Care About Your Money? How to Evaluate Fiduciary Financial Planners
You hear it all the time in the advisory industry: We are fiduciaries, we put your interests above ours, blah blah blah. Heck, we do it, too. But just because someone is supposed to be a fiduciary doesn’t mean they are actually putting your interests first.
The Coleridge Group recently finished working as an expert witness for the Securities and Exchange Commission on a case filed against an investment advisor for not following their fiduciary duties. Because of our experience, we’ve been hired to consult on these types of cases for more than a decade. Through this work, we’ve gotten to know the many ways investment advisors fail to follow the standard of care that is expected from them by the SEC and, most importantly, their clients.
In some of these cases, the investment advisor was totally unscrupulous and committed indisputable fraud: taking money from client accounts, front running client transactions, creating false credentials, recommending investments that were not suitable in order to get higher commissions. But most of the enforcement actions that we’ve worked on involve dually registered investment advisors (investment advisors who are also registered as broker dealers) whose actions are not as blatant but still very harmful to a client’s finances. It is the ability to earn additional compensation, above and beyond what is agreed to in the advisory agreement, that gets these advisors into trouble. In our opinion, this subtle misconduct is the most troubling because it can go undetected for many years.
Several of these cases deal with those controversial mutual fund 12b-1 fees. Here’s an example: an investment advisor is getting paid their agreed upon fee. They proceed to purchase for clients mutual fund share classes that pay them 12b-1 fees, in the neighborhood of .25%, for as long as the client holds the mutual fund. But there was an alternative share class (the exact same investment option) that wouldn’t pay them a 12b-1 fee and, therefore, was a lower-cost option for the client. Now, as a broker dealer, it is totally legal to earn 12b-1 fees. But as an investment advisor with fiduciary duties who is already charging an advisory fee, was this share class really in their clients’ best interest? Or was the advisor incentivized by the additional compensation? Our argument, of course, is that this conduct didn’t meet the standard of care that is expected of them. How can an investment advisor justify recommending a more expensive (worse performing) share class when the exact same investment was available at a lower cost? Well, you’d be surprised at the excuses investment advisors make to justify this.
One recurring argument that investment advisors make regarding this type of misconduct is that they disclosed the conflict of interest so clients tacitly consented to it. Yet, once we look at the “disclosure” they made to clients, we conclude that it’s ambiguous and/or misleading. Therefore, it falls short of the advisor’s duty to fully and fairly disclose it. For one, they never tell the client that there was a lower-cost version of the share class that didn’t pay the advisor the 12b-1 fee. Wouldn’t you like to know that the exact same version of the car you’re about to buy (year, model, trim level, color, and miles) is available at a significantly lower cost? We think this is material information that a reasonable person would like to know.
Or they disclose that they “may” receive 12b-1 fees when in reality they make tens or hundreds of thousands of dollars from them each year. Really, they “may” receive them? Why don’t they disclose that this additional compensation can buy them a new Tesla every year for the rest of their lives? They also place the disclosure in places other than in their Form ADV, where it belongs. Therefore, clients are on the hook for trying to find this important piece of information among a shitload of other material.
So, how can you protect yourself from not being a victim to this type of conduct? Start by always reading an individual advisor’s broker check and the firm’s Form ADV. Pay special attention to Form ADV Items 5 (Fees and Compensation), 10 (Other Financial Industry Activities and Affiliations), and 14 (Client Referrals and Other Compensation). Item 4 of Form ADV’s Brochure Supplement should also disclose conflicts of interest for that particular advisor. But, as mentioned above, many times this won’t be enough because advisors, whether intentionally or not, leave out material information. Therefore, we highly recommend working with a Fee-Only advisor. These advisors cannot make money off of the products they recommend. That is not to say they don’t have conflicts of interest (which I’ll write about in an forthcoming blog), but in our opinion it is the compensation method that most aligns with a client’s best interest.
And finally, ask questions. Lots of questions. Ask until you are completely satisfied with the advisor’s method of compensation. A lot of people don’t know this, but the SEC has stated that “investors have the responsibility, based on disclosure they receive, for selecting their own advisors, negotiating their own fee arrangements and evaluating their advisors’ conflicts.” Therefore, it is up to you to be informed about the advisor’s practices.
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