Posted on April 13, 2015 in ,

Does Your Broker Have a Conflict of Interest?

Is your current broker/dealer legally obligated to act in your best interest?  If your broker/dealer firm doesn’t use the words “fiduciary” or “true investment advisor,” chances are they may have a conflict of interest in advising you on your account.

A long-awaited rule currently being drafted through the Labor Department would try to correct this issue.  In the end, all rules in the financial industry are geared towards helping the consumer.  This rule would require more investment professionals to put their client’s best interests ahead of their own or their employer, also known as “fiduciary duty.” Until this rule is changed, broker/dealers are continuing to sell commission-heavy products to individuals with IRAs who may not necessarily need them.  The Federal Reserve estimated current IRA holdings at $7 trillion, and broker/dealers are continuing to lobby against this rule change to capture some of that market.

Current rules have certain loopholes for broker/dealers that allow incentives for organizations to capture high fees rather than provide high-quality advice.  Basically, some firms won’t sell products that don’t pay them back.  Also, unlike registered investment advisors who are held to the highest fiduciary standards under current law, many broker/dealers don’t have to adhere to such strict standards.  The current law allows broker/dealers to sell “suitable” investments, but suitable is a very broad term and can create a wide range of commissionable products for the broker/dealer.

Most investment companies and mutual funds capitalize on this exclusion.  A broker/dealer that is handsomely paid from a fund will continue to invest client dollars in the fund.  Mutual fund wholesalers do a wonderful job of keeping these brokers happy with incentives and trips regardless of the fund’s true performance after fees.  Most mutual funds sold by broker/dealers are active funds, which charge a higher management fee, compared to passive index funds with lower management fees and better performance.  These active funds typically underperformed similar index funds over a period from the 1990s to 2004, cited from a study through the University of Toronto in 2009.

New rules for IRAs and retirement accounts like 401(k) plans would require an advisor to act as a “fiduciary” when providing investment advice.  The new “fiduciary standard” would restrict conflicts of interest, thus potentially banning commissions from these types of accounts altogether.

What will most likely occur is a new ruling with limited liability on broker/dealers. It would also protect consumers ensuring that broker/dealers follow a higher standard using new policies and procedures to mitigate conflicts.  Do you still want your money managed by someone who falls into this category with potential conflicts of interest, or do you want the peace of mind that the advice you’re given comes from a true fiduciary; one that puts your interest above their own or the interests of their company?  It’s your money, so make an educated decision about who manages your hard-earned dollars.

Source: The New York Times

Next time:  Why saving for retirement is more important than your kid’s college fund.