Broker-Dealers vs. Fee-Only Investment Advisors

The highly regarded investment firm Edward Jones suffered a hit to its reputation back in 2004, when it was challenged by the SEC for a failure to disclose important conflicts of interest. Issues surrounding conflicts of interest still trouble the company, and other broker-dealers in the industry. This post will explore why Edward Jones and other brokers continue to fail to act in the best interest of their clients, and why fee-only advisors are a superior choice for anyone looking for a financial advisor.

Back in 2004, Edward Jones agreed, without admitting any wrongdoing, to a $75 million regulatory settlement with the SEC for failing to disclose that it received tens of millions of dollars from preferred mutual fund partners each year on top of commissions and other fees. Today, Edward Jones continues to receive revenue-sharing payments from its preferred mutual fund partners, but it provides a detailed disclosure of those payments on its website. The company earned $98.1 million in revenue-sharing payments from mutual funds and another $54.1 million from insurance product partners in 2011. That was a significant percentage of its overall $4.6 billion in revenue during the period.

The broker-dealer advisory model is one in which financial advisors provide advice and assistance to customers in return for commissions, fees, and other payments that result from financial transactions. Edward Jones argues that this model benefits ordinary investors by offering them counsel and guidance that is free, unless there is a transaction. If potential conflicts are disclosed, Edward Jones states that solves any issues of conflict. Unfortunately, that is not so. Financial advisors at Edward Jones are primarily compensated by commissions. They get paid by selling customers financial products (e.g. mutual funds, insurance) that generate commission revenue. Most financial advisors in the broker-dealer industry are paid on a roughly similar model. Unfortunately, academic research in behavioral ethics is clear that “when people have a vested interest in seeing a problem in a certain manner, they are no longer capable of objectivity.”

Many investors would be surprised to know that most financial professionals who are paid to offer advice are not legally required to give their best advice. Only a fee-only advisor, with a fiduciary duty is required to act in the investor’s best interest. There are two basic classes of financial professions who will offer advice on investments: “brokers,” like Edward Jones and numerous other financial services firms, who are paid on commission to execute trades, and “investment advisors,” who derive their revenue only from charging the client a fee. Different rules govern how they’re allowed to treat clients. Fiduciary investment advisors have an ongoing legal obligation to act in the best interest of clients, whereas brokers are only required to deal fairly with clients.

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Adding to the confusion, many professionals are registered as both brokers and investment advisors, in one instance acting with a fiduciary duty and in another, not. Furthering the confusion, brokers often market themselves ambiguously as “financial advisors” or “financial consultants.” According to an SEC-commissioned study, 59% of investors are under the impression that professionals with those designations are required to act in their client’s best interest. (A separate survey by the Consumer Federation of America found that 76% of investors mistakenly believe that professionals who call themselves “financial advisors” are required to put their clients first.) Just as troubling, only 34% of investors knew that such professionals typically receive commissions based on the fees they generate through their recommendations.

There is a simple way you can protect yourself from these industry-pervasive conflicts of interest. When searching for an advisor, look only for advisors that designate themselves “fee only”. For instance, in the San Francisco Bay Area (where I have my practice), there are fee-only firms in almost every major city (San Francisco, San Jose, Oakland, Walnut Creek, San Rafael). Also, when you’re interviewing the investment firm, make sure to ask if the advisor you work with will always have a fiduciary duty to you. It wouldn’t hurt to also look at the long-term portfolio performance of the advisor. Advisors that work in the client’s best interest often have a better track record of performance, because their trades aren’t clouded by motives other than meeting the client’s long-term objectives.

4 Comments
  1. Interesting discussion. I have had a broker for years, but I never asked about whether he is compensated by anyone else. I’ll have to check and see if he is fee-only.

  2. Great topic, very good article to read. I love the site.

  3. I’ve been looking at investment firms in the San Francisco Bay Area and I’m trying to decide between a broker and a fee-only financial adviser. This article was really helpful. Thanks.

  4. I’m glad you found this topic helpful. One of the goals of this blog is to help people in the Bay Area (and beyond) compare and contrast the different types of investment advisors available; particularly, helping people better understand the fee-only investment advisor system.

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