Financial planners, stockbrokers and insurance salespeople all play key roles in the investment marketplace. But they don't all play by the same rules.
When investors turn to a professional for guidance, it's about more than money. "The bottom line is to do business with someone you trust," says Frank Ingwersen, vice president of Sweney Cartwright & Company, a broker-dealer that buys and sells stocks and municipal bonds.
"People have to trust who's sitting across the desk from them," agrees Jordan Miller Jr., president and CEO of Fifth Third Bank in Central Ohio. "After the solutions are identified and the disclosures are made, that's the biggest thing they have to be concerned about."
Whom to trust, though? A brokerage house? A registered investment advisor (RIA)? A Certified Financial Planner (CFP)? Some combination of professionals?
The proliferation of similar titles and professional designations can lead consumers to the conclusion that all financial professionals essentially do the same thing. A 2008 Rand Corp. survey indicates that trends in the financial services industry over the past 15 years have blurred the boundaries between broker-dealers and investment advisors. Respondents generally knew the differences between services offered by the two professions, but were unclear about the legal obligations each had to their clients.
If you're an investor seeking advice, here are a couple of critical questions to ask: Does the person who's sitting on the other side of the desk have an obligation to put your interests ahead of his or her own financial benefit? Or is the advisor permitted to steer you toward an investment that maximizes his or her gain, without considering whether it's the optimum product for you?
In some cases the answers are clear. Registered investment advisors, attorneys and certified public accountants (CPAs) are fiduciaries-legally bound to place their clients' interests first. When you read about a lawyer who's been disbarred or suspended for "borrowing" from a client's trust account, it's the fiduciary standard that's been violated.
At the other end of the scale, legally at least, are broker-dealers, registered representatives (stockbrokers) and insurance agents who sell annuities. They are not considered fiduciaries, but are governed by a "suitability standard" that requires them to sell clients only appropriate products. If several investments are suitable, a broker may select the one that pays the highest commission, even if it's likely to cost the client more or produce less return.
Certified Financial Planners and other planners who haven't earned the CFP designation may or may not be fiduciaries, depending on the specific terms of their agreements with clients and the level of "discretion"-basically, control-they exercise over client assets.
"Each type of professional can have advantages to the customer, but the customer must understand not only their investments but also the role of their advisor," Miller says.
Despite the spate of recent headlines about such fraudsters as the infamous Bernie Madoff and Upper Arlington financial planner Julie Jarvis, most investment professionals of all stripes operate ethically and honestly. The Financial Industry Regulatory Authority (FINRA) reports that nine out of 10 registered representatives have no disciplinary history. And those who push the limits usually don't last long without the trust of their clients.
Even so, wise consumers do their homework and know exactly what type of relationship they're entering--before handing their money over. Here are some insights from Central Ohio investment professionals about the regulations that govern their conduct, their responsibilities and how they deal with clients.
RIAs as Fiduciaries
Registered investment advisors are governed by a fiduciary standard that's outlined in the Investment Advisers Act of 1940. It mandates that RIAs place the clients' best interests before their own. Conflicts of interest and fee structures must be fully disclosed. Ultimately, the client and RIA jointly develop a financial plan and investment strategy.
"We simply do for our clients what we would do for ourselves if we were in a similar situation," says Larry Waller, CEO of Waller Financial Planning Group. "We provide objective advice that's not connected to sales commissions."
"Some registered investment advisors charge a flat annual fee to manage a customer's assets, but it's more common to charge a percentage of the value of the assets under management. We charge 1 percent," says Matt Palmer, chairman and president of the Joseph Group. "There also can be a sliding scale where the fee is reduced as the customer's account balance grows."
Once the strategy is set, an RIA often has discretionary authority to adjust the assets as needed in accordance with the plan. "The RIA and client have a mutual vested interest. When the assets increase in value, the RIA gets paid more," Miller says.
RIAs rely on broker-dealers to execute their investment transactions. "We have an independent relationship with a broker-dealer that executes the transactions we direct on behalf of our clients," Waller says.
"We stand in the shoes of the client and purchase investments on their behalf," Palmer says. "We don't have physical custody of our clients' assets. The brokerage house does. We're an advisory firm, not a custodial broker-dealer."
Brokers & Suitability
Broker-dealers and their registered representatives buy and sell stocks, mutual funds or other financial instruments at their clients' direction. Insurance agents who sell annuities are registered agents of a broker-dealer. Generally, these financial professionals are paid a sales commission for each transaction, rather than a fee for financial advice.
"When making stock trades, the broker-dealer has no discretion to buy or sell without specific permission from the customer each time," Miller says.
The suitability standard that governs broker-dealers, registered reps and annuity salespeople requires all recommended investment products to be appropriate, or suitable, for clients. Salespeople must take into account a client's financial objectives, risk tolerance and tax bracket. A tax-free municipal bond, for example, would likely not be a suitable investment for a widow on Social Security, who doesn't need a tax shelter.
"As a brokerage firm, we have to know our customers and understand their needs. It's one of the rules of our licensing and speaks to knowing the suitability of the investments we recommend," Ingwersen says.
