We know there are four primary types of financial professionals who market investment advice, services, and products to the public: Planners, advisors, managers, and sales representatives (reps). In a recent Paladin Research survey only 9.7% of investors selected the right job description for each of the four types. 0% of the investors knew which types of professionals were financial fiduciaries. And, 0% knew why fiduciary status was an important credential for financial professionals.
Why is fiduciary status important? Fiduciaries are held to the highest ethical standard in the financial services industry. They are required to put investors’ financial interests ahead of their own. This broad mandate applies when they sell and provide financial services.
Who are the fiduciaries? Financial advisors and money managers who are Registered Investment Advisors (RIAs) or Investment Advisor Representatives (IARs) are fiduciaries. Sales representatives are not fiduciaries. Planners who are RIAs or IARs are fiduciaries. However, planners who hold securities or insurance licenses are not fiduciaries.
You might be asking why fiduciary status is so confusing? You might also ask who benefits from the confusion? The answer is Wall Street! Its companies employ more than 100,000 sales representatives who are held to a lower ethical standard called suitability. Consequently Wall Street companies have a lot less liability when its legions of representatives sell investment and insurance products that are not in the best interest of investors.
Wall Street already has its fair share of legal problems for cheating investors to maximize company profits and executive bonuses. Goldman Sachs was the latest company to make headlines when it cheated investors out of hundreds of millions of dollars. If Wall Street companies and representatives had to adhere to a fiduciary standard of care it would have to discontinue many of its shadiest business practices.
Wall Street interests are currently spending millions of dollars fighting a movement to make sales reps financial fiduciaries. It is also spending millions to confuse the public when they select advisors and reps. Wall Street marketing creates the perception that reps provide the same standard of care as advisors, but they don’t want their reps held to the same ethical standards. If investors accept this contradiction, Wall Street should win an Oscar for Best Obfuscation.
Why confuse people? Money is always the answer, but in this case it is a huge amount of money. Wall Street executives are very aware that given a choice only 6.3% (source: Paladin Research) of investors with more than $100,000 to invest would knowingly select a sales representative to invest their assets for them. Therefore, it is in Wall Street’s best interest that investors do not know the nice, well-dressed professional from the brand name firm is a sales rep. Over 90% of investors would not buy from reps if, and that is a big if, they knew the truth.
Why is Wall Street so reliant on sales representatives? Again, the answer is money. Wall Street makes a lot of money two ways. Reps sell company products that generate substantial amounts of continuous fees. And, reps sell products that produce 5% of upfront commissions. What you may not know is companies pay half of the commission to their reps and retain the other half as earned income. They are paying the commission to themselves. From a cash flow point of view the companies get a big hit upfront (2.5% of assets) and a monthly or quarterly revenue stream (1% to 2% of assets per year) that lasts as long as there is a relationship.
Contrast that to financial fiduciaries who are compensated with fees. The investor pays a 2% wrap fee that covers advisory, money management, custodial, and transaction services. This fee is usually billed quarterly in advance so the company only receives 0.5% in the first quarter and still has to pay the advisor. So 3% of upfront revenue is reduced to 0.5% or less on all new assets – an 83% reduction in first quarter revenue.
A large body of advisors and their support organizations believe sales reps should be labeled financial fiduciaries. However, as you have just read, fiduciary standards that put investor interests first, will devastate Wall Street’s short-term profitability. Consequently, Wall Street will fight tooth and nail to avoid higher ethical standards for sales reps. The fiduciary issue may be resolved in 2013, but it is going to be a war.