Why conflicts of interest aren’t going away

The private client was sitting across the table from his financial adviser in their regular quarterly meeting when the client received an e-mail from the firm's chief executive announcing that the CEO was resigning.

In another case, a senior executive of a wealth advisory boutique broadcast to a very large e-mail list that his e-mail address was changing, effectively announcing his departure from his firm.

These days, rapid-fire executive changes are commonplace and no big news. The refrain could be taken from the old hit song, “Another One Bites the Dust.”

What does a private client, or any investor, make of all this? For that matter, how does the the adviser community perceive this?

Businesses catering to the ultrahigh-net-worth have kept a dirty little secret under wraps for far too long. A constant conflict is insurmountable.

Serving as a fiduciary, i.e., adhering to a professional standard of care, conflicts at every turn with running a profitable business. This conflict is constant and in fact impossible to eliminate.

HOW IT WORKS IN MEDICINE

Consider an analogy from another industry: Doctors buy expensive MRI machines for their practice and then routinely recommend MRI exams.

When investors were less sophisticated, the wealth advisory business was profitable. It is no longer, which explains why investors sense a certain inexplicable tension with their adviser. Rational thinkers, however, would ask: If a firm takes only the richest people as clients, how can that strategy not be profitable?

Because the very path toward profitablity, i.e., standardization of service and a preset menu of investment choices, is despised by most ultrawealthy clients, who wish to be seen as unique and even treated as the most important client.

No patient wants to feel that the doctor is rushing an examination because the waiting room has too many paying and anxious patients. A sidebar question for doctors: Do patients pay what it actually costs the doctor to listen patiently to the symptoms, or are diagnostic procedures the only way to break even for a medical practice today?

Private clients must share some of the blame, though, because ultrahigh-net-worth clients' demands often are too unrealistic — even naive and selfish.

“Why shouldn't I receive favored fees over retail investors? Aren't I more valuable to your firm?”

“Why can't you produce that report for me, even though it takes hours of manual input into your systems?”

“Why can't you spend hours explaining what trades you are doing?”

“I deserve such attention from your chief investment officer or at least from my portfolio manager because, after all, I have more assets with your firm than most other families. I pay based on assets under management and thus I deserve to get more of your time, one on one.”

There is no silver-bullet solution or even a straightforward way to address this conflict of interest. If both investor and adviser were truly candid with each other, they would acknowledge that fulfilling the professional standards of any field often presents a conflict with the requirements of a profitable business, whether in wealth management or medicine.

Accepting that immutable fact and then genuinely attempting to balance the self-interests of both sides are two necessary steps to take toward a healthier wealth management industry.

Charlotte Beyer is the founder of the Institute for Private Investors.