Originally published on Advisor Perspectives, January 24, 2018

By Knut A. Rostad

On January 10, the Wall Street Journal’s Jason Zweig and Anne Tergesen made news in the advice industry. They reported on how the “big three” discount brokers use sales incentives to get their advisors to gather assets and push certain products.

This article is an investor alert. Never mind disclosures and labels. Caveat Emptor. Discount brokers are fiduciary-free zones. Investors must arm themselves with pointed questions. Investors must demand in writing that advisors meet “Best Practices for Financial Advisors.”

Zweig and Tergesen, from interviews with “dozens” of former employees of Fidelity, Schwab and TD Ameritrade, wrote, “Nearly all the former employees said compensation practices encouraged workers to sell products that were more lucrative both for the firm and the employee – and cost customers more.”

Examples included how Fidelity reps earn “more than twice as much” when a customer invests in a managed account or annuity as opposed to most mutual funds and ETFs.

According to Zweig and Tergesen, former employees of all three firms “pointed to managed accounts they were urged by supervisors to sell.” These accounts, which are often “combined with a financial plan and advice,” may cost customers from 0.2% to 1.7% of assets annually. This is compared to lower cost investments such as target-date funds at 0.5% or robo/advice services “for as little as 0.3%.”

One former Fidelity employee, Sean Gray, said, “There is no way I can be a true fiduciary” acting in a client’s best interests when paid more to sell some choices than others. (This) created a conflict of interest and made it impossible to act in a true fiduciary capacity.”

According to a Fidelity internal compensation plan reviewed by the WSJ, extra incentive compensation, or “achiever” bonuses, “could amount to as much as $92,400 a year, jumping by thousands when incentive pay hit thresholds.” Fidelity consultants were motivated to reach these thresholds, according to several former employees, and “often favored products that paid them more to get there faster.”

A Fidelity spokesperson said the firm would not tolerate such a practice and, “We pride ourselves on doing the right thing for clients all the time.”

The story reported that all three firms, “said their advisory businesses comply with federal rules by acting in clients’ best interests.” Lawyers unaffiliated with the firm confirmed the compensation practices “are permissible under the rules so long as the complexity of the products is taken into account, potential conflicts are disclosed and the firms pledge to put clients first.”

This story is an ”Investor alert,” especially for investors who don’t care about registration (state, SEC or FINRA) or the difference between “suitable” and “best interest” advice. It tells investors:

  1. Discount brokers, who are RIAs, are no different from full-service brokers. They are all about sales. Their disclosures, designations, labels and promises look alike. Forget what they say.
  1. If investors want to find a true fiduciary advisor, it’s on them. They’re on their own. They must ask better questions about education and experience to separate advisors from salespeople. But, they must do more.
  1. Investors must require advisors put into plain writing what they will do to act in their best interest. This requirement works. Many advisors or brokers can’t do it. Yet, advisors who are real fiduciaries, like those who have been certified by the Institute for the Fiduciary Standard as Best Practice Advisors, are proud to do so.

This story is also an alert for genuine fiduciary advisors. They’re tarnished along with others. The legal explanation offered, that the discount brokers’ practices are “permissible,” impugns the quality of advice provided by fiduciaries such as fee-only advisors.

The story magnifies the compelling rationale for fee-only advice – a rationale that’s been lost in the debate over “best interest” today. The WSJ puts it front and center: The brokerage firms unabashedly promote objective advice, implied to be fee-only, while hidden financial incentives offer advisors great rewards to sell some products over others.

Geoffrey Brown, CEO of the National Association of Personal Financial Advisors (NAPFA), noted, “While legally permissible, the sales practices cited in the Wall Street Journal here illustrate the added challenges in reconciling trusted advice with product sales commissions. Fee-only advisors, by definition, don’t face these challenges.”

For decades, fee-only fiduciary advisors have said that being compensated only by client fees is better. Advisors are less conflicted, offer more fee transparency and clarity, and this makes for better client advice. The WSJ story’s other “alert”: this rationale is still compelling today.

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