Keep in mind that "suitable" and "best" are not synonyms. Your stockbroker isn't required to reveal conflicts of interest and commission structures, though many ethical brokers do so anyway. The suitability standard doesn't legally require stockbrokers and annuity salespeople to offer or sell the lowest-priced product, or the one whose past returns have been the highest.
Stockbrokers, whose income comes predominantly from sales commissions, have an incentive to choose products that maximize those commissions. That's a primary reason many registered reps steer customers to "load" mutual funds that carry "front end" or "back end" sales commissions-often 5 percent or more. Some brokerage houses won't even offer the "no load" mutual funds that are staples in the portfolios of many fee-only financial planners.
Brokers argue that load funds may outperform no-load funds over time, and that there's more to "suitability" than just the minimum requirements. "I live with a fiduciary responsibility on my shoulders every day, because I want to do a good job for my customers," Ingwersen says. "I want them to be customers for life, to take care of their children and grandchildren's needs and for them to give me referrals. The only way that happens is if I put them in the right products that achieve their goals."
Mix & Match
As broker-dealers have added financial planning and investment advice to their array of services, some consumers count on their stockbroker both to execute trades and provide financial guidance.
Brokers who register as RIAs with the U.S. Securities and Exchange Commission assume a fiduciary obligation. However, a 2005 SEC rule exempts them from registering if their advice is incidental to their primary business of buying and selling investments. The SEC also allows an advisor to wear a fiduciary hat when creating a financial plan for a client, but then switch to the suitability hat when executing trades to fulfill the client's plan.
Fifth Third Securities has both registered representatives and RIAs on staff, as does Huntington Investment Company, a subsidiary of Huntington Bancshares. "We help customers develop a plan and the best strategy for their goals and objectives," says Patrick Riepenhoff, vice president at Huntington Investment Company. "Then depending on their needs, we can offer our fee-based products or utilize our broker-dealers. Sometimes we use both platforms. We explain what role Huntington Investment Company is taking, what tools we're using for them to achieve their goals and then provide the appropriate disclosures."
The SEC regulates RIAs that manage $25 million or more in assets, including Waller Financial Planning Group and the Joseph Group. The Ohio Department of Commerce's Securities Division regulates RIAs that manage lesser amounts. The Ohio Department of Insurance regulates insurers who sell annuities.
FINRA-created in July 2007 through the consolidation of the National Association of Securities Dealers and the New York Stock Exchange's member regulation, enforcement and arbitration functions-governs nearly 4,700 brokerage firms and more than 635,000 registered representatives. Fifth Third Securities, Huntington Investment Company and Sweney Cartwright & Company are FINRA members.
A Single Standard?
Consumer advocates have long contended the fiduciary standard should govern all financial professionals to ensure customers' interests come first. "Average consumers shouldn't have to figure this out. Two people who use essentially the same title and provide the same type of service are actually subject to two very different standards," says Barbara Roper, investor protection director for the Consumer Federation of America.
"Consumers need to understand that some people calling themselves financial advisors in some capacity really have no legal obligation to act in the consumer's best interests," Roper adds. "They're free to recommend products that better their own bottom line. It's not illegal, but consumers can end up buying products that aren't the best for them."
The investment and insurance industries say adding a layer of fiduciary responsibility is unnecessary. "We do not concede at all that registered representatives, broker-dealers and insurance agents are not serving their clients well under the suitability standard," says Thomas Currey, president of the National Association of Insurance and Financial Advisors (NAIFA).
"There's a characterization that operating in a fiduciary capacity is the only way to serve clients' best interests. We disagree with that specifically and strongly. The suitability standard is a stringent standard. Ask any strong salesperson and they'll tell you the secret to longstanding customer relationships is doing it right, whether or not that rises to the legal definition of fiduciary," Currey says.
On the other side of the debate, FINRA supports the move to a single fiduciary standard, as does SEC Chairman Mary Schapiro. The financial reform bill passed by the U.S. House of Representatives in December 2009 includes the standard.
When the SEC filed civil fraud charges against investment banking firm Goldman Sachs and one of its employees in April, it gave momentum to U.S. senators who favored extending the fiduciary duty to all financial professionals as part of the Senate's version of the financial reform package.
The U.S. Senate banking committee initially considered the single fiduciary standard option during its debate on the Restoring American Financial Stability Act, but wound up inserting a provision directing the SEC to study the issue. In May, switching to the fiduciary standard was resurrected through at least two proposed amendments.
NAIFA says a hasty change in standards would lead to unintended consequences. "NAIFA has always supported common-sense regulation that protects consumers from bad actors," Currey says. "Our issue is with the term ‘fiduciary.' It's a broad and poorly defined standard in the legislation. That lack of definition and what it means in the real world of financial products is something we believe will put our members at risk.
"Commissions are a concern to us, but that's not the issue driving this discussion," Currey says. "If a product was the best product available at the time, but the market shifted or the investor changed his mind, there's no way to know that in advance. We don't want our members' decision-making process to play out in court over the next 10 years."
The fate of the campaign for a single fiduciary standard likely will be decided as a House-Senate conference committee hammers out the final version of the financial reform bill this summer.
Lisa Hooker is a freelance writer.
Reprinted from the July 2010 issue of Columbus C.E.O. Copyright © Columbus C.E.O.