Brokers vs Advisors vs Clients’ Best Interests
Last week the NYT ran another story on the screwy financial regulatory landscape here in the States. With so many financial professionals calling it quits with big firms and hanging out shingles as advisors, the big money (brokerage firms) do their best to obfuscate their incentive to SELL, rather than ADVISE or MANAGE.
The story ably illustrates how some individual brokers provide advisor-like services while some advisors closely resemble brokers.
At the center of the discussion are business practices and regulatory guidelines that are rarely understood by the client and often blurred in practice. Brokers are governed by the “suitability rule,” which requires them to have “reasonable grounds for believing that the recommendation is suitable,” according to the Financial Industry Regulatory Authority. Registered financial advisers are supposed to adhere to a higher standard — “fiduciary responsibility,” an ethical and legal requirement that the investor’s best interest comes first, not the adviser’s own financial gain.
What may matter more than the array of services is the mind-set of the adviser. When a broker tells a client to buy or sell something, the suitability rule does not mean the broker has to be free of conflicts of interest. After all, the broker’s salary is ultimately paid by the brokerage firm, which has various products to sell. But brokerage firms say they are trying to eradicate that appearance of conflict.
Advisers like Mark Matson, chief executive of Matson Money, said brokerage firms should get out of the advisory business altogether. “The problem is they hold themselves out as offering advice and value-added services,” he said. “They should just tell clients, ‘I work for a brokerage and I’m going to suggest some things, and you have to make the decision if they’re right for you.’ ”
This is where the fiduciary standard gets invoked. Rooted in trust law, that standard means that an adviser has to act impartially and solely for the benefit of the client, avoiding conflicts of interest and self-dealing.
One advisor’s view
I interviewed Derek Hernquist, Chief Investment Officer at Integrative Capital, LLC in Charlotte, NC on this matter.
Derek: “It makes no sense to me that there are two standards, and I think the brokerage industry has blurred the lines by changing titles to “financial advisor” from broker or registered rep. Most people I speak with are unaware of the distinction between financial advisors and investment advisors.
“Seriously, how can anyone read this line from the article and not think there’s a problem “Congress is now considering a provision that could alleviate some of this confusion by requiring brokers to act in their clients’ best interest. ‘Requiring brokers?’ Shouldn’t a client be able to trust this is already the case?”
Derek’s a smart guy with principles. While I had his ear I asked a few more questions:
Q: Why did you launch your own advisory practice?
A: I found myself frustrated with my answer when friends asked “What do I do with my money? The growth of Wall St. left investors with an overwhelming array of underwhelming choices. It became harder and harder for the true risk managers to be noticed amidst the race to beat the benchmark. I felt compelled to step in and help filter the noise for those without the time to do so.
Q: Why did you choose Registered Investment Advisor (RIA) registration?
A: I needed complete independence of investment choices as well as fair pricing to give clients a shot at attractive risk-adjusted returns. This eliminates everything but the hedge fund and investment advisory models,and I felt that the demographic I wanted to help was outside the scope of hedge funds.
Q: Compensation is a big issue. How did you determine your fee structure?
A: I love the performance-driven aspect of hedge fund fees, but had to compromise in order to open my tent to individuals that don’t qualify as accredited investors.
In Warren Buffett’s early days, he charged nothing for the 1st 6% of return and asked for 25% of profits above that. I’d love to do that, but that’s outlawed for non-accredited investors under the 1940 Act. To this point, I’ve settled for charging clients 1% of assets up to a max of $10,000 per year. Account size doesn’t dictate required workload, so this is my way of flattening the cost curve a little as clients grow into accredited investors.
Prompts for Professionals
I wrote about compensation and the need for some honest disclosure on how any professional is paid last June. One of the comments included this observation: “Funny – no one asks their doctor how they get paid either. Might be worth asking. Most doctors I know have incentive to rush you through their office because they are paid by the HMOs based on how many patients they see per day.”
- If you own your firm, tell your clients why you decided to structure your compensation as you did. If you work for a broker or agency, tell your clients why you believe the comp structure you work under is fair to you and to them.
- Explain how you balance the competing interests of your financial future and theirs.
- Have an up-front discussion about how they can challenge your ethics.
- Do you belong to a professional organization that requires credentialing? Tell your clients about the credentialing process and how your preparation and credentialing benefit them.
- Publish your continuing education plans for the year.
- Solicit feedback from clients: what topics do they find most confusing?
How about it? Let’s have a hearty discussion in the comments section.
