Is Your Financial Advisor Working in Your Best Interest, or Theirs?
"It said financial advisor on my business card, but that's not what JPMorgan actually let me be," said one former broker. "I had to be a salesman, even if what I was selling wasn't that great."
"It was all about the money, not the client," said another former advisor.
These are quotes from a recent New York Times article and editorial concerning one of the latest scandals to emerge from the financial services industry, where internal emails and comments from former advisors with JPMorgan's investment advisory operations clearly show the culture of the firm placing its interests ahead of those of its clients.
Unfortunately, this type of practice occurs all too often in the aggressive sales-oriented cultures that permeate bank and broker-dealer financial advisory businesses catering to ordinary investors.
Despite marketing pitches of "trusted advisor" and dressed-up titles, financial incentives and corporate culture often pressure these "financial advisors" to aggressively sell products and services that maximize their employer's profit, rather than offering objective advice in the best interest of the client.
According to the New York Times, "what investors have to realize is that the nation's securities laws still do not impose a fiduciary duty on brokers who give investment advice, which would require them to act in the best interest of their clients. Brokers have to recommend 'suitable' investments, but that standard gives them leeway to pitch products that boost their firm's profits, exposing investors to misleading pitches and overly expensive products."
While the New York Times article deals specifically with a U.S. firm and U.S. securities law, these practices are prevalent in all markets, and even more so in offshore markets where lack of regulation and customer abuse is rife.
Arising out of a historical patchwork of regulation, different types of financial firms offering investment advice are held to different legal standards in the United States.
An investment advisor as defined under the Investment Advisers Act of 1940 is "any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities."
That sounds pretty much like what every financial advisor, whether working for a bank, broker-dealer, or registered investment advisor firm, claims to do.
The difference is that a Registered Investment Advisor (RIA) is formed and regulated by the SEC under the Investment Advisers Act of 1940, and as a consequence of being formed under that Act, is held to a fiduciary standard.
That means that a RIA is legally obligated to place the interest of its clients ahead of its own and to fulfill critical fiduciary duties such as attempting to avoid outright conflicts of interest. Under this standard, an RIA is legally obligated to operate in the best interests of the client.
This is what most investors think their getting when they work with a financial advisor or financial services firm, but that's not necessarily the case or the norm.
Broker-dealers and other non-RIA financial firms providing financial advice are not fiduciaries, which means they are not legally obligated to work in your best interest and avoid conflicts of interest. These firms are regulated under the Securities and Exchange Act of 1934 and are only required to provide "suitable advice" to their clients, even if that advice is not in the best interest of the client as under the fiduciary standard. The suitability standard does not require the broker-dealer/financial firm to place the interests of the client ahead of its own.
The Financial Industry Regulatory Authority (FINRA), the self-regulating authority that governs broker-dealers, recently announced changes to its suitability rules. The old suitability rule stated:
In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.
Under the new rules, which went into effect on July 9, 2012, an associated person (adviser or firm) shall:
Have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer's investment profile.
The new rule expands the information the advisor must attempt to gather to determine suitability. It also expands the broker-dealer's suitability obligations, but falls far short of the fiduciary standard.
Why It Matters
In the old days, broker-dealers didn't give investment advice. They only executed orders to trade stock or bonds or at best only provided advice incidental to transactions executed on behalf of the client. There was arguably no need for a fiduciary standard. This has all changed today.
In an effort to bolster profits and to smooth out volatile proprietary trading revenues, banks/broker-dealers are increasingly entering the investment advisory business. The result is that different firms providing the same investment advice are being held to different standards of care in regards to their clients. Moreover, with everyone using the same titles and marketing pitch, there is no way for clients to tell the difference.
The lower suitability standard allows advisors and financial services firms to push proprietary and higher fee/commission products, conduct less due diligence, and offer less comprehensive and less constructive advice. It also affords the client significantly less recourse to address wrongs when they do occur. This to a client who thought they were working with a firm or advisor who had their best interests at heart. After all, that's what was implied in the marketing material.
Attempts to Impose a Uniform Standard
Many (including the Obama administration) believe that all firms providing investment and other financial advice should be held to the same fiduciary standard of care towards their clients. This would mean replacing the suitability standard that currently governs broker-dealers with the fiduciary standard that now governs registered investment advisors.
Obviously, broker-dealers oppose this change and have every financial incentive to avoid becoming fiduciaries. So far, attempts by the Securities and Exchange Commission and the Obama administration to impose a single fiduciary standard have been blocked by the deep pockets of broker-dealers and their heavy lobbying of Congress. This latest change in their suitability standard is an attempt to get out in front of the issue and shape the outcome.
The fight is not over, but for now, it's up to the consumer to look out for themselves and determine who is acting in their best interest and who is not.
You Need to Look Out for Yourself
While the details covered here are specific to the U.S., similar issues exist in the U.K., Australia and other developed markets. Even more caution is warranted in the offshore markets where the conflicts of interest and lack of standardized legal care to the client (not to mention outright fraud) are even more prevalent.
Before working with any advisor, ask them to show you in writing the legal standard of care they are required to follow and the regulatory authority by which they are governed. After all, it's your money and your future.
About Creveling & Creveling Private Wealth Advisory
Creveling & Creveling is a private wealth advisory firm specializing in helping expatriates living in Thailand and throughout Southeast Asia build and preserve their wealth. Through a unique, integrated consulting approach, Creveling & Creveling is dedicated to helping clients cut through the financial intricacies of expat life, make better decisions with their money, and take the steps necessary to provide a more secure future. For more information visit crevelingandcreveling.com.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Copyright © 2012 Creveling & Creveling Private Wealth Advisory, All rights reserved. The articles and writings are not recommendations or solicitations, and guest articles express the opinion of the author; which may or may not reflect the views of Creveling and Creveling.