Can Sales Reps Claim to be Financial Advisors? – updated September 2014

sales reps claim financial advisorsYou bet they can and they do. I checked the legality of the claim with FINRA, the SEC, and California (my state of residence) to ask them this straightforward question. After one and a half hours of being on hold and talking to seven different people I concluded there is no regulation that prohibits reps from calling themselves financial advisors. No regulation creates a major source of risk for investors.

Why is there no regulation? Wall Street does not want one and it usually wins because its companies spend hundreds of millions per year on lobbyists who make sure regulations favor companies and not investors.

A regulation may not even matter if the rep claims to be a financial advisor in a sales pitch. Investors have no record of what was said to them so it would be very difficult to enforce the regulation. It would be their word against the reps. A regulation would be easy to enforce if investors require reps and financial advisors to document their role in writing before selecting them.

Obvious Differences

I thought the differences between real financial advisors and reps were pretty straightforward. Financial advisors provide financial advice and ongoing services for fees. Sales representatives sell investment products for commissions. This sounds simple enough until a sales rep with substantial sales skills manipulates the two roles so they sound similar if not identical.

Why the Confusion? 

In the absence of regulations, Wall Street is in a position to create a substantial amount of confusion. Why confuse investors? Confused investors are dependent investors so they are more likely to buy what Wall Street reps are selling.

Why does this form of deception work? Most investors have no idea there are major differences between sales reps and real financial advisors. If they did, they would never select sales reps to invest their assets in the securities markets.

The second form of deception is even slicker. Sales reps are allowed to make recommendations. Advisors are allowed to provide advice. What is the difference between investment recommendations and investment advice? There is no difference. The rep recommends investing in a load fund. The advisor advises investing in a no-load fund. The results are the same. Investor assets end-up in mutual funds. The principal difference is the method of compensation for reps and financial advisors and future services you receive. If you selected a rep there aren’t any future services. His role stops at the sale.

Three Critical Questions

There are three critical questions you should ask the person who wants to sell you investment products:

  1. Are you a registered investment advisor or an investment advisor representative? If the answer is no, the person is a sales rep.
  2. Are you a fiduciary when you provide financial advice for fees? If the answer is no, the person is a sales rep.
  3. Are you compensated with fees for your knowledge, advice, and services? If the answer is no, the person is a sales rep.

You do not want sales reps investing your assets. Why? Regardless of what they say in sales pitches, they are paid to sell you investment and insurance products. They are not paid to help you achieve your financial goals because they do not receive any continuous compensation. Only real financial advisors receive ongoing compensation for providing ongoing services.

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One response to “Can Sales Reps Claim to be Financial Advisors? – updated September 2014”

  1. Nice article.

    One of the things the regulators often neglect to say, however, is that “fiduciary status” can attach to salespeople, under state common law, when a relationship of trust and confidence is formed. And, there are several reported court decisions in which holding out as a “financial advisor” or “wealth manager” or “financial consultant” was a significant factor in finding that fiduciary status attached.

    This is important because, when lawsuits are filed (or cases submitted to FINRA arbitration, where breach of fiduciary duty is the #1 claim the last five years), customers sue for breach of fiduciary duty through the application of state common law. (Neither the federal Investment Advisers Act of 1940, nor most state statutes, provide a private cause of action for breach of fiduciary duties.)

    Here’s a sampling of the cases in this area:

    Koehler (1985). A U.S. District Court in 1985 held that a fiduciary relationship existed in part because of a defendant’s status as financial planner to a client. In Koehler v. Pulvers, 614 F. Supp. 829 (USDC, Cal, 1985) the defendant, CSCC, was primarily in the business of real estate syndication, but also in business under the name Creative Financial Planning. As stated in the decision, “The developer defendants obtained investment capital from the public by posing as financial planners … The financial planners typically had a background in either insurance or real estate sales … As an alleged financial planning company, CSCC, dba Creative Financial Planners, contacted potential investors by conducting Creative Financial Planning seminars open to the public. Utilizing a slick presentation… CSCC attempted to lure investment capital out of savings accounts, home equity, insurance policies, and other conservative investment vehicles and into the speculative real estate ventures it controlled … At the seminars, CSCC offered to draft a ‘Coordinated Financial Plan’ for attendees at little or no charge. Individuals who accepted this offer received recommendations to purchase limited partnership or trust deed interests in CSCC controlled partnerships and project ….” The court also noted, “Most of the plaintiffs are and were unsophisticated investors. Few had a preexisting relationship with the developer defendants at the time they purchased their securities … [the investors] relied upon the misrepresentations discussed in detail below. This reliance was reasonable in part because of the developer defendants’ purported disinterested financial planner status.”

