Ask Advisor About Fiduciary Ethics

Ask Advisor About Fiduciary Ethics

I recently wrote a column in addressing the value of fiduciary advice and some of the things to look for when trying to find such advice. I received feedback that prompted me to elaborate on it.

People seem to be interested in the subject, but a bit confused about the reasons for addressing it. Why is this a current topic in the wealth management and financial planning profession? It's a hot topic because of the recent market decline, excesses revealed during the past four years and the increasing public awareness of inherent conflicts within the industry. These conflicts were well-hidden for many years as financial advice was provided by firms that also sold financial products that compensated the salesperson.

Consequently, the advice often led to the purchase of the company's main product. If we walk into a Lexus automobile dealership, we expect the salesperson to show us the benefits of owning a Lexus -- take us for a test drive, review the neat gadgets and point out how it's different from competitors. That's a suitable approach when shopping for a product. We don't expect the salesperson to be an "automotive adviser" or to offer a spreadsheet of various makes and models with an unbiased recommendation at the end of our visit.

One of the problems in the financial services industry is that providers can hide behind the veneer of a title, such as financial adviser, financial consultant, wealth manager or even financial planner. When we talk to someone who represents themselves in such a manner, we want to believe the advice is unbiased and objective. If the advice is guided by compensation from a product vendor or its firm, then a fiduciary duty may have been violated.

Financial planning as a profession is a relatively recent phenomenon. We are just now getting to where the public accepts paying a fee directly to advisers for objective advice. In the past, a client typically went to his or her stockbroker, banker or insurance agent for advice. No fee was discussed. When you factor in the relationship between advisers and their employers, the scenario gets more cloudy and frightening.

In a paper written by Ingo Walter of New York University titled "Conflicts of Interest and Market Discipline Among Financial Services Firms," he identifies two types of conflicts of interest confronting firms in the financial services industry: 1. Conflicts between a firm's own economic interests and the interests of its clients; and 2. Conflicts of interest between a firm's clients or between types of clients, which place the firm in a position of favoring one at the expense of another. We all understand type 1, and experienced investors are increasingly capable of identifying these situations. But what about type 2?

Type 2 conflicts have become exposed in recent years as demonstrated by brokerage firms with institutional research and underwriting departments. When a significant portion of a firm's revenue comes from IPOs and consulting arrangements with client companies, the individual client can take a back seat.

Probably one of the most creative examples of this took place in 2003, when a large New York brokerage firm assisted Enron Corp. with a series of sham transactions involving Nigerian oil barges that effectively defrauded the common stock investors in favor of the corporate insiders. This column easily could be a book, as examples provided by history are practically endless.

The moral of the story is all investors should become familiar with best practices and ask the hard questions of their adviser prior to accepting advice.

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