Shades Of Gray In The Advisor World
October 17, 2014 by Cyril Tuohy
Consultant, advisor, counselor, broker, intermediary. Call them what you will, each provides a service.
But following testy exchanges last month between proponents of different standards of fiduciary advice, it was easy to get lost in the fog of labels identifying a registered investment advisor, a fee-based advisor or a commission-based broker.
Nailing down the nuances of what defines a broker and a fee-based advisor isn’t easy, particularly when advisors operate within the legal shell of a broker/dealer.
Brokers are also known as registered representatives. They sell stocks, bonds and mutual funds among other securities products, and must be licensed to do so. A broker’s first responsibility is to his or her employer, the brokerage firm.
Regulated by the Financial Industry Regulatory Authority (FINRA), brokers are licensed sales reps and exempted by the Securities and Exchange Commission (SEC) from serving in a fiduciary capacity.
That doesn’t mean that brokers aren’t capable of serving in a fiduciary capacity, nor that they aren’t doing so on a day-to-day basis — since FINRA regulators exact high standards, said financial advisor and National Association of Insurance and Financial Advisors President Juli McNeely. It only means that brokers are not beholden to it by federal regulators.
Brokers and millions of investors are fine with that. Good brokers will always do what’s best for clients, brokerage folks insist. If they didn’t, the theory goes, the broker would go out of business — let the market decide which broker lives and which one dies.
The point is that brokers are held to a suitability standard toward retail clients, and if a broker is going to produce for his or her firm, then he or she had better do right by the client.
If the client is aware of every transaction and knows exactly how his or her broker is compensated, then everyone is happy. No further questions. But here’s what many people — advisors included — may not know:
Brokers can’t give advice unless it’s “solely incidental” to a sale. Brokers sell investments limited to products and services endorsed by their brokerage firm, which means they are on the sell-side of a transaction.
Why? Because compensation for the broker comes from commissions and sales incentives in the form of a “load.”
Commission-based brokers operate as the political equivalent of the populist.
Then there are fee-based advisors, sometimes called broker-advisors. The expression “fee-based,” however, is no longer being used. It has been replaced by the “fee and commission-based” advisor. This advisor is a hybrid.
Brokers who also want to provide financial advice can register with the SEC as an investment advisor representative, which makes them a registered investment advisor (RIA). That means the advice they give must be held to a fiduciary standard.
Along with their fee, they still earn a commission and the investments they recommend are limited to those endorsed by their brokerage. For their service, broker-advisors receive compensation in the form of fees, commissions and sales incentives.
Chameleon-like, broker-advisors can act as brokers in the morning meeting the suitability standard of care. After lunch, though, these very same brokers are free to spend their afternoons as financial advisors, as long as they’ve been so designated by the SEC. Advisors, however, have to meet the fiduciary standard of care.
How can the same intermediary be a broker and an advisor? How does a middleman play both sides? Good question.
John Taft, chief executive officer of RBC Wealth Management U.S., said the fiduciary standard which advisors must follow isn’t a “no-conflict” standard.
“A fiduciary standard is a standard in which conflicts are disclosed and they are not acted upon unless the client accepts and waives the conflict,” he said.
None of this sits well with the fee-only advisor community, which rejects the commission structure because they say it simply doesn’t work. The only way to give clients unvarnished advice that’s in their best interest, they claim, is to shut down the product sale.
“Fee-only fiduciaries always, not ‘fee-based’ fiduciaries sometimes,” FirsTrust Private Wealth Management Group, a fee-only advisor with offices in Florida and Georgia, said in a recent blog posting on its website.
The fee-only crowd stresses purity of the advice and that fee-only advisors are the equivalent of the purist: no divided loyalties, no corporate shareholders, no sale incentives, no outside interests — nothing but for a fee.
Charging a fee is fine so long as a client can pay for it. For most investors, though, fee-only advisors are out of reach.