    Cunningham (1990). Insurance agents who introduced themselves as “investment counselors or enrollers” and who tailored retirement plans for each person depending on the individual’s financial position, and who led the customers to believe that an investment plan was being drafted for each customer according to each customer’s needs, was held by a federal court, apply Iowa state common law, to lead to the possible imposition of fiduciary status. Cunningham vs. PLI Life Insurance Company, 42 F.Supp.2d 872 (1990).

    Mathias (2002). “In the fall of 1985, plaintiff, having recently divorced and relocated to Columbus, Ohio, sought investment advice from Thomas J. Rosser. At the time, Rosser was a licensed salesman for Great Lakes Securities Company and held himself out as a financial advisor … [T]he evidence established that Rosser was a licensed stockbroker and held himself out as a financial advisor, and that plaintiff was an unsophisticated investor who sought investment advice from Rosser precisely because of his alleged expertise as a broker and investment advisor. Further, Rosser testified that plaintiff had relied upon his experience, knowledge, and expertise in seeking his advice. Therefore, we conclude that plaintiff presented sufficient evidence to establish that she and Rosser were in a fiduciary relationship.” Mathias v. Rosser, 2002 OH 2531 (OHCA, 2002).

    Actually acting as a financial advisor could lead to a finding of fiduciary status. “[A] fiduciary relationship can arise in fact regardless of the relationship in law between the parties. . . . For example, acting as an advisor may contribute to the establishment of a fiduciary relationship.” Hatheway vs. U.S. Trust Company, N.A. (Ct. of Appeals, Washington State, unpublished decision, case no. 33966-8-II

    Millar (2003), Applying Pennsylvania Law. “Merrill Lynch invited the Millars to its headquarters in New York City to meet with some of its highest ranking executives. At that time, Merrill Lynch was aware that the Millars were meeting with other firms in order to find advisors to help them manage their wealth and achieve their investment objectives. Merrill Lynch was also acutely aware that the Millars had a net worth at that time in excess of $10 million. Moreover, the program that Menill Lynch presented Doug Millar was its Private Advisory Services. The PAS offered the Millars world class advisors that would work with and through the Millars local advisors. This is what Merrill Lynch was selling. Merrill Lynch did not at any time assert to the Millars that it would not monitor their account or that it would not give them advice on an ongoing basis. To the contrary, Merrill Lynch told the Millars it would work with them to formulate strategies with the most suitable recommendations for their investment needs … There is no evidence that would suggest that the aggressive option strategy employed by Merrill Lynch was developed by Doug Millar. This was Dave Foster’s strategy. Further, there is no evidence that Doug Millar would call Dave Foster on a systematic basis and instruct him to buy or sell puts and calls. To the contrary, Dave Foster was the prime mover behind the options strategy. Yet, after selling the Millars on its experience and ability to advise, manage and achieve their financial objectives, Merrill Lynch contends its only duty was to act with diligence and competence in the execution of an order. The Court finds such contention untenable. The Millars were not invited to Merrill Lynch headquarters in New York City merely to find technicians capable of executing a brokerage order. Regardless of Merrill Lynch’s argument that the duty owed to the Millars was surprisingly narrow, the Panel found an unambiguous indication of the Millars’ intent to sell 100,000 shares of Free Markets stock on September 5, 2000. Moreover, whether a fiduciary duty exists cannot be determined “by recourse to rigid formulas.” Scott v. Dime Sav. Bank of New York, 886 F. Supp. 1073, 1078-79 (S. D. N. Y. 1995) (“Under New York law, stockbrokers may owe fiduciary duties to their customers.”) Rather, it depends upon “whether one person has reposed trust or confidence in another who thereby gains a resulting superiority or influence over the first.” Id. More simply, “the existence of fiduciary duties depends on the facts of a particular relationship.” Vannest v. Sage, Rutty & Co., 960 F. Supp. 651, 655 (W. D. N. Y. 1997) (quoting Boley v. Pineloch Assoc., Ltd., 700 F. Supp. 673, 680 (S. D. N. Y. 1988)). The Panel obviously determined that the relationship between the Millars and Merrill Lynch exceeded that found ordinarily between a broker and a nondiscretionary account holder … Aside from an obvious failure to execute its client’s order, Merrill Lynch clearly failed to deliver the services it promised to the Millars. Instead of using its “world class advisors” to implement a reasonable and prudent plan of monetization and conservative diversification that would have allowed the Millars to preserve a portion of their $10 million nest egg, Dave Foster placed their money into the high risk arena of options trading. This strategy was unsuitable to meet the clear objectives of the Millars ….” Merrill Lynch, Pearce, Fenner & Smith vs. Millar (W.D. Pa. 2003).

