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We celebrate the Declaration of Independence on July 4th each year, but chances are that your financial adviser is far more like a member of the British Empire than someone ready to fight at your side. There were many spies on both sides during the Revolutionary War. They dressed and acted like they were on your side, but they were secretly plotting against you. Could your financial adviser be doing the same?
Large financial companies often consist of several different lines of business. This can include banking, investment banking, brokerage, trust, insurance, investing, and others. They often have a goal of having their clients become customers of multiple business groups through cross-selling. It’s good for their business, but is it good for you?
Your trusted adviser, whether they are called a financial adviser, wealth manager, or any other title, is often seen as someone who has an ethical responsibility, if not a legal one, to look out for the best interests of their clients. Cross-selling creates a natural conflict of interest because it erodes the independence required for an adviser to always look out for the client’s best interest instead of the employer’s. It looks fairly benign to most financial clients, possibly even logical. Doesn’t it make sense that you should have your insurance, brokerage, trust, and investments all in one place if you like and trust that entity? Possibly not, and that misplaced trust is the basis for a situation in which the client may be the victim of a conflict of interest.
Your financial adviser may have goals or quotas they need to fill in order to help other business groups meet their goals. This is what flips the financial planning process around to one that does not benefit the client. Generally, the financial planning process should start with the client. The adviser determines the specific financial needs of each client based on their unique situation and helps them meet those needs. That may include insurance, mutual funds, a trust, brokerage, or the client may not need any of those services. When an adviser has specific financial product goals or quotas, the process works in reverse. They look at these goals and see which of their clients they can push into these products and services. Of course, they disguise the process to their clients to make it look like the client’s needs were the driving force instead of their employer’s. How likely is it that the best insurance solution, mutual fund, or other service or product just happens to come from their employer instead of the countless other financial service providers?
Independent financial advisers are able to avoid these conflicts of interest because they have no ties to any other business groups. There is no insurance quota, annuities sales goal, or new private investment offering they must help fill. Independent advisers are able to do the right thing for their clients, every time. They are free to direct clients to any insurance provider, mutual fund family, or other financial service provider without any personal financial interest or pressure from their employer.
There are a few ways clients can avoid conflicts of interest that potentially harm them. The first way is to consider avoiding financial advisers who work for large multi-line financial service firms as there may be hidden conflicts of interest in pushing the products and services they offer of other internal groups. Another way is to see how the financial adviser is registered.
They may be an investment adviser, broker, or registered as both. The Financial Industry Regulatory Authority (FINRA) has a tool called BrokerCheck that shows exactly how your financial adviser is registered. BrokerCheck can be found at http://www.finra.org/. Smart financial services clients should insist that their financial adviser be registered solely as an investment adviser. This means that their adviser has a fiduciary duty to them and does not accept commissions as compensation. Brokers, on the other hand, do not have a fiduciary duty to their clients and may accept commissions from the products and services they sell to their clients. Advisers who are registered as both investment advisers and brokers are of particular concern because it’s not obvious when they are functioning as a broker without a fiduciary standard and accepting commissions or when they are acting as an investment adviser. This often creates a false sense of trust that they are always acting as an investment adviser and sets them up to then possibly take advantage of clients.
If clients must work with an adviser at a large financial services firm, they should request written documentation of that adviser’s compensation arrangement. When that adviser suggests a particular investment product or service, the client should insist on a written statement that confirms that the adviser is not receiving any compensation from that advice directly or through a bonus for achieving a sales goal or quota. Failure to provide that basic assurance should be cause for concern.
There are wealth managers and financial advisers who have declared their independence from the conflicts of interest that plague the financial services industry. They work for Registered Investment Adviser (RIA) firms who have no financial interests in outside firms, products, or services. Their wealth managers are registered only as investment advisers and maintain the fiduciary duty to their clients.
by Jason Self, CFA, CFP®