Fee-Based Financial Advisors, aka dual-registrants, have both a series 7 stockbroker license and a series 65 investment adviser license. Sometimes they have an insurance license too. According to FINRA, approximately 90% of financial advisors are fee-based dual registrants. A fee-based financial advisor wants you to think they are the same as a fee-only investment advisor, but they are not!
Fee-Based Financial Advisors Have Conflicts of Interest
Fee-based financial advisors have conflicts of interest because they can receive advisory fees and commissions. Fee-based advisors use their series 65 investment adviser license to receive fees. They use their series 7 stockbroker license or their insurance license if they have one, to receive commissions from products too. Whenever a financial advisor receives commissions, they have conflicts of interest with their compensation model.
How Fee-Based Financial Advisors Hide Their Commissions
Are you the person who receives a 250-page statement from your wealth management firm? Did your fee-based financial advisor tell you they are a fiduciary? You are the prime candidate to pay hidden commissions and not even know it. Here is how it happens. You have multiple accounts with your fee-based financial advisor. The advisor tells you they are a fiduciary, and they work on a fee basis. But they neglect to tell you that one of your accounts is a brokerage account. In this account, they hide the commissions from you. They may sell you hedge funds, limited partnerships, private equity, structured notes, real estate partnerships, etc., and receive commissions that you are completely unaware of.
The hidden commissions on the product sales go unnoticed by you because:
- You didn’t realize that one of your accounts was a commission account.
- The advisor told you they are working as a fiduciary.
- The 250-page statement is overwhelming.
- The fee-based advisor intentionally neglected to tell you he receives commissions too.
The Shield Fee-Based Advisors Hide Behind
When a fee-based financial advisor sells you products with hidden commissions, like private equity, private credit, structured notes, etc., they don’t have to tell you they are receiving a commission. Instead, they rely upon disclosure through prospectus. Buried in the complex and difficult to read prospectuses for the investments they sell you, you can find the commission. Most investors don’t read the prospectus and therefore they are unaware of the hidden commission in many of their investments. If you don’t ask about the commissions and don’t study the prospectuses you receive in the mail, then you won’t know that the commissions are there.
Does a Fee-Based Advisor Have to Act in My Best Interest?
No. A fee-based advisor may be required to act in your best interest when they open an advisory account for you, but if you have a brokerage account with them, they are not required to act in your best interest on the brokerage account.
Recently I took on a new client, a couple who had IRA accounts with a fee-based advisor. The husband’s account was an advisory account where the advisor was acting as a fiduciary. The wife’s account was a brokerage account with class C share mutual funds paying hidden commissions to the fee-based financial advisor. On this account, which was the largest account, the advisor was acting as a broker, in her best interest and not in the client’s best interest. The couple was shocked when I explained the advisor was getting under the table commissions on the C share mutual funds. They never knew. The advisor never explained the high expense ratios of the funds or the hidden commission she was receiving. She didn’t have to either, when she bought the funds, several prospectuses were sent to the client and the client never read the prospectuses. This game happens all the time with fee-based advisors. Have your guard up!
How is Fee-Only Different?
A fee-only investment adviser can only receive transparent fees and must disclose their compensation to you. These fees will be visible on your custodian statement. Fee-only investment advisers are required to disclose any conflicts of interest they may have in simple and easy to understand language on form ADV. Fee-only investment advisers must provide you with a copy of form ADV before you do business with them. Fee-only investment advisers act as fiduciaries putting your interests first.
Ethan S. Braid, CFA
President
HighPass Asset Management