When people think of meeting with a financial adviser, they often assume the adviser will try to sell them a commissioned product, such as a mutual fund, insurance policy or annuity.
While these products can be useful financial tools, they are not always appropriate for every client. If an adviser has a financial incentive to sell products that are not aligned with a client’s individual needs or best interests, a conflict of interest may arise.
Conflicts of interest occur when a financial adviser’s personal or professional incentives are misaligned with the best interests of their clients. Advisers may be encouraged or pressured to recommend products that generate higher commissions or provide financial benefits to their employer rather than those that are most suitable for the client.
To mitigate conflicts of interest, my firm follows its own strict No Golf Ball Rule. This policy prohibits advisers from accepting any gifts from investment managers or service providers, regardless of perceived value.
Prohibited items range from something as small as a logo-branded golf ball to meals, trips and sponsorships. The No Golf Ball Rule reinforces an adviser’s fiduciary responsibility to act solely in their clients’ best interests.
These safeguards are especially important because some mutual fund companies engage in revenue-sharing arrangements with financial advisers whose clients invest in their funds. Such arrangements may include payments for marketing support, data analytics, or reimbursement for a client event — such as a hosted steak dinner. These revenue streams can create conflicts of interest by incentivizing advisers to recommend products that are financially beneficial for them or their firms, rather than those that are the best option for the client.
There are several red flags that may indicate potential conflicts of interest, including the following:
How are they paid?
Financial advisers fall into one of three categories based on how they are compensated:
• Fee-only advisers are compensated solely by their clients, either through a percentage of assets under management or via project-based or hourly fees.
— These fees typically range from 1% to 2% of the assets under management. Fee-only advisers do not receive commissions or other compensation from financial product providers. Many fee-only advisers operate under a fiduciary duty, meaning they are required to place their clients’ best interests first.
— This obligation is supported by regulations such as the Investment Advisers Act of 1940.
• Fee-based advisers are paid by their clients but may also receive compensation from other sources, such as commissions on financial products they sell. This dual compensation structure can create potential conflicts of interest, as an adviser may have an incentive to recommend products that generate additional income rather than those that are best suited to the client.
• Commission-only advisers earn income entirely though commissions on the products they sell, such as insurance policies, annuities or mutual funds.
—The more transactions they complete or accounts they open, the more they are paid. Again, this compensation model can create conflicts of interest or raise questions about whether recommendations are aligned with the client’s best interest.
Regulatory standards
Registered financial professionals generally operate under one of two regulatory standards:
Investment advisers are held to a fiduciary standard and are regulated by the U.S. Securities and Exchange Commission. This standard requires them to act in the client’s best interest when recommending investments. Investment advisers are compensated only by their clients.
Brokers operate under a suitability standard and are primarily regulated by the Financial Industry Regulatory Authority. Under this standard, broker-dealers must recommend investments that are suitable for the client’s circumstances but are not required to place the client’s best interests above their own. Brokers may receive compensation from companies whose products they recommend.
Adviser credentials
Spend time researching a prospective adviser to understand how they are licensed and compensated. Online tools make it relatively easy to review an adviser’s credentials, disciplinary history, and professional designations. Be sure to confirm that the adviser has earned—and is properly using—any credentials they claim.
Helpful resources
• INRA BrokerCheck: brokercheck.finra.org. Use this tool to research fee-based advisers, brokers, and insurance or annuity sales professionals governed by FINRA.
• SEC Investment Adviser Public Disclosure: www.advisorinfo.sec.gov. Use this site to review fee-only registered investment advisory firms and investment adviser representatives.
• Certified Financial Planner Board of Standards: letsmakeaplan.org. Use this site to verify whether an adviser holds the certified financial planner designation, a recognized standard for financial planning professionals who are required to act in their clients’ best interests.
Next week: A look at adviser promises and pitches.
Teri Parker is a certified financial planner and vice president for the Riverside office of Captrust Financial Advisors. She has practiced financial planning and investment management since 2000. Contact her via email at Teri.parker@captrust.com.