More On Legal & Compliancefrom The Advisor's Professional Library
- Updating Form ADV and Form U4 When it comes to disclosure on Form ADV, RIAs should assume information would be material to investors. When in doubt, RIAs should disclose information rather than arguing later with securities regulators that it was not material.
- Trading Practices and Errors When SEC-registered investment advisors conduct annual audits of firm policies and procedures, they should pay close attention to trading practices. Though usually not required to, state-registered advisors should look at their trading practices and revise policies that do not fully protect clients.
Some advisor-client relationship contracts include termination fees — even steep ones — for clients seeking to take their assets elsewhere, but that’s not the only method advisors use to hold on to unhappy clients.
The ethically questionable practice of a client termination fees got wide attention through Jason Zweig’s recent column in the weekend Wall Street Journal, which noted that even “fiduciary” advisors imposed duties as high as 1% of the account for clients exiting within a year of the account opening.
Dave Dickinson, co-founder of FireMyAdvisor, a relatively new firm that seeks to facilitate advisor-client divorces and shepherd disgruntled clients into the care of fiduciary advisors, says such termination fees — especially such steep ones — are rare.
“The great majority of advisors we’ve seen don’t use a termination fee,” he told ThinkAdvisor in a phone interview. Dickinson, who has long run a separate business helping advisors with compliance, says such fees couldn’t pass regulatory muster in most cases.
“Regulators seem much more amenable to fixed fees, like a $200 charge for leaving; they do not like percentages, or language that ‘if you leave, we’ll charge [fees that would have been assessed for balance of the year had the client stayed].’ I don’t think [a percentage fee] has any relationship with costs incurred, I think that’s just a penalty.
“There’s no way you can lock a client in.”
Except, of course, when advisors manage to do just that, as in the cases cited in Zweig’s article. So how could a fiduciary advisor pull that off?
“Regulators often miss things,” says Dickinson, who calls such a practice at odds with the fiduciary standard.
“If you’re a fiduciary,” Dickinson asks, “how can you try to lock someone into your services without the ability to leave when the client’s paying so much in fees? I’d be amazed that trying to keep a client through withdrawals charges matches up with the fiduciary standard in any way. It doesn’t seem to me that you’re acting in the client’s best interest when they may be interested in leaving for any number of reasons.”
The FireMyAdvisor client advocate does acknowledge cases where an advisor might legitimately want to impose a termination fee to discourage abusive clients — but never as a percentage of client assets.
Dickinson said he recently had a case where a client established a relationship with the advisor, then withdrew his assets after just a month, apparently to benefit from the advisor’s asset allocation model.
“Soon afterwards the son of that client wanted to hire him, but the advisor said ‘No thank you.’ So from the advisor side, a termination fee is understandable if very minimal, although I don’t know if it would have much effect [discouraging unethical clients],” he says.
But in the case of an unethical advisor, is there any recourse for the client who’s signed a contract with a termination fee?
Says the FireMyAdvisor principal:
“The first thing he can do is speak with the advisor and ask him to waive the fee,” the FireMyAdvisor principal says. “And I’d put that in writing if I were the client.
“And if I were advising client, I’d tell him to mention the fiduciary standard and tell him [the fee] doesn’t match up with that standard,” he says.
“If the advisor wouldn’t waive the fee,” he continues, “the client could file a complaint with the SEC or state, depending on how that advisor was regulated.
“If that didn’t work, he could try arbitration or the courts,” he says.
But Dickinson, whose firm seeks to pair unhappy clients with advisors who are happy to take them, has a less nettlesome, more practical approach to offer as well.
“The easier thing would be to find a new advisor and see if the new advisor would pick up some of the termination fee; often that would happen if the client were a good client."
While a contract requiring a client to pay to fire the advisor is a relatively rare occurrence, Dickson says there are other approaches advisors more commonly used to shackle clients that he has seen in his experience in both his compliance and FireMyAdvisor businesses.
Chief among them, he says, are back-end mutual funds and annuity contracts with steep surrender fees.
“They’re a huge bear,” Dickinson says. “Many investors don’t understand the withdrawals charges that they’ll incur if they change their mind.”
In a recent case, a client signed the paperwork for a fixed index annuity from which she cannot withdraw her funds within the contract’s first 10 years without surrendering 10% of its value, or $50,000. The woman put about half a million dollars — nearly the entirety of her retirement portfolio — into the annuity.
“She didn’t get good advice, but it was her responsibility to check it out before signing on dotted line.”
An advisor she found through FireMyAdvisor gave her the name of a good securities attorney who could challenge her current advisor on the unsoundness of putting virtually all her net worth in that one annuity.
At root of the many of these thorny issues is that the industry is heavily geared to keeping clients, at almost any cost.
“Cleints are so hard to get these days, the first thing many advisors do is try and talk them into staying,” Dickinson says.
This confrontational approach is the raison d’etre for FireMyAdvisor, which aims to help clients avoid this kind of psychological browbeating.
“The good advisors will say, ‘If the client doesn’t want me, I don’t want to keep an unhappy client.’"
Dickinson says the investment industry does a good job of creating the impression that it’s hard to leave your advisor, though in fact it is generally quite easy and can be arranged without any contact between the departing client and his advisor.
“If client is unhappy with you, let him go; you don’t want that kind of relationship,” Dickinson says.
“It’s just a cost of doing business for the advisor,” he says of departing clients. “You win some, you lose some.”
Related on ThinkAdvisor: