Which Firms Specialize in Misconduct?


A few weeks ago, in reference to ABC’s Madoff mini-series, I posted about how to avoid such a situation. (In case you missed that post, the short answer is making sure there’s an independent third party custodian actually holding your funds, never the investment advisory firm itself.) Today, in light of this week’s University of Chicago / University of Minnesota joint report on brokerage firm misconduct, I thought I’d talk briefly about how to avoid getting otherwise bamboozled, short of having your money stolen, and to be honest, the risk of getting bamboozled is MUCH higher than that of getting “Madoff-ed”. I see this way too frequently when I meet with prospective clients and review their current situations and/or hear about some of the recommendations that had been previously made to them.

In case you missed this week’s study, its authors found that brokerage firm misconduct was rampant – at some firms, nearly endemic. The study commented that there were some firms that seem to “specialize in misconduct.” Among the worst offenders: Wells Fargo Financial Network (about 20% of their brokers have been disciplined for misconduct), UBS (15% of their brokers had been disciplined), and Raymond James (14%). The single biggest category of misdeed was the recommendation of unsuitable investments, followed by misrepresentation – i.e., lying (18%), and omission of material facts (12%). What is wrong with these people?

So, we know how to prevent someone from actually stealing your money (see the opening paragraph or my post from last month), but how do we prevent the kinds of misdeeds (unsuitable investments, misrepresentation, and omission of material fact) that are too rampant in the brokerage world – and more rampant at some firms than others? Fortunately, the answer is pretty simple, and it can be summed up in four words: fiduciary standard of care.

I won’t venture terribly far into the weeds here, but I will take a minute to explain something that is too little known outside of the industry, and that is the difference between the standard of care to which different practitioners are held. You can divide the financial services world into two distinct halves with a clear, bright line distinction separating them, and that distinction is the fiduciary standard. On one side of the fiduciary line (the wrong side), you have firms that are generally large brokerage firms – and this includes many of the names you know and frequently see advertised on TV. I’m sure you could easily name a few. While the firms have very effective advertising, what they generally don’t reveal is that they are not broadly subject to a fiduciary standard of care (meaning they are not legally obligated to put the clients’ best interest first and foremost in all dealings) . . . and not only that, they – as a group – have fought tooth and nail to not be subject to a fiduciary standard of care. (See the recent huge battle over the Department of Labor’s efforts to implement a fiduciary standard of care in work-place retirement plans and take note of which firms were lined up and paying for the battle against such a standard.)

Generally, these firms (and they are almost all brokerage firms) are regulated by FINRA (the Financial Industry Regulatory Authority) and in many of their dealings, they are paid by commissions and/or other back pocket arrangements, whether seen by the client or not, for transactions they execute or products they sell. As a general rule, if an organization or broker is receiving commissions on products sold or recommended, whether or not those commissions are seen or unseen by the consumer, the firm is not subject to a fiduciary standard, and the potential for conflict of interest is significant. Buyer beware, as the “advice” offered by these firms – and I use that word “advice” in the loosest sense here – is often a sales pitch, however well disguised.

On the other side of that bright line (and clearly, in my opinion, the right side) are firms – such as this one – that are legally obligated to a fiduciary standard of care. These firms are overseen by the Securities and Exchange Commission (SEC), or in some cases, an individual state’s division of securities, but in either case, the standard of care is clear: was the client’s interest put first and foremost in any and every recommendation? Period. End of discussion.

When advice is the product or service, and when the firm’s or advisor’s compensation does not vary based on how that advice is implemented, most – if not all – of the conflict of interest between client and firm is removed, and so is the incentive to commit the misdeeds too commonly seen in the brokerage world: unsuitable investments, misrepresentation, and omission of material facts.

Here’s a short table showing the differences between the two:

Brokerage FirmRegistered Investment Advisor
Standard of CareSuitability Standard: "Don't blame me: the suit I sold them fit, and I have the measurements to prove it."Fiduciary Standard: "…but it was also the right one for the occasion and looked good on them. It was also the best one available not just in this store, but in the entire mall, given the occasion."
Firm CompensationCommission: "The green suit paid me more than the blue suit, so I recommended the green suit (but didn't tell them that, of course)."Fees: "The fee didn't change based on the brand or color of the suit, and it didn't matter to me which one they bought. I just wanted them to get the right one for the occasion."
Organizational CultureSalesAdvice / Service
Regulator BodyFINRASEC
ExamplesMerrill Lynch, UBS, Wells FargoRetirement Planning Specialists

Switching metaphors, think medicine: All doctors are required to take the Hippocratic Oath, part of which says, “I will apply, for the benefit of the sick, all measures which are required, avoiding those twin traps of overtreatment and therapeutic nihilism.” Essentially, what we have in the fiduciary standard of care is a Hippocratic Oath in the domain of financial advice, and yet – somehow, some way – we have the largest actors in this space fighting tooth and nail to avoid being subject to such a standard. And given this week’s University of Chicago/Minnesota report, it would appear they are doing a pretty good job of avoiding that standard.

So, if you happen to come across the news stories this week about the rampant misconduct in the industry, know this: almost all such activity that is reflected in the study occurred at brokerage firms, not registered investment advisory firms, and that as a group, brokerage firms have fought long and hard – and continue to do so – against a fiduciary standard of care to which this firm – and others like it – are subject.

Thought you might like to know that.

Always happy to talk over, so please don’t hesitate to call or email if you would like to do so.