A Sales Culture
When I first entered the financial planning industry in 2001, I was excited about the prospect of helping people with their finances. My goal was to become a CERTIFIED FINANCIAL PLANNER™ practitioner, and the six-step financial planning process as outlined by the CFP Board of Standards made practical sense to me: Find clients who could benefit from professional financial advice; guide them through a comprehensive financial planning process; then, make professional recommendations in an effort to help them achieve their financial objectives.
Having been in the finance industry in various roles for many years prior to becoming a CERTIFIED FINANCIAL PLANNER™ practitioner, I had already witnessed people make major financial planning mistakes. When the dot-com bubble burst in 2000, I saw investors lose their entire retirement portfolios. I also saw many people lose their money in high-risk limited partnerships, private LLCs, and other speculative investments. I wanted to help clients make better investment decisions, and I was excited to enter a business that was supposed to be all about helping people.
When I first started in the business, I found that I had indeed entered an industry that was largely centered on helping people. I had great mentors; I was surrounded by well-educated people, and many sincere people taught me the ropes. One thing about which I was surprised, however, was the extent to which I found the industry to be dominated by a culture of selling. I had never been a sales person before, and I didn’t want to become one. I entered the business not to make sales, but to give people sound financial advice. Nevertheless, what I found was an industry centered on making sales. Financial advisors were called “producers”, and what they were “producing” were sales—and lots of them. They sold stocks, bonds, mutual funds, health insurance, retirement plans, life insurance, annuities, limited partnerships, oil and gas leases, and a wide variety of other financial products.
As one might imagine, the more products a producer sold, the more money he or she earned. The most important measure of a producer’s success was always measured by “First Year Commissions” (FYC). First Year Commissions were commissions earned on the sale of new products as opposed to trailing commissions, which were commissions earned on previously sold products. Producers who earned significant amounts of FYC were lauded as industry exemplars and were regularly awarded with a variety of perks and prizes. Such awards included bonuses, trips to “Leaders” conferences at destination resorts, kick-backs, and higher commission payouts.
Beyond commissions and perks, a sales culture was evident in other ways. Every month our firm’s management sent out an office-wide e-mail in which the sales numbers for every advisor in the office were included. The numbers didn’t lie, and this was management’s way of making it evident that our priority as financial advisors was to produce sales. It was also evident that the only way to be a leader in the office and to have one’s name featured at the top of the list was to sell more. Regardless of how knowledgeable, ethical, or how good of a person one was, management would not hesitate to fire an advisor if he or she couldn’t sell. I witnessed many good people “fail” in the business not because they were bad advisors, but because they weren’t good sales people.
A sales culture dominated our firm in other subtle ways. The final meeting in what was typically a three-meeting financial planning process with clients was referred to as a “closing”. This always made me feel conflicted: I was supposed to be an objective financial advisor, yet my number one goal in the “closing” was to close the deal. And of course the only way to close the deal was to sell a financial product, something which in turn generated more FYC. The advisors who were able to consistently close deals made a generous income, and they had offices replete with industry plaques and trophies that were awarded on the basis of sales production. These awards were given out to top producers in every category: Top life insurance producer; top investment producer; top annuity producer; top health insurance producer, top long-term care insurance producer and so on.
As an ambitious young man who was just getting into the business, it wasn’t difficult for me to get caught up in this sales culture. Although I never expected to become a sales person, I quickly found my sales legs and became a top producer myself. As it turned out, I was good at selling. I earned one of those hackneyed trophies for being Rookie of the Year, and I earned enough FYC to earn an all-expense-paid trip to my company’s Leader’s Conference my first year in the business. I went on to break the record for the most FYC ever produced during an associate’s first 90-days in the business. By my second year in the business I earned enough FYC to get moved out of cubicle land and into my own office. It was at this point that I began working my way into a management role with new producers underneath me, something which generated additional revenue based on the total FYC produced by each person I supervised. By my third year in the business I earned enough FYC to become a member in the prestigious industry association the Million Dollar Round Table, and I became well-acquainted with the prestige and awards that came along with being a top producer. In fact, my wife still wears an expensive diamond ring that I was able to earn by being a top producer for a certain company’s products.
It might be tempting at this point for one to compare my office to the high-pressure sales offices featured in the film The Wolf of Wall Street, or perhaps even of Ponzi scheme artist Bernie Madoff who bilked investors out of billions of dollars. When it comes to the type of office I’m describing, however, let me state categorically that such images couldn’t be further from the truth. My colleagues were good people and, although my firm was dominated by a sales culture, I believe we did good work for people. What is more, no one in my firm, or anyone I knew in the industry, was a criminal. Even though we were sales people and, even though we were backed by billions of dollars in corporate money that helped us sell more, it’s important to point out that sales is not inherently immoral. Many good people have had successful careers in sales while doing good for others. But doing good for clients does not necessarily mean doing what is best for them. Based on my own experience and observations in the financial services industry, I have come to believe that the dominance of an industry-wide sales culture is a bane to the industry, disadvantageous for consumers of financial services, and frequently prevents clients from receiving financial advice that is in their best interest.
Conflicts of Interest
It is not difficult to imagine the multiplicity of ways in which the existence of a strong sales culture in the industry can give rise to conflicts of interest between the advisor and client. Money is a powerful motivator. When “closing” the deal is the only way in which an advisor gets paid, there exists a strong motivation for the advisor to sell enough products to make a living. And even though making a living isn’t wrong, it should cause one to wonder if the advisor truly has one’s best interest in mind or is merely selling a product to provide for his standard of living. Whose best interest gets priority? When one’s paycheck is directly tied to the products being recommended to a client in need of sound financial advice, both interests conflict and are clearly competing for priority.
