Think your discount broker is giving you unbiased investment advice? Think again. A recent WSJ article reports that Fidelity, Schwab and TD Ameritrade employees received monetary and other incentives to get customers to invest in products that made more money for the broker.
Paying higher compensation to financial advisors for getting customers to invest in more costly products creates a conflict of interest that made some former employees interviewed by the WSJ uncomfortable. You can read the WSJ article here: http://on.wsj.com/2CYzv9V
We should all be grateful for the courage of the individual financial advisors who spoke with WSJ reporters about these issues. Financial services employees with integrity are as important, if not more important, to policing the industry as regulators. But for the numerous whistleblowers from brokers, investments advisers, and banks, things would be much worse for investors.
Not all incentives are commissions
Commissions are not the only way that discount broker financial advisors are compensated. There may be sales incentives that influence financial advisor recommendations to customers that are not called “commissions” but achieve the same result.
Customers sign up with discount brokers to avoid conflicts of interest as well as get lower trading commissions. They often get calls from financial advisors who work for the broker offering investment advice. (I get those calls periodically from my discount broker.) You may think that the advice you would get from those financial advisors is not conflicted because discount brokers are the rebels that rejected the traditional high commission sales model. That is wrong.
Discount brokers may offer significant sales incentives to their financial advisors. Those incentives may be monthly cash payments, end-of-year cash bonuses, or non-cash incentives. Employees can win an award like a trip to Hawaii. If your employer were dangling the possibility of an all expense paid trip to Hawaii in front of you, wouldn’t you try to get it?
Conflict disclosures in fine print
Discount brokers disclose their employees’ pay incentives on their websites — but when is the last time you read those disclosures? According to the employees interviewed by the WSJ, the firms do not require employees to tell customers about these incentives.
The disclosures in fine print are not specific. TD Ameritrade discloses that it pays employees more for selling some investments than others and “may have a conflict of interest when it guides prospects toward these services,” according to the WSJ. That does not tell you whether the financial advisor calling you today to invest in a managed account is eligible for a bonus or trip to Hawaii if he reaches a certain goal.
I would bet money that TD Ameritrade has incentives to get its financial advisors to encourage its customers to get into options trading — even when those customers know nothing about options. In my opinion, you should run if your financial advisor offers to teach you how to get into trading options on its website.
Vanguard, which also offers discount brokerage services, says that it does not offer sales incentives to its employees.
Ordinary churning occurs when a broker generates commissions and fees by executing an unreasonable number of transactions in a customer’s account. This happens less frequently in today’s world of lower commissions.
Reverse churning occurs when a broker has a customer move from a commission-based account into an account that charges a fee based upon the balance in the account. While a fee based account makes sense for investors who need or want ongoing investment advice from a fiduciary who puts the investor’s interests ahead of their own, it is not always best for the customer.
Just because a customer has a fee-based account, does not mean that the broker is acting like a fiduciary. If your financial advisor works for a firm that is both a broker and investment adviser, you could end up getting advice that you think is from a fiduciary, but your financial advisor claims was not. Even if your financial advisor says he is advising you as a fiduciary, that is not what the broker/investment adviser will say in the arbitration of a dispute. What good is that?
If an investor engages in very little trading — for example has a buy-and-hold portfolio made up of mutual funds that are held for years — that investor may not belong in a fee-based account. I have parked money in various Vanguard exchange traded funds and not paid attention to it for over a decade. I paid a commission of $17 to buy it and another $17 commission to sell it. That was fine for this account of mine because I did not seek and did not get ongoing advice from the brokerage firm about this investment. Paying a fee every year for this account would have cost me a lot more money.
Don’t get me wrong. I place a high value on good investment advisers. I have had investment advisory accounts at various times and I will have investment advisory accounts in the future.
Bottom line – the advice you are getting from your discount broker is not necessarily in your best interest.
Lisa Bragança recovers losses for investors all over the country, protects whistleblowers, and defends individuals and businesses in government investigations. As a Branch Chief with the SEC Division of Enforcement, Lisa supervised a wide range of investigations of investment fraud and financial industry misconduct.
You can reach Lisa at (847) 906-3460 or BragancaLaw@gmail.com. You can follow Lisa on Twitter @LisaBraganca.
Disclaimer: This information is for general purposes only and should not be interpreted to indicate a certain result will occur in your specific legal situation. The information on this website is not legal or investment advice and does not create an attorney-client relationship.