    In Re Gregory Smith (2005). In a bankruptcy case involving an insurance agent (Mr. Smith) who filed for bankruptcy and sought to discharge a claim based upon breach of fiduciary duty, the Court stated: “In the present instance, both Ms. Wilson and Ms. Judson were parties devoid of any financial sophistication. On the other hand, Mr. Smith claimed to be and, in fact, was a ‘financial advisor’ who certainly possessed a far superior expertise concerning investments than either Ms. Wilson or Ms. Judson. Mr. Smith was fully aware of the financial conditions of both considering their age and their situation in life. Ms. Wilson was retired and Ms. Judson was working as an administrative assistant for a healthcare provider … Even to suggest and recommend, let alone persuade Ms. Wilson and Ms. Judson to invest their entire retirement assets in such a [Ponzi] scheme, was while not fraudulent, certainly amounted to a breach of the fiduciary duty owed by Mr. Smith to Ms. Wilson and Ms. Judson.” In re Gregory Smith, (Bkrpt.Ct. M.D. Fl. 2005).

    Williams (2006). In a case arising from Oregon, a self-employed insurance seller and licensed financial planner took advantage of his position as a financial advisor to gain the trust of an 87-year-old man, Stubbs, convincing the elderly man to grant him a power of attorney, with which the financial planner stole about $400,000. The court held that the licensed financial planner was employed as a fiduciary, specifically noting that the elderly man relied upon the fiduciary as a financial advisor and estate planner. U.S. v. Williams, 441 F.3d 716, 724 (9th Cir. 2006).

    Hatleberg (2005). When a bank held out as either an “investment planner,” “financial planner,” or “financial advisor,” the Wisconsin Supreme Court held that a fiduciary duty may arise in such circumstances. Hatleberg v. Norwest Bank Wisconsin, 2005 WI 109, 700 N.W.2d 15 (WI, 2005).

    Graben (2007). A dual registrant crossed the line in “holding out” as a financial advisor, and in stating that ongoing advice would be provided, and other representations, and in so doing the dual registrant, who sold a variable annuity, and was found to have formed a relationship of trust and confidence with the customers to which fiduciary status attached. “Obviously, when a person such as Hutton is acting as a financial advisor, that role extends well beyond a simple arms’-length business transaction. An unsophisticated investor is necessarily entrusting his funds to one who is representing that he will place the funds in a suitable investment and manage the funds appropriately for the benefit of his investor/entrustor. The relationship goes well beyond a traditional arms’-length business transaction that provides ‘mutual benefit’ for both parties.” Western Reserve Life Assurance Company of Ohio vs. Graben, No. 2-05-328-CV (Tex. App. 6/28/2007) (Tex. App., 2007).

    These cases are not a new development in fiduciary law. They reflect the common law which existed before the enactment of the Investment Advisers Act of 1940.

    Stewart (1937), Applying Arizona Law. The Arizona Supreme Court early on held that a confidential relationship exists between a client and his or her financial adviser when there is an imbalance of knowledge so that the client relies heavily on the adviser for advice. Stewart v. Phoenix Nat’l Bank, 49 Ariz. 34, 64 P.2d 101, 106 (1937) (holding that a confidential relationship existed when the bank had acted as the plaintiff’s financial adviser for many years and he relied upon the bank’s advice).

