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Ted the advisor is a great guy. He is passionate about taking care of his clients. The only thing he is more passionate about is taking care of his family. Like most advisors, he works on 100% commission – aka “he eats what he kills.” In normal business, you would call Ted a salesman (he gets paid to sell, right?). But in financial services, it’s different.

Ted goes through intensive training designed to mold him into the trusted advisor. Much like the CPA or the Attorney, he works to build trust with clients. Ted believes he is a trusted advisor. Ted wants to be a trusted advisor. But Ted’s advice alone is free and will not help him feed his family. Fortunately, he has clients that need financial products. His clients will buy what he, the trusted advisor, recommends. And that’s when Ted gets paid.

The Conflict

Ted is excited to connect with Susie the successful prospect. She just got a new high paying job and wants to hire an advisor to help her figure all this stuff out. She is super busy, uninformed, and needs lots of help. Ted takes Susie through his process and eventually becomes her trusted advisor. Although she wonders why she never paid him anything directly, she trusts him and doesn’t worry about it.

Eventually, one of the financial products Ted sells comes up as a natural recommendation. His firm pushes the XYZ product. All his peers sell it. It’s got some sweet features. It’s pretty pricey. And then there is also this ABC product. Nobody in his office really sells it but it always seems to do really well. Coincidentally, XYZ pays Ted $5,000 each time he sells it, and ABC pays $0.

Ted’s family is running low on money and things are getting stressful at the house. An extra $5,000 sure would be nice right now. In fact, he really needs it. His wife keeps asking when he expects to get paid again. He tells her not to worry – he’s got good things in the works. Ted is feeling the pinch!

Back to work and Ted is analyzing XYZ vs. ABC. XYZ has a few features that ABC doesn’t, but he is having trouble with the fact that ABC always seems to do better in the long run AND the fact that XYZ is way more expensive for the client. He asks his fellow advisors for their opinion. They tell him ABC has had a good stretch and they are due for a bad turn. “You pay for what you get”, they say. Unanimously, all are in favor of XYZ.

So then Ted asks the product experts at his firm for their opinions. They reinforce the positive qualities of XYZ over ABC. Although Ted still feels a bit uneasy, he ultimately decides on XYZ and takes that $5,000 home to his family. Would ABC have been better for the client? Maybe. Probably. But everyone around him is doing it, XYZ is still a pretty good product, and he has bills to pay. His family is counting on him. So Susie takes his advice without question – he is the trusted advisor, after all.

This is a daily battle for most financial advisors. I’ve been there myself and it’s really no fun. In fact, it was a driving factor behind my decision to start my own firm. I wanted to ALWAYS do what was best for my clients. I eventually realized that these types of conflicts clouded my judgement and made the distinction between GOOD advice and the BEST advice extremely difficult. Unfortunately, my firm’s model is extremely rare. But I expect that will change in the coming years.

This conflict is especially important for consumers to understand as they work with financial advisors. Although consumer education and awareness are improving, it is still lacking overall. My goal is to explain how this came to be, how it’s changing, and what you should know as consumers when working with financial advisors.

How Did We Get Here?

Regulations in the 1940’s established up RIA’s (Registered Investment Advisors) and Broker Dealers (and the SEC was established to regulate).

RIA’s are investment firms that advise and manage wealth. As fiduciaries, they MUST act in the BEST interest of clients. They would be held to a standard similar to others providing advice (such as CPAs, Attorneys, or Doctors). Disclosure of potential conflicts and compensation is/was required.

Broker Dealers are firms that distribute financial products. They are NOT required to act in the best interests of clients. They would be held to a standard similar to that of your general salespeople. Conflicts were assumed and compensation disclosure wasn’t required.

RIA’s typically managed pensions and the investments of wealthy families, and Broker Dealers distributed capital to the world. This worked well until the 1970’s.

