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November 30, 2016 at 03:33 AM
This is the third in a series of blog postings–Clark Explains the Industry–that explores the dynamics of, and the definitions around, the professional financial advice-giving industry.
About 10 years ago or so, the National Association of Professional Financial Advisors (NAPFA) was facing a crisis. Its public relations campaign to promote the benefits of fee-only advice had been so successful that financial advisors of all stripes were claiming to be fee-only, regardless of their actual status. The common explanation in the brokerage world and among many financial planners was “when I’m charging fees, I’m fee-only; when I’m charging commissions, I’m not.” Even the CFP Board was found to be in on this deception, when Financial Planning magazine’s Ann Marsh revealed that hundreds of brokers has listed themselves as “fee-only” on the Board’s “Find a CFP” website.
In response, the NAPFA Board was considering changing its focus from “fee-only” to “fiduciary” advice, and asked a number of industry observers what we thought of the idea. (The NAPFA folks proved to be ahead of the curve, when four years later, the Dodd-Frank Act popularized the concept of fiduciary advice, and more recently, the Department of Labor made it a national conversation.) At the time, I told the NAPFA board that I thought the concept of a “fiduciary” was both too legal sounding and too complicated for most investors to grasp. Instead I suggested the term “independent advisor,” to differentiate sources of truly client-centered advice.
While NAPFA did not take my suggestion, they did heed my advice (and undoubtedly that of many others) and passed on the fiduciary nomenclature—which has proven to be a wise move. In the years since that meeting, a majority of brokers have embraced managing assets for a fee, making them fiduciaries when advising on client portfolios, but not fiduciaries when selling the investments that go into those portfolios. They have been able to co-opt this term in marketing and speaking to confused clients, just as they did “fee-only.”
Which is why I still believe that “independent advisor” is the best description to market truly client-centered advice. However, like most things in financial services “independence” isn’t quite as simple as one might think. To be clear, we’re talking about financial independence here. And, as it turns out, there are degrees of advisory “independence” for financial advisors. Some advisors are more financially independent than others. Here’s a breakdown of advisor independence, along with a breakdown of how client-centered advice can be affected at each level.
Levels of Independence: Employee Advisors
At the bottom of the independence scale are brokers at the large brokerage firms: Merrill Lynch, Morgan Stanley, Wells Fargo Financial Advisors, UBS. The brokers at these firms are W-2 employees, so there’s no confusion about whom they are working for. Their salaries, bonuses, forgivable loans, promotions, offices, staff support, entertainment allowances, client referrals and payout percentages (the portion that they get to keep of the revenues that their clients generate, which typically range between 25% and 50%) are all controlled by their employer.
Since the primary business of these firms is underwriting (creating) securities such as stocks and bonds, and investment vehicles such as mutual funds and hedge funds for outside client companies, the primary mission of their brokers is to sell these securities to investors. Consequently, these BDs have considerable amount of influence over what—and how much of it—their advisors recommend to their clients.
Levels of Independence: Independent Broker-Dealer Advisors
On the next level of independence are advisors who affiliate with so-called “independent broker-dealers.” These BDs are called “independent” for two reasons.
