Imagine you are going to attend an important social event. You need to look your best so you head to your favorite store to buy the right outfit. You select a few items to try on and as you come out of the dressing room to look in a mirror, a salesperson approaches you gushing about how great you look. They offer you a few more items that you “would look great in.”
Now, instead of shopping by yourself, imagine you take a close friend. This friend is fashionable and honest – the type of friend who doesn’t just tell you what you want to hear. Do these jeans make me look fat? Yes. Does my new haircut look good? Sorry, no. It’s not that this friend is mean – they just know you well enough to be honest, even if it’s not what you want to hear.
In this scenario, whose interests most align with your own, the salesperson’s or your friend’s? It’s obvious when you are buying everyday items.
A Salesperson’s Interests
To be sure, the salesperson may very well be a perfectly honest, ethical person. He may tell you an item of clothing doesn’t look good on you, even when it would earn him a higher commission. There is nothing wrong with trying to sell clothes, and shoppers often need someone to assist them with purchases. However, shoppers should understand (and most do), that the salesperson has an interest in selling you clothes. And that interest may naturally conflict with your interest in getting the clothes best suited to you.
In contrast, your friend that goes with you to shop has no interest in the clothes you purchase. She doesn’t stand to gain based on the clothes you choose. Her only real interest is what’s best for you.
Registered Investment Advisers and Broker-Dealers
In the field of investment advice, investors have two main choices, registered investment advisers (RIAs) or broker-dealers (BDs), though there are also some entities that are registered as both. These two types of entities operate and earn fees differently. Generally speaking, RIAs work on a fee-based model, where they are compensated for their services by charging a fee based on the amount of client assets they manage. So, an RIA’s income will increase as a client’s assets increase, and vice versa.
In contrast, BDs operate on a commission-based model, where they earn a fee based on the products a client purchases. Their fees do not necessarily increase as a client’s assets increase. Certain BDs even set “proprietary product minimums” where their advisers have to sell a certain amount of their employer’s products. Putting it in terms of the analogy above, it would be like a clothing store requiring its employees to sell a certain amount of a store-brand product, even when other comparable products of different brands are available at the store and better suited to your needs.
An RIA can operate more like the friend in the above example because the RIA has no interest in selling you certain products. On the other hand, BDs are more akin to the salesperson because they are trying to sell you products and earn commissions from them. Of course, the BD’s commission-based model isn’t necessarily a bad thing. And to be fair, RIAs can face conflicts of interest, too. Nevertheless, investors should be aware of who they’re dealing with and where their interests lie.
A Specific Example: Wells Fargo
In July 2018, the Wall Street Journal reported that four former Wells Fargo advisors sent the Justice Department a letter alleging “long-standing problems” in the bank’s wealth management business. Specifically, the Journal reported that “lofty sales goals” encouraged advisors to push “clients into products that generated additional fees” and to move client assets “between different products or investing platforms to generate more revenue and bigger bonuses.” Though Wells Fargo (and other BDs) offered fee-based accounts to minimize the incentive to sell products, several former advisors felt pressured to push “unnecessary financial planning fees on clients.” In many ways, Well Fargo’s conduct is a natural outflow of its business structure. When any BD’s revenue is generated by selling products, the BD will naturally try to promote and incentivize sales. But no investor should have to worry that his or her retirement assets are being pushed into certain products to earn an “adviser” a bigger bonus.
Who (or What) Is Your Adviser?
When choosing an investment adviser, an investor should ask if the adviser is structured as an RIA, a BD, or both. This structure is important because it determines how the investor pays the adviser and what legal duties the adviser owes the investor. Much of the confusion surrounding fiduciary responsibility and rules (the DoL’s now-defunct Fiduciary Rule and the SEC’s Regulation Best Interest) stems from the use of the term “investment adviser.”
The term “adviser” connotes a role of trust and disinterested advice, but such is not always the case. Returning briefly to our clothes-shopping example illustrates this principle. If a clothing store started calling its salespeople “clothing advisers,” most people would still understand that they are trying to sell you clothes, not give you the best advice. For a variety of reasons, the same has not been true in the field of investment advice. Many investors assume that their “investment adviser” has only their interests in mind, but where the adviser is an agent for a BD, he may also have his own interest in selling certain products.
Analysis: RIA Is the Superior Model Because It Best Aligns Interests
As an independent RIA, we at Black Cypress view ourselves as the trusted friend in our fictional scenario above. We don’t make money by selling products to clients, and our interests are the same as our clients’. We feel that the RIA approach to investment advice is superior primarily because both adviser and investor have the same goal: growing the investor’s assets. Because we have no products to sell, we can analyze our clients’ financial situation and make investment decisions based on that objective analysis, not sales goals.
Investors also benefit from an advisory relationship with us because RIAs are held to a higher fiduciary standard than BDs. We believe that with all the recent focus on fiduciaries, the old era of investment advisers as salesmen is dying, and a new era of fee-only advice is beginning. While BDs can make recommendations that are simply “suitable” for clients, as an RIA we must “act in the best interests” of our clients and “provide investment advice in our clients’ best interests.” That is, we cannot consider our interests when making recommendations to clients. Our firm’s mission statement reflects these values. Since our founding, we have strived to put our clients first and to equip them for success. And because our interests are aligned with our clients’, their success is also our success.