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Breaking Ranks: Former Broker Turns Bomb Thrower

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Joshua Brown is one angry former broker.

The 35-year-old financial advisor, whose Reformed Broker blog has brought him wide acclaim in recent years, has just written a book meant to uncover the perfidy of Wall Street. Backstage Wall Street is part plea, part mea culpa, part screed. Brown unmasks the financial industry for all to see, revealing the less-than-honest sales tactics of boiler-room brokers and dressing down investment banks for running away with fees and riches while Mom and Pop retail investors are left holding the bag.

Brown makes some startling claims: wirehouse brokerage firms will be gone in 10 years, as will the “suitability” standard governing broker-dealers. Mutual funds? They’ll be gone too, replaced by their fast-rising cousins, ETFs. Brown takes his readers on the bumpy ride of Wall Street, from 2000 (when he started), through the credit crisis of 2007-2008, to the present day, when you can find him as a reinvented registered investment advisor, happily banking management fees instead of commissions.

But with the anger, there is also care. Brown, currently a vice president of investments at New York-based Fusion Analytics, truly wants to create a better financial industry, one where advisors can continue to make a living while always acting in their client’s best interest.

What motivated you to write the book?

I’d say the primary reason is I had all this stuff in my head and weighing me down for a long time and it was just something that had to come up in some format. The second reason is, I think there’s a story here that is more than just writing a series of blog posts, so I wanted to do something with this stuff. Blog posts are very disposable. People read them on Monday and then on Tuesday there’s a whole new crop, so I felt that what I was trying to say with the book should have a little more of a shelf life.

In the beginning of the book, you write that you hope to reveal the “reality behind all the false glamour, contrived accuracy, and manufactured confidence” on Wall Street. Why?

People have said about my site, that the goal of [it] is how to make Wall Street better. So I think that has something to do with it. I hope that I’m part of a new wave of investment professionals that work to be truthful and only do things with the client’s best interest at heart. So I hope that the book is part of that, an extension of that. Without sounding too high on the horse, that was something that just kind of evolved.

On this theme, in the beginning of the book, you describe your disappointment, even disgust, with the industry. At one point, you write “I’ll starve on the street before I’ll ever be a retail stockbroker again.” What’s so bad about being a retail stockbroker?

Everything. At its core, it’s one giant conflict. The way we get paid, the way we’re incentivized to do one thing over another, the fact that there are pay periods. In other words, there are considerations to what makes one person versus another person successful that are in diametric opposition to what is good for the client. I guarantee you if regulators want to do one very simple thing with a retail brokerage firm, the only thing they have to do is go into a firm and ask to see the commission books. Ask to see any Wednesday of the month versus the last day of the month. If they did that, I guarantee 12 months out of 12, for any given year, they would find an increased number of transactions and obviously an increased level of gross on that last day of the pay period versus any other Wednesday of the month. And what that tells you is that there are people making decisions that have more to do with brokers’ compensation than what is best for the client. There are certain things that are endemic to being a retail broker that are in opposition to what is best for the client. So I’m not ever going to put myself in that position again where I have to rationalize and say things like “look, I really care about the client, but I’m $500 away from hitting a certain number and if I don’t hit it I’m going to have a lower payout, so I better do this trade.” I’m not going to do that ever again. I would prefer to sell oranges on the highway.

The readers of this magazine are retail stockbrokers, so I’m wondering, do you think they are all embroiled in conflict?

To greater and lesser extents, depending on what the firm does and what their niche [is]. I think there are very few firms left that are all the time full-service brokerage firms and nothing else. That’s a rarity. I think what is more likely is that anywhere where your magazine gets delivered, somebody opens it up and reads it, that person works at a firm where some of the business they do is full-service brokerage and some of it is advisory.

What about those who are exclusively brokers?

They’re not going to like what I have to say, but I think they’re going to know that I’m telling the truth.

You talk a bit about the different standards applied to broker-dealers and RIAs and write that clients have no idea that those two kinds of financial advisors are governed by very different regulatory standards. Do you think this is something that Wall Street wants to obfuscate?

I think they benefit from the confusion, but I don’t think there’s a conspiracy. This is one of those things where it’s lying by omission. There was a survey in 2010 where 93 percent of all investors didn’t understand that their stockbroker didn’t have a fiduciary duty to them. So what that means is that more than 9 out of 10 Americans think that any financial professional they work with has a fiduciary responsibility to them, when in reality, as a broker, the broker only has a suitability standard on a transaction on transaction basis.

You write a lot about the rough-edge stockbroker culture and the boiler room atmosphere and basically suggest that most brokers care more about the sale than the customer and basically don’t know very much about what they’re selling.

I’m speaking about a very specific kind of broker and that broker is dying, a relic of the ’90s, that broker is dwindling down. When I’m talking about blue collar Wall Street brokers I’m basically talking about the guy who has built [his business] through advanced cold-calling skills. Basically, they lie for a living. Their pitch is that they somehow have the ability to outperform the market consistently, which of course is a lie, but they say it as though it’s fact.

So you’re not talking about the big wirehouse broker?

Not in this particular instance, no. I think the wirehouse is different. The wirehouse, there’s been a tendency to just do as they say, so the wirehouse broker is not someone who wants to be ignorant or anything like that. The wirehouse broker says “I asked the client eight questions, I put the answers to those eight questions in a computer, the computer tells me what portfolio to recommend to the client.” And that process is repeated almost like shoveling coal into a furnace.