1970’s – Now

401ks begin replacing pensions and giving more control to the individual investors. The market for financial advice shifts from primarily wealthy clients, to clients of all levels of wealth. Discounted brokerage firms make stockbrokers irrelevant, and new regulations make it easier for banks and insurance companies to become broker dealers and/or RIAs.

Broker Dealers begin to realize that consumers want advisors, not stock brokers – they are in danger of failure and try to adjust to these needs in a way that still remains profitable. They adjust by telling consumers they are now financial “advisors,” while still continuing to rely on the distribution of products for a profit. They develop massive training programs to teach brokers to become the trusted advisor.

The SEC doesn’t enforce the 1940’s rule which opens up the flood gates for everybody to call themselves financial advisors, further muddying the water.

Broker Dealers continue to rely on making money by distributing products, even though these products slowly become commoditized. As product commoditization occurs, commissions make the firm’s products less and less competitive. People continue to follow the advice of the “trusted advisor” even though it involves purchasing sub-par products.

Regulators begin looking into the business practices of the broker dealers and acknowledge the major conflicts, but nothing really changes.


Broker Dealers have huge sales forces very openly describing themselves as providers of financial advice. They still operate under the “rules” of the old school Broker Dealer sales model and aren’t required to act in their client’s best interest. This is a very clear violation of the rules, however, the SEC continues not to do anything about it.

Broker dealers put massive incentives in place to push their “trusted advisors” to continue recommending their sub-par products. Advisors are starting to catch onto this and some are bailing out and changing to the RIA model because of the higher professional standards and reduced conflicts of interest. And the consumers, in general, remain mostly clueless about all of this.

Why Did This Occur?

The purpose of the Broker Dealer has always been to distribute products. But business is changing. Products are becoming commoditized and people want advice. Essentially, Broker Dealers saw an opportunity to continue to exist as product distributors disguised as financial advisors and the SEC let it happen.

How It’s Changing – The New Rule

Well, the SEC still hasn’t done anything about it. It’s really interesting to see the lobby force they face from the massive broker dealer industry any time they propose regulation to change this. Recently, though, the Department of Labor stepped up and began addressing the issue. And just this last month they released details on a new rule that would go into effect in 2017. The new rule would require ALL advisors managing or advising on retirement accounts (IRA, 401k, etc) to act in the BEST interest of clients.

Summary Of The Rule

Essentially, this rule requires all retirement advisors and firms to put their client’s best interest first. No more selling XYZ instead of ABC in the example we used in the beginning. Firms dealing with retirement accounts are being required to adopt procedures designed to mitigate conflicts of interest. These firms must also clearly disclose all conflicts (like hidden fees, backdoor payments, kickbacks, etc), and certain conflicting financial incentives related to retirement accounts were banned.

Challenges For Advisors And Consumers

As a result of operating in my model, I charge clients directly (to get rid of conflicts), and that is the only compensation I receive. This is sometimes surprising to people who are used to working with the “free advisor”.

It is especially difficult to convey this point when people don’t understand these conflicts of interest or believe that their trusted advisor is immune to such conflicts. It’s also challenging to explain how all the hidden fees associated with the “free advisor” work, and how they’re negatively affecting the client. It’s not a level playing field with financial advisors, and the consumers feel the brunt of this.

What You Should Know

If you seek advice, make sure your advisor is operating under an RIA (instead of a broker-dealer). Many advisors working for broker dealers are great people and give great advice. But you should know they operate in an extremely conflicted environment brought on by their firm. Know that some RIA’s are also broker dealers. Ideally, you work with an RIA that’s strictly an RIA. This increases your chances of receiving less conflicted advice.

Be prepared for changes coming from your advisor in the next year (especially if they are tied to a broker-dealer). If you stick with your broker, you should pay attention to the disclosure documents coming down the pipe. They should be much more transparent than in the past.

There is still a loophole where advisors can get around all this. If the advisor strictly advises non-retirement plans, none of this applies. So watch out for advisors uncomfortably pushing non-retirement plans in the next few years.

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