Why You Should Consider an Investment Adviser vs. A Traditional Broker
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Over the last several days (4/30/05 – 5/3/05), the Dallas Morning News wrote a four part series called “Trade Secrets” which sought to expose some of the gross inadequacies of the brokerage business. I thought the article made some very salient points but failed to emphasize the real problem with securities brokers.
In my view, it all comes down to conflicts of interest. The more conflicts that exist the greater the chance of unethical behavior.
I learned about the reality of conflicts very early in my professional career. Out of college, I started with Arthur Anderson LLP (I assume you can see where this is going.) On one of my first gigs, I uncovered a gross accounting error by a local oil and gas firm. Basically, they had land on their books that they never planned to drill and should have been written off. A fairly black and white situation compared to other potential accounting issues.
The partner signed off on the books despite the companies unwillingness to write off the worthless land. There reluctance was due to the fact that writing off the land would have resulted in everyone in the company losing their annual bonus. I was shocked by our firm’s willingness to sign off on such an obvious accounting error. So I asked my manager how this could be allowed and his simple response was “if we don’t sign off on it, someone else will and the partner can’t afford to lose this audit.”
There was the real problem. While the beneficiaries of our work should have been the shareholders but the Management Team was writing our checks. We were paid by Management, but we were suppose to be working for the shareholders.
While it’s easy for us to judge the auditors of Enron, Worldcom and Global Crossing, the fact is that if those auditors would have stood up to the management of those companies, they would have lost the audit in a heartbeat. And if you were the Audit Partner responsible for losing Enron, you would have been immediately excused from the company. I am not making excuses for those auditors. What they did was wrong and it cost millions of people, millions of dollars. But the real culprit was the system that allowed for the conflicts of interest.
Once I became a securities broker, I was immediately exposed to the many conflicts of interest in the brokerage industry. My first job as a broker was for Allstate Financial Services. I started with them in ’02 and due to a fortuitous call by my business partner, we had all our clients invested in cash. None of our clients lost money during the worst bear market since 1929. We thought that Management would be ecstatic about the job we were doing for the client but quite the opposite was true.
In reality, they were irate because holding cash didn’t generate any commissions or production credit. In April of 2003 – near the beginning of the current bull market - we invested all our clients in various mutual funds that were not on Allstate’s “Preferred Mutual Fund Family” List (Nearly every brokerage firm was engaged by Mutual Fund families which provided additional fees and kickbacks in order to be on their Preferred Fund Family list. The SEC has since cracked down on these arrangements.) Shortly after investing our clients, we were given an ultimatum; either invest in Allstate’s Variable Annuity and the Preferred Mutual Funds or resign. Since we knew that Allstate’s VA and the preferred Mutual Funds were all crap (pardon the expression) and given that we highly value sleeping at night, we decided to resign.
Again, a conflict existed because the people cutting our checks were not the people we served. I was working for the client but I was being paid by the brokerage firm. Getting clients to invest in the firm’s proprietary products was far more profitable than the mutual funds that we recommended. It was in Allstate’s short-term best interest for us to push their products regardless of what was in the client’s long-term best interest.
Upon leaving Allstate, I interviewed with several of the large wirehouses and brokerage firms. Their recruiting pitch sounded like a broken record. I quickly concluded that none of these firms were willing to overcome the conflicts of interest inherent to the securities business to put their clients’ needs first.
That is when I decided that the only way for an Investment Professional to align his or her interest with the client was to be become an independent Registered Investment Adviser. It is the only means of providing services sans conflict of interest because I am paid by the person that I serve – the client. In the Wednesday article by the Dallas Morning News, they provide a quick comparison between brokers and investment advisers. I advise checking it out at
http://www.dallasnews.com/sharedcontent/dws/bus/stories/DN-brokersday4_03bus.ART.State.Edition1.36fab56.html
