Something Doesn’t Sound Just Right

“Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you understand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest. We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits, and our salespersons’ compensation, may vary by product and over time.”

Something just doesn’t sound right about the above disclosure. My adviser’s interests may not always be the same as mine? And he can be compensated by others based on what I buy? This statement is actually a required disclosure in agreements between broker/dealers and their clients. In April 2005, the U.S. Securities and Exchange Commission set forth regulations that require commissioned financial professionals to include that language on their advertising materials:

So, what are these hybrid advisers I hear about?

A “hybrid Adviser” can also be referred to as a “dually registered adviser/financial professional.” This is and individual who is both a registered representative associated with a broker-dealer and an investment advisor representative of an RIA. This person may either be associated with a single, dually registered firm, with a broker-dealer and a registered investment advisor that are affiliated, or with a distinct broker-dealer and a distinct RIA. A “hybrid firm” or “dually registered firm” refers to a registered broker-dealer firm where the same legal entity or an affiliated legal entity is also a registered investment advisor.

So, here’s where the waters get a little muddied. Hybrid advisers are both RIAs and broker dealers. RIAs are held to a fiduciary standard where broker dealers are only held to a suitability standard. Suitability means you only need to recommend a “suitable” investment for a client, which may or may not be the best option available to them.

There should be no question about whether or not an adviser is acting in a clients’ best interest at all times. But how do you know? A typical investor may get confused when working with a broker dealer who acts as a fiduciary on their IRA, but is not required to do so on their individual investment account because of the suitability standard. A situation like this is begging the question: Have consumers been given a full sense of security with their money?

What’s the Big Deal?

Under the Advisers Act, a registered investment advisor must always act in the “best interest” of its clients. The firm cannot put its interests ahead of its clients. In other words, a registered investment advisor is obligated to always put client interests first.

However, that general rule, for purposes of the federal securities laws, a registered investment advisor is permitted to render advice and make recommendations to clients in instances where it may have a conflict of interest, as long as the conflict of interest has been fully and understandably disclosed to the client, and the client has consented on a fully informed basis.

The legal basis for this exception is the idea that the advisor has made “full and frank disclosure” of its conflicts of interest. The advisor’s client is then capable of evaluating these conflicts and making informed decisions about moving forward with the advice.

Advisory account relationships established by hybrid firms typically also involve a brokerage account with the same firm. In such instances, the sources of revenue available to the broker-dealer often can give rise to a conflict of interest. With respect to mutual fund investments, for example, any revenue sharing arrangements that the broker dealer may have with a particular fund could provide a financial incentive to the firm’s advisory arm to recommend this fund based on firm revenue considerations. Under such circumstances, it is important that the investment advisor identify the conflict to its clients and take steps to ensure that the client is consenting to the advice with full knowledge of the conflict.

Therefore, with the proper conflict of interest disclosures, advisory account relationships and investment recommendations can move forward. However, how can you gain certainty and confidence that the investment recommendations are “right” for you.

Show Me the Money!

Many times it is very difficult to connect the dots when looking at the investment advice an adviser (of any type) is offering. Far too often, advice is simply product sales, which may or may not support the financial best interest of the client. Recommendations that are presented with no relationship to a financial plan may prove to be even more suspect than when some sort of supporting evidence is available. One of the best questions you can ask your adviser is the following: Can you connect the dots for me? I’ve given you all the information regarding where I am today, investment-wise, income-wise, need-wise, etc., and you are aware of my desires and income needs down the road. Based on the information about me that you have, you have made a number of investment recommendations. Please connect the dots for me from where I am, to where I want to be, and how your recommendations are going to take me there. It there isn’t a basis, like a plan, supporting the recommendations, how could you know if the advice, and the investments recommended, are in your best interest.

The Simplicitree® analysis discussed in the associated video shows how connecting the dots might be beneficial to you, as someone looking for investment advice.