analysts (CFA®) are required to put a client’s best interests first and act as fiduciaries. Certified Public Accountants (CPA) who work as financial advisers must also act as fiduciaries. Certified Financial Planners (CFP®) also must act as fiduciaries when working as financial planners.
· You can ask. No one would lie about it.
· If the person works for a registered investment adviser, they are required to act as a fiduciary. You can check their Form ADV Part 2, which is available on the SEC website. The adviser is also required to give you a copy of his/her ADV before you become a client.
You can also ask the advisor the following questions:
- How are you compensated?
- Do you work for a fee, a commission, or both?
- Do I pay you, or are you paid based upon what I invest my money in? For example, a salesperson can earn a commission for selling an annuity, mutual fund, stock, bond, or alternative investment.
- Are you a Registered Investment Adviser representative?
- What professional designations do you hold?
Note that these are all essentially “yes” or “no” questions. No long answers are required.
You can also look up the advisor on FINRA’s BrokerCheck website. After putting in their name, see what it says. If it says “B – Broker Regulated by FINRA,” it means they are only held to the lesser suitability standard (meaning they can put their interest ahead of yours if their recommendation is at least suitable for you). If it says “IA – Investment Adviser,” then the individual is a fiduciary who must always do what is in your best interest. If it says “PR–Previously Registered Broker,” they used to be a broker. Now they are either retired, no longer working as an advisor, or are now a fiduciary.
What It Means to Be a Fiduciary
A fiduciary’s loyalty is to you, not a company. A fiduciary acts in your best interest, not theirs. A fiduciary should provide full disclosure of all fees and not buy “financial product(s)” for your account that are for their financial benefit rather than yours.
A fiduciary is paid directly by you. This can be by the hour, a flat fee, or an agreed-upon percentage based upon your assets or your net worth. It is paid for managing your assets and may include providing a financial plan, financial advice, or a combination of any of these items.
Medical professionals are not putting their own interests ahead of their patients. Attorneys are required to put their clients’ interests first. Why should financial advice be any different?
In the end, the goal should be to build a lasting relationship with your adviser. One that is based on honesty and showing that you want your client to reach her financial goals. Transparency and honesty are required elements in a mutually beneficial relationship.
A Fiduciary Oath
Whether a fiduciary rule ultimately passes or not, it is important to work with a fiduciary. As a client, you can also ask your adviser to confirm in writing that he or she is a fiduciary who will place your best interest above their own. TheFiduciaryStandard.org provides a fiduciary oath that advisers can download and provide to clients. Apprise Wealth Management is taking the necessary steps to be included in the list of firms that have signed this oath. We also discussed our willingness to sign a fiduciary oath during this radio interview. Apprise also adheres to the CFA Institute’s Code of Ethics and Standards of Professional Conduct, which goes beyond the standards followed by many RIAs.
In the end, it is hard to make a convincing argument for working with any financial professional who is not bound to put your best interests ahead of their own.
If you would like to talk to us about your investments or creating a financial plan, please fill out our contact form, and we will be in touch.
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Phil Weiss founded Apprise Wealth Management. He started his financial services career in 1987 working as a tax professional for Deloitte & Touche. For the past 25+ years, he has worked extensively in the areas of financial planning and investment management. Phil is both a CFA charterholder and a CPA.
Located just north of Baltimore, Apprise works with clients face-to-face locally and can also work virtually regardless of location.