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Is Your Financial Adviser Working for You?

by on February 06, 2011 10:20 AM

The securities industry is getting an overhaul. 

The aftermath of the meltdown that occurred in 2008 has resulted in the Dodd-Frank Wall Street Reform and Consumer Protection Act. Dodd-Frank is an overhaul of the industry that passed in July 2010, and with it the Securities and Exchange Commission has been given a serious task. The SEC is a federal agency that holds primary responsibility for enforcing securities laws. Among many new rules, the SEC has been given the mission to determine if all advisers should be required to put investors’ interests first.

I know what you’re thinking:

What?! You mean the person handling my life savings is not required to put my interests first?

In reality, a broker regulated by the Financial Industry Regulatory Authority has the duty of recommending “suitable” investments, and their primary role is one of trading. An investment is deemed suitable if it fits the client’s risk profile, age and goals, but does not necessarily need to be the best product. A broker is typically paid in commissions, which are paid by and determined by the product being sold. (Annuities pay the highest commissions, which is why, in my opinion, they are oversold in our industry.) 

Brokers or registered representatives can have conflicts of interest. A prime example is the “in-house” product. For instance, a broker works for XYZ Company and therefore sells that company’s mutual fund, thus keeping more of the client’s money and fees in-house. Other times, mutual fund companies may offer additional fees to the XYZ Company for promoting its products, thus paying the broker or firm more than another firm with a comparable or even better product.  

Another example is the principal trade, wherein XYZ Company may have securities that it is looking to get off of the company books, and that the broker will sell to the client. There are many ways conflicts can arise in the industry, and many are not disclosed to unsuspecting clients.

By contrast, a registered investment adviser (not just any adviser, which is a common, albeit erroneous, synonym for broker these days) is registered in Pennsylvania either with the SEC or the Pennsylvania SEC, depending on its size. Currently, a firm with more than $50 million in assets under management is registered federally with the SEC. A registered investment adviser is required to put its clients’ interests ahead of its own and is given a fiduciary responsibility. This type of adviser is usually paid on a fee basis, as opposed to a per-transaction basis. This means the adviser who is registered and carries fiduciary responsibility needs to avoid conflicts of interest, disclose those that exist and look out for the client’s best interests.

The SEC is looking to see if these two models can be and should be harmonized. Yet, the common misperception of the public is that there is one model and that anyone calling himself or herself an “adviser” is  held to the higher, registered standard. 

Not surprisingly, large firms in the brokerage industry are fighting the new fiduciary standard. In the new model, brokers at the very least would need to disclose their conflicts of interest. Brokers who work for insurance companies (folks who sell lots of annuities!) lobbied strongly against the rule. The fear is that the new requirement would limit common business practices in the industry that historically have made companies large amounts of money.  

The need to change the rule came into play after 2008 due to the conflict between what brokers knew about the real-estate investment instruments that collapsed, and how they represented them to clients. Even when the real=estate bubble was bursting, many brokers continued to sell them to clients, disregarding the risks.  With the new rule in place, this action would result in censure if the broker was aware of the risks involved. 

Will the new rule make its way into the industry? The reality is that money talks and the rule will probably go through changes or deletions before being passed. It is imperative that you know your broker’s conflicts and how they are paid so that you can build trust. If you are not sure how your adviser is being paid, ask. 

Full disclosure leads to better decision making, for both you and the person you choose to trust with your future.



Judy Loy, ChFCâ, is a Registered Investment Advisor and CEO at Nestlerode & Loy Investment Advisors, State College, Pa. A graduate of Penn State University, Loy has been with the firm since 1992, assisting clients with retirement planning, brokerage services and investment advice. She can be reached at [email protected]
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