More On Legal & Compliancefrom The Advisor's Professional Library
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- Dealings With Qualified Clients and Accredited Investors Depending upon an RIAs business model and investment strategies, it may be important to identify “qualified clients” and “accredited investors.” The Dodd-Frank Act authorized the SEC to change which clients are defined by those terms.
Investors looking for expert hands to handle their retirement assets sometimes rely on certifications as a signal of specialized knowledge.
Indeed, investor advocacy and advisor-client matchmaker Paladin recently found one advisor with 28 letters after his name. But the alphabet-heavy advisor rated only two stars out of five from Paladin, whose site provides consumers with free research tools to rate advisors.
“Most of the designations were weak, he lacked meaningful experience, and his main method of compensation was commission,” Paladin’s founder and chief executive Jack Waymire told ThinkAdvisor.
“The main role of the 28 letters was to convince naive investors he was an expert in his field,” Waymire adds.
The Consumer Financial Protection Bureau (CFPB) in April released a report listing more than 50 different designations targeted to seniors in the retirement investment marketplace — most with little or no coursework, accreditation, complaint process or disclosure standards.
Paladin’s researchers, with a more street-level view of the advisor marketplace, have found 260 designations. The firm has created 1-page report on each designation and established an algorithm to rate them, one of its site’s free research tools for consumers.
Waymire says the plethora of designations contributes to consumer confusion. Eighty percent of consumers recognize the CPA title, but the second-most recognized, the CFP mark, is familiar to only 5%.
“That’s why it’s called an alphabet soup,” Waymire says. “Investors don’t know what the advisor did to get the designation: Did he buy it or did he earn it?”
The Paladin founder compares the situation to diploma mills that can put someone into a PhD for a price. These phony certifications can work, he says, because “the investor wants an expert managing his money.”
Indeed, investor cluelessness is what drove Waymire to found Paladin 10 years ago, after the publication of his 2003 book, Who’s Watching Your Money?
The book listed 17 principles for selecting a financial advisor, and Waymire found that investors were asking for more than just principles but for referrals to actual advisors.
So he created an algorithm that rated advisors according to these 17 criteria and established a website where investors could use that tool.
Paladin’s own surveys find that some 3 million to 4 million investors fire their advisors every year and replace them with other advisors because they don’t meet client expectations. “That’s telling us there’s a big problem out there,” Waymire says.
But he laments that they usually end up repeating their original mistaken process and hire another bad advisor. That’s the problem Paladin is trying to solve — distinguishing between good and bad advisors.
Waymire profiles the situation of a retiring boomer:
“I’ve got a $1.5 million in 401(k) and I roll it over into an IRA. I’ve never dealt with this kind of money before. I need an advisor…One of us [the retiree or his spouse] is going to live well into their 90s. The money’s got to last through market crashes and wars. If my first advisor loads me up on crappy annuities, and I pick him because he belongs to my church or plays golf at my club, the odds that I run out of money before I get to my 90s is pretty good.”
The problem, Waymire continues, is that the vast majority of the people handling such clients are sales reps selling mediocre products that pay large commissions.
“You could probably make a case that 10% of advisors know what they’re doing; 75% are sales reps. Keep in mind that sales reps don’t have any mandatory disclosure requirement; most of them will tell you they’re financial advisors. The reason is they want to lower your sales resistance. But smart investors don’t want sales reps running their retirement money,” Waymire says.
Whereas ordinary investors lack sophistication in choosing an advisor, Paladin has a process available to investors at no cost.
“If they want us to gather data [on advisors] on their behalf, we archive it on their account. If they have a future dispute with their advisor, we’ve got it on record. One of the problems [in the industry] is that everything is verbal.”
That’s a big problem for an investor who may be told by an unscrupulous broker that he can deliver a 12% return on his money.
Waymire contrasts the consumer market free-for-all with Department of Labor requirements for pension plans that require money managers to document their credentials, processes and fees.
Arguing that an individual’s retirement wealth is similarly too important to rely on verbal assurances, Waymire has instituted a “request for information (RFI)” — similar to the “request for proposal (RFP)” that pension funds use — that asks advisors key questions.
“What’s your education? Do you have compliance problems? How are you compensated? We take the information from the RFI and put it in an advisor scorecard," he says. "We know the right questions to ask — rather than the investor using his own process, we use ours."
So if a retiree knows three advisors in his community — any advisor in the country — Paladin can send out the RFIs and will allow the investor to see their scorecards side by side.
Investors who do not know any advisors can search among the advisors in Paladin’s registry. The 1,000 or so advisors in Paladin’s database pay from $50 to $300 a month with rates dependent on geographic location (someone in Montana will pay less than someone in Chicago, he says) and “different levels of service.”
Waymire is adamant that Paladin does not sell leads and accepts only 5-star advisors. “We could have 25,000 advisors if we didn’t use the algorithm,” he says.
There are some 700,000 sales reps among the advisor population, he says, and but no more than 100,000 higher qualified investment advisors. “We only take the 90th percentile [and up] of those, with a good education, fee-only or fee-based,” he says.
A wirehouse advisor with only a Series 7 license can’t get into the registry. “The algorithm won’t treat that very nicely,” he says, adding that a few wirehouse advisors who have formed their own RIA have made it in.
“We think the advisor must be a fiduciary and his main compensation a fee,” Waymire says. A wirehouse advisor who derives his income mainly from commissions, but who has a serious designation like a CPA/PFS, CFA or CFP, won’t get more than 3 stars, he says.
Check out Dalbar: Advisors Should Sell Goals, Not Funds on ThinkAdvisor.