HOW DO CONFLICTS OF INTEREST ARISE WITH FEE-BASED FINANCIAL ADVISORS?
Approximately 90% of financial advisors are dual registrants which means they are both financial advisors and stockbrokers. Dual registrant financial advisors often market themselves as “fee-based.” Fee-based financial advisors can get paid fees and commission. Additionally, they may also be insurance licensed. If you look closely at the business card of many of today’s financial advisors, you may see the words: advisory and brokerage services. Financial advisors who receive fees and commissions have conflicts of interest.
When you work with a dual registrant financial advisor, the potential for them to sell you a product with hidden commission is always present; you cannot escape conflicts of interest when working with a “fee-based” dual registrant financial advisor.
I have met with 100s of wealthy families in my 25+ year career and I cannot count the number of times I have seen a wealthy family get taken advantage of by a dual registrant, “fee-based” financial advisor. Often a family will have multiple accounts with their financial advisor and be completely unaware that in one of the accounts, they are paying hidden commissions. The financial advisor sells them on paying transparent fees and claims to be a fiduciary but neglects to tell them that he is also using his broker’s license and selling products too.
If you have multiple accounts with a “fee-based” dual registrant financial advisor, there is a very good chance that one of your accounts is a brokerage account where the advisor is receiving hidden commissions. Products like private REITs, private equity, hedge funds or structured products are generally sold with hidden commissions.
To demonstrate just how deep the conflict of interest can be, let’s consider an example. Suppose that a woman named Jane is a Dr. who recently retired. Her husband, Bill, recently sold his company. Jane has a pension and they both receive social security.
Hypothetical Clients Jane and Bill:
Age: 66 years old
Total Investable Assets: $10.0 million dollars
Net worth: $12.0 million dollars
Pension & Soc Security: $150k annually
Goal: $300k annually in retirement income
To keep this example simple let’s just focus on what can happen when Jane and Bill walk into the office of a fee-based dual registrant, insurance licensed salesperson aka financial advisor.
Example options A & B (in terms of payment to financial advisor):
- The financial advisor invests $1m in a variable annuity with a 7% commission, $4m in limited partnerships & hedge funds at 3% hidden commission and $5m in a fee-based account at a 1% annual fee (paid .25% quarterly).
- Immediate non-transparent commission of $190,000 to the advisor.
- Immediate transparent fee of $12,500 to the advisor.
- TOTAL FEE OF $202,500
- The financial advisor shows the clients a $10m balanced ETF advisory account at a 1% annual fee (paid .25% quarterly)
- Immediate transparent fee of $25,000 to the advisor.
You don’t have to be very good at math to see that by changing the product mix, the fee-based financial advisor can dial up or dial down how much he or she gets paid. Does the financial advisor want to get paid $202,500 or $25,000 this month? What a dilemma! To add insult to injury, in many cases, especially with annuities and investment bank products, the commissions are not transparent and difficult to gauge.
This payment scheme should certainly cause you to think twice about where you get financial advice. Caution should be exercised with dual registrants, especially those who are also insurance licensed. Do your homework. Ask lots of questions. Be critical of anything with a huge prospectus – these investments generally enrich the financial advisor completely at your expense.
There is a better way to receive investment advice – work with a fee-only financial advisor who is subject to the Investment Advisers Act of 1940 and operates as a fiduciary for clients. A fee-only advisor will be a fiduciary 100 percent of the time vs a fee-based advisor who is a part-time fiduciary at best. A fiduciary has a legal duty to act in the best interest of the beneficiary (client). The fiduciary duty is a much higher standard than that of a stockbroker (Securities Act of 1934), which only requires suitability be established before products are sold. A fee-only investment adviser can offer you transparent, easy to understand pricing. There is a great comfort that comes in knowing your advisor is putting your interests ahead of her interests and not merely selling you products for commission.
Ethan S. Braid, CFA
President
HighPass Asset Management