    We tend to forget that the Advisers Act, upon its enactment and ever since, was known to make all registered investment advisers de jure fiduciaries. Yet nothing in the Advisers Act ever stated that brokers or insurance agents could not be fiduciaries. Brokers were only excepted from registration under the Advisers Act, under an exemption that applied only when “solely incidental” advice was provided and for no “special compensation.”

    Other cases have held that an inexperienced or naive investor is likely to repose special trust in his stockbroker because he lacks the sophistication to question or criticize the broker’s advice or judgment. See Paine, Webber, Jackson & Curtis, Inc. v. Adams, at 517. This may be particularly true where the broker holds himself out as an expert in a field in which the customer is unsophisticated. See, e.g., Burdett v. Miller, 957 F.2d 1375 (7th Cir. 1992); Paine, Webber, Jackson & Curtis, Inc. v. Adams, at 517, citing Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Boeck, 127 Wis. 2d 127, 145-146, 377 N.W.2d 605 (1985) (Abrahamson, J., concurring) (“By gaining the trust of a relatively uninformed customer and purporting to advise that person and to act on that person’s behalf, a broker accepts greater responsibility to that customer”).

    In its 1940 Annual Report, the U.S. Securities and Exchange Commission noted: “If the transaction is in reality an arm’s-length transaction between the securities house and its customer, then the securities house is not subject’ to ‘fiduciary duty. However, the necessity for a transaction to be really at arm’s-length in order to escape fiduciary obligations, has been well stated by the United States. Court of Appeals for the District of Columbia in a recently decided case: ‘[T]he old line should be held fast which marks off the obligation of confidence and conscience from the temptation induced by self-interest. He who would deal at arm’s length must stand at arm’s length. And he must do so openly as an adversary, not disguised as confidant and protector. He cannot commingle his trusteeship with merchandizing on his own account…’” Seventh Annual Report of the Securities and Exchange Commission, Fiscal Year Ended June 30, 1941, at p. 158, citing Earll v. Picken (1940) 113 F. 2d 150.

    The SEC also “has held that where a relationship of trust and confidence has been developed between a broker-dealer and his customer so that the customer relies on his advice, a fiduciary relationship exists, imposing a particular duty to act in the customer’s best interests and to disclose any interest the broker-dealer may have in transactions he effects for his customer … [BD advertising] may create an atmosphere of trust and confidence, encouraging full reliance on broker-dealers and their registered representatives as professional advisers in situations where such reliance is not merited, and obscuring the merchandising aspects of the retail securities business … Where the relationship between the customer and broker is such that the former relies in whole or in part on the advice and recommendations of the latter, the salesman is, in effect, an investment adviser, and some of the aspects of a fiduciary relationship arise between the parties.” 1963 SEC Study, citing various SEC Releases.

    So, while your article states that regulators do not regulate the use of titles, I would ask: “Are not our regulators charged with preventing and punishing fraud?” It has been a simple ignorance by the SEC and FINRA of the fundamental truth that “to provide biased advice, with the aura of advice in the customer’s best interest, is fraud.” [Angel, James J. and McCabe, Douglas M., Ethical Standards for Stockbrokers: Fiduciary or Suitability? (September 30, 2010), at p.23. Available at SSRN: http://ssrn.com/abstract=1686756.%5D

    50 years ago the SEC cautioned broker-dealer firms against the use of advertising and the use of titles which denoted relationships of trust and confidence. It is time for us to question our regulators – why do they now permit fraud to continue to be perpetrated, under their noses?

    The Dodd-Frank Act clearly gives the SEC power to correct the SEC’s failings over the past several decades, and in essence to “right the ship.” If a salesperson utilizes a title or designation that denotes a relationship of trust and confidence, such as “financial advisor” or “financial consultant” or CFP(r) or ChFC, then the SEC should hold that salesperson to a fiduciary standard. Likewise, if a salesperson actually provide financial advice or personalized investment advice, that salesperson should be held to a bona fide fiduciary standard. Let’s hope the SEC gets it right this time around.

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