Most financial advice is tainted by advisers’ self-interest

Honesty starts with calling things by their right name. Brokers of old were mostly salespeople. The “suitability” standard applied to them and others who managed money for third parties. This standard is akin to the “implied warranty of fitness,” which applies to all salespeople. Car salesmen and insurance agents are not fiduciaries.

Investment advisers offer investment products for a commission, which may be a front-end load, a back-end load or a continuing load for assets under management. All are commissions contingent on a sale, so they are salespeople. “Gathering assets” is a sale.

A financial planner offers advice for a fee that is clearly stipulated and based on hours or a flat rate, but is not tied to the sale of a product and addresses all facets of a client’s finances. So financial planners are fiduciaries.

When I was starting out as a family financial planner 43 years ago, I learned from my attorney that if I encouraged clients to invest in my then-profitable real estate syndication, it would be a breach of my fiduciary obligation. He told me that I must recuse myself from advising clients on this investment because it was a conflict of interest: I could not pit my investment against other investment opportunities objectively, as they had hired me to do. I took his advice and never syndicated projects again.

Most asset managers are in fact money managers, who are indistinguishable from the brokers of the past. They prefer to characterize themselves as objective “financial advisers” since they claim to provide a comprehensive approach, including tax planning, estate planning and insurance advice, most of which are contracted out to other firms receiving a split of the fee.

CANONS OF ETHICS

Professions that are respected for upholding fiduciary obligations — doctors, lawyers and CPAs — address these issues in their respective canons of ethics. For example, it is considered an ethical breath for doctors to refer patients to labs they own. Accountants are held to a higher standard to prevent unseemly “independent” audits of firms that are their clients. Attorneys must refuse new clients when conflicts could arise with other current clients.

It is time for the profession to recognize that most financial advisers give advice tainted by their own self-interest. Indeed, the financial industry gives their producers an incentive to sell clients whatever is most advantageous to the employee’s firm.

Advisers who charge clients based on the amount of AUM inevitably confront many conflicts of interest.

President Barack Obama mentioned the need for a fiduciary standard, especially when competing to manage retirees’ 401(k)s and other investments. While promising tax-efficient investing, most of these advisers are not qualified tax advisers. Money managers are prone to recommend high-cost money management or even annuities without reviewing prior tax returns or preparing detailed tax planning projections. Less expensive investments aren’t offered, as they provide less compensation for the adviser.

AUM compensation taints other areas of advice, too. For example, should a client sell her old home or rent it? Should she remortgage and withdraw more money for investment? Borrow for children’s college? Use donor-advised funds? Should a lower AUM rate be charged on cash and bonds, which have a lower yield than other asset classes? These decisions all affect the adviser’s AUM income.

Typically, AUM full disclosure addresses an annual fee but does nothing to address the above issues. While the full disclosure standard is endorsed by the leading financial planning organizations (including the National Association of Personal Financial Advisors, the Certified Financial Planner Board of Standards Inc., etc.), it is a weak palliative that does little to address the potential abuses the public faces with an adviser. When confronted by conflicts, investment advisers often see the opportunity to gather more assets.

For years I have used the following Alliance of Comprehensive Planners model as my gold standard: A financial planner’s compensation cannot depend on the outcome of any transaction regarding which the client is relying on their counsel.

This strict fiduciary standard prevents the appearance of a conflict of interest, and safeguards the professional relationship from being used as a marketing tool. The model uses a fee calculation formula that takes into account not only assets but also income, complexity of the situation, responsibility undertaken, estimated time and value added.

Our industry is still dominated by structures that support salespeople, not fiduciary advisers. Leaders of the financial industry must step up and adopt standards recognized by other professions if we are to be held in the same high regard.

Bert Whitehead is president of Cambridge Connection Inc., a national RIA with over $500 million under management, and has been a fee-only planner since 1972. In 1995, he founded the non-profit Alliance of Comprehensive Planners, which has trained over 300 financial planners.

An earlier version of this Op-Ed misstated the name of Mr. Whitehead’s training organization. It is the Alliance of Comprehensive Planners, not the Alliance of Comprehensive Advisors.