Complicating matters is the fact that some products pay significantly higher commissions than others, and there are often multiple ways for a client’s needs to be met. If an advisor can meet a client’s need with product A, which might pay a significantly higher commission than product B, the advisor will always be faced with a dilemma: If both products meet the same need, should the advisor recommend product A or B? While the decision might seem neutral on the advisor’s end, it is rarely so on the consumer’s side. This is because the product with the higher commissions is almost always the one that is least advantageous to the client, namely as a result of higher costs and limited accessibility to the client’s funds.
Prestige is also a powerful motivator which can create conflicts of interest between the advisor and client. When obtaining advice from a financial advisor, how does one know if the advisor truly has one’s best interest in mind, or if the advisor isn’t merely trying to win a trip to Hawaii or get his name featured at the top of his firm’s list of FYC production? What if yours is the final sale needed to solidify whatever goal it is that the advisor has in sight? It is extremely difficult, if not impossible, for advisors who operate in such conflicted environments to offer objective financial advice.
A $17 Billion Problem
The problems associated with conflicted advice and that are inherent in sales-based financial services aren’t merely theoretical: It is well known in the financial services industry that advice proffered by advisors who don’t have the consumer’s best interest in mind has serious financial consequences for hard-working Americans. As a result, the Obama administration is currently working with the Department of Labor to craft new rules which are aimed at fixing what they argue is an unfair system. This system, the administration maintains, is one in which
…firms can benefit from backdoor payments and hidden fees often buried in fine print if they talk responsible Americans into buying bad retirement investments—with high costs and low returns—instead of recommending quality investments…. A White House Council of Economic Advisers analysis found that these conflicts of interest result in annual losses of about 1 percentage point for affected investors—or about $17 billion per year in total. To demonstrate how small differences can add up: A 1 percentage point lower return could reduce your savings by more than a quarter over 35 years. In other words, instead of a $10,000 retirement investment growing to more than $38,000 over that period after adjusting for inflation, it would be just over $27,500.
The SEC has also recognized a problem with conflicted financial advice, the result of which is that it is currently proposing its own rules known as the uniform fiduciary standard. According to the Wall Street Journal, “The SEC’s proposal would be broader than the Labor Department’s, forcing brokers to recommend financial products solely in the best interests of their clients whenever they give advice to individual investors, not just retirement advice.”
As of right now, conflicting and confusing regulatory standards make it so that some advisors act in a fiduciary capacity, whereas many other advisors do not. By law, advisors who act in a fiduciary capacity must always place a client’s best interest above their own. Advisors who are not held to such a fiduciary standard, however, only have to demonstrate to regulators that their advice was “suitable” for a client. According to this suitability standard, an advisor could recommend a product that is “suitable” for a client, but not necessarily the best out of all available alternatives. As a consequence, these advisors are able to steer clients towards high commission and high-cost products that are better for their own bottom line than they are for the client. These expensive products, as the Department of Labor points out (above), can significantly reduce a client’s overall rate of return and prevent clients from achieving their long-term retirement objectives. Both the uniform fiduciary standard and the Department of Labor’s proposed rule-changes seek to ameliorate this problem by making more advisors accountable to a fiduciary standard.
The Fee-only Solution
Perhaps ahead of their time, there has long been a small segment of the financial planning community known as “fee-only” financial planners who have recognized the need for clients to have access to conflict free advice. Unlike advisors who operate their practices in a sales culture, fee-only advisors remove inherent conflicts of interest by structuring their practices in such a way that they never sell financial products or earn sales commissions. Instead of buying products that pay commissions, clients pay solely for financial advice, and they do so in the form of flat, hourly or percentage-based fees based on the value of a client’s portfolio managed by the advisor. The idea behind such a fee-only structure is that it allows advisors to be on the same side of the table as their clients and to have no other interest than to do what’s best for their clients.
Fee-only advisors are usually associated with independent firms that have gone through a lengthy and expensive process to become Registered Investment Advisors (RIAs). While some RIAs are “hybrid” advisors, something which allows them to receive fees and commissions, many have structured their practices as true fee-only practices. When choosing a financial advisor, it’s important to inquire how the advisor’s practice is structured: Is it commission based, fee-based (meaning the advisor is a hybrid advisor who can receive both fees and commissions), or is it fee-only? If the firm is truly fee-only, then it is solely regulated by the Investment Advisor’s Act of 1940 and must always be held to a fiduciary standard. Fee-only advisors are passionate about operating in a conflict-free environment; therefore, they never sell products or earn commissions, and they are free from the inherent conflicts of interest associated with becoming “top producers”, earning bonuses, vacations, kick-backs, or other incentives that are commonplace in sales-oriented firms.
With experience in both commission and fee-based advisory cultures, I am convinced that the fee-only model is the best model for the consumer. This is precisely why I chose to structure my own firm, Dunston Financial Group, as an independent, fee-only practice. It feels good to know that I’m doing what’s best for clients and to no longer have an internal conflict regarding my own compensation. It also feels good to be able to offer clients solutions that are significantly less expensive than what I was previously able to offer. Most importantly, it feels good to know that clients can now get what they need: Objective, conflict-free advice.