The two investment products that you discuss most are mutual funds and ETFs. Regarding mutual funds you suggest that mutual fund companies and brokers work together closely, and not always to the benefit of the customer.

The reality is that [fund managers] mean-revert. Even a manager who outperforms for three years straight will probably under-perform long enough so that in the end it nets out just to be the same. So essentially mutual funds have found themselves to be the high-cost provider of something that most people don’t need. In other words, there are $2 trillion in mutual funds right now. And a lot of that is in things like — and I’m just making up names — but let’s say the Putnam Semiconductor Fund. And the reality is that if somebody just buys the semiconductor index as an ETF, it’s very, very unlikely that the acting manager at Putnam is going to be able to beat that index over long stretches of time.

You write that 80 percent of mutual funds don’t beat the market. Do you think the average investor realizes that?

No. Within the industry, we all know it. You can’t not know it. However, there are a handful of funds that spectacularly outperform in a given year, or in a given two-year period or five-year period, and unfortunately for investors, just when these funds are coming off their best three or five years ever, that’s exactly when they’re going to get their five-star ranking from Morningstar and more importantly when their story is the easiest to tell. According to mean reversion we all know that that’s actually the worst time that people could be throwing money at a top manager. I don’t think there’s a conspiracy, but most of them don’t live up to what they’re supposed to do. That’s an extraordinary failure rate.

Near the end of the book you reveal details of the “Straight-Line” pitch and write that it’s never been revealed before. What’s so sacred about the pitch?

Wow. I think that everyone has their own version of the pitch, but slightly different. It’s more like the Icelandic sagas that were told and told and told and then finally someone wrote them down. But in the meantime every tribe in every village had a slightly different version of it. That’s what the Straight Line is for the brokerage industry. Every single person that reads this book that is a high-net-worth individual with a working phone line has heard some variation of it. They’ve heard it a million times in some cases. There are people that are going to buy this book and open it and say ‘Oh my God, that’s the exact thing this guy said to me yesterday! So it’s got a lot of authors, it’s kind of an oral tradition. I actually took a bunch of different versions and put together this version and I think it’s the most accurate representation of the Straight Line that everyone has as a result of the cold-calling boom of the ’90s.

The last chapter of the book is particularly damming. You write, “The Street’s perpetuation of half-truths and outright myths about investment products and services has been near fatal to the average portfolio.” You go on to say that the traditional broker model is “a business model that is broken beyond all repair.” As I said, readers of this magazine are brokers. What’s your message to them?

I think they probably agree with me. I think most [brokers] are looking for ways to become more fee-based. Because I don’t think they are bad people. I was one of them less than two years ago. So I don’t think it’s a personality flaw. What I think is that some people [are] slower than others to wake up to the reality that there’s a better way.

There’s a better way to have integrity in your work and serve your clients?

It took me forever to figure that out, so I’m not even casting judgment on people who haven’t figured that out yet. I could’ve been doing what I’m doing now let’s say three or four years ago, so I stuck around doing that for longer. I’ll give you the primary reasons why people do it. Number one, they’re ignorant of the fact that they can do this differently. Now they’re running out of excuses for being ignorant at this point, but fine. Number two, they don’t care. There are people who just say, “Look, I want to sell people investments that give me 3% to 5%. That’s how I make my money.” That’s their prerogative. I personally think they are doing their clients a disservice.

The third reason is: Think about how hard it is to transfer a commission-based business, in other words a transactional business, to fee-based business. To make money with a transactional business, you can have $2 million under management and make a quarter-million dollars per year as a broker. However, you need $25 million under management if you’re going to make a quarter million as an advisor, minimum. Because keep in mind you are charging 1% on your assets. It’s not easy, and that I think is another reason why a lot of the people that are going to read this haven’t made the switch.

Given everything you’ve said, what do you see as the future of Wall Street? What is Wall Street going to look like in 10 years?

I think in 10 years the wirehouse disappears. I think eventually the SEC will adopt a fiduciary standard for brokers. It will be impossible for them to justify the commission model. I also think the mutual fund industry goes away. The independent advisories — some of them will get really big and they will look like the wirehouses of today, but that’s going to be fee-based, people selling advice as opposed to commission-based people selling products.

I can imagine what this means for the broker, but can you spell it out?

For the person that’s fully commission-based, I don’t think they’ll exist because when the regulators finally decide that there’s a uniform fiduciary standard for anyone dealing with the public, they’ll be forced to adapt. It sounds like I’m making a shocking prediction now, but what I’m saying is the only rational prediction. It would be shocking to predict that things will stay the way they are. That would be way more shocking.

So despite all the bad feelings, and everything I read, you are still in the industry, so you still must enjoy being a financial advisor.

The last chapter of the book is called “Breakaway” and I truthfully feel that after almost a decade and a half [in the industry] I finally found a format that gives the advisor the best chance of a successful career and gives the client the best chance of untainted, uncompromised service. So I spent a decade selling things to people and finally found a way to work with people and not be on the other side of the table. I think it’s the Holy Grail in this industry and I’m really excited that I finally found it. And every day I wake up and I’m thankful that I’m doing this instead of what I used to do and what a lot of people are still doing. I have not given up on the advisor business at all. If anything I feel as though I found the right way to do it. 


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