My colleague Erin Hadary and I were recently in an office building in which we could overhear a “financial advisor” meeting with his client. Within a few minutes, it became clear to us that the advisor was putting the hard sell on his client to try to get her to purchase an annuity with a 5% “guarantee”. We were able to track down this advisor’s website, and we found the following description of the firm’s compensation (firm’s name redacted):
Compensation to the advisor is in the front of most clients [sic] minds when hiring an advisor. [—] prides itself in being a predominantly fee based practice. We believe this allows the client and the investment advisor representative to be on the “same team”. The client never has to wonder if there is a conflict of interest because of commissions paid to the investment advisor representative because fees are disclosed prior to opening an account. Our types of fees are hourly rates, flat fees and percent of assets under management.
After reading this extremely misleading description, it’s no wonder the general public is often confused about how advisors get paid and where conflicts of interest truly lie. I agree that “Compensation to the advisor is in the front of most clients [sic] minds when hiring an advisor.” After this, however, the description of the firm’s compensation model completely falls apart. First, the firm describes itself as being predominantly fee-based. This in and of itself isn’t a problem, but the next line reads, “We believe this allows the client and the investment advisor representative to be on the ‘same team'”. A fee-based advisor does not put the client and the advisor on the same team. This is where it’s important to understand the critical distinction between “fee-based” and “fee-only”. Many consumers think fee-based advisors only get paid in the form of fees from the client. This isn’t true. A fee-based advisor is what the regulatory body FINRA considers a “dually registered” advisor, which means the advisor is legally registered with the state to be able to get paid in the form of both fees and sales commissions. While some fee-based advisors are genuinely ethical people who run sound practices, there are many out there who are not, and who are simply looking for a quick way to sell someone a product they don’t need.
The description only becomes more misleading from there. The next line reads, “The client never has to wonder if there is a conflict of interest because of commissions paid to the investment advisor representative because fees are disclosed prior to opening an account.” Yes, in fact the client does “have to wonder if there is a conflict of interest” due to the fact that the advisor can be compensated in the form of commissions at all. The fact that the advisor can even receive sales commissions creates an immediate conflict of interest between the client and the advisor, something which has already been the never-ending subject of press articles over the past year-and-a-half, and something which has led to the much discussed and debated Fiduciary Rule. In fact, the very aim of the Fiduciary Rule is to prevent such conflicts of interest between commission-based advisors and clients. Simply because the firm states that “fees are disclosed prior to opening an account” does not obviate an inherent conflict of interest from an advisor who gets paid in the form of sales commissions. While disclosure is nice, many clients have had fees disclosed and have still been sold unnecessary products that paid the advisor generous sales commissions. What is more, simply because one discloses fees doesn’t necessarily mean that one discloses commissions. A commission is not necessarily a fee, but rather a form of compensation, and one that is rarely, if ever, disclosed in a company’s marketing materials.
Finally, the description goes on to imply that the advisors at the firm only get paid in the form of fees, or that the advisor is fee-only when it says, “Our types of fees are hourly rates, flat fees and percent of assets under management.” Not true. The line before just talked about “commissions paid to the investment advisor…”, something which makes it clear that the firm’s advisors also get paid in the form of sales commissions. This is extremely misleading, if not outright deceptive.
So how do you as a consumer protect yourself? Certainly no one can expect you to be an expert in our industry’s confusing jargon. Here are three simple steps:
1.) Work with a true fee-only advisor. This advisor should be a member of NAPFA. If they aren’t, don’t work with them. NAPFA members take an oath to never get paid in the form of commissions or any form of compensation that creates a conflict of interest.
2.) Ask the advisor if her/his firm is “dually registered”. If it’s a dually registered firm, this means the advisors can get paid in the form of fees and sales commissions.
3.) Be sure to work with not only a fee-only advisor and NAPFA member, but also a CERTIFIED FINANCIAL PLANNER™ practitioner. CERTIFIED FINANCIAL PLANNER™ practitioners represent the gold standard in the financial planning industry. Interestingly, not a single person at the aforementioned firm holds this credential. With this said, some CERTIFIED FINANCIAL PLANNER™ practitioners still work for firms that pay them commissions, so be sure to start with questions one and two, above.
If you’d like more than three ways to protect yourself, Your Money columnist Ron Lieber over at The New York Times recently wrote an article that enumerates 21 questions you can ask to ensure that you won’t get duped by an unscrupulous financial advisor.