Is Your Advisor Conflict-free?

Is Your Advisor Conflict-free?

Last weekend, Leonardo DiCaprio finally took home the Oscar for best actor.  While it was his first win, this wasn’t Leo’s first nomination.  In 2007 he was nominated for his role as diamond smuggler Danny Archer in Blood Diamond.  The title “blood diamond” refers to diamonds that were mined in war zones and sold to finance conflicts, reaping profits for warlords and diamond companies across the world.  These atrocities led to the development of the Kimberley Process Certification Scheme, which sought to certify the origin of diamonds so buyers could rest assured the diamonds they purchased were “conflict-free.”

*prepare for pop culture-to-finance leap*

For the past several years there has been a regulatory battle brewing in the personal finance industry regarding whether or not financial advisors should be required to disclose all potential conflicts of interest.  Should investors have the right to know that the advice they receive is conflict-free?


I don’t want to get into the dirty details of the legislation, but I do think it is very important for people to understand the different standards advisors are currently held to.

Who Are the Players?

In one corner of this argument we have advisors who are held to a suitability standard.  In the other corner we have those who uphold a fiduciary standard.

Suitability Standard

Licensed financial advisors who work for broker-dealers are regulated under the Securities Act of 1934.  They are held to the suitability standard and can recommend an investment or product as long as it is suitable given the individual’s circumstances.  Suitability only considers an individual’s income, net worth, investment objectives, risk tolerance and other security holdings; not their best interest.

Advisors working for large retail banks, regional banks, independent broker dealers and boutique banks typically fall under the suitability standard.


Fiduciary Standard

Registered Investment Advisors are regulated by the Investment Advisers Act of 1940 and must adhere to a fiduciary standard of care.  The Act requires that investment advisors act and serve in a client’s best interest with the intent to eliminate, or at least expose, all potential conflicts of interest which might incline an investment advisor – consciously or unconsciously – to render advice which was not in the best interest of their client.

Registered Investment Advisors (RIAs) are held to a fiduciary standard.

Which Standard is Better for Investors?

Ariadne is a registered investment advisor and operates under the fiduciary standard.  While floating this term has become somewhat cliche, I strongly believe this standard is the only way to do business when clients are relying on me for objective, conflict-free advice.


Suitability is an incredibly vague and low standard.  It essentially provides little more direction than “Don’t sell IPOs to grandmothers.”  I believe people deserve to know their advisor has a duty of care and loyalty that the fiduciary standard calls for.

Those not held to a fiduciary standard are rarely required to disclose conflicts of interests that may influence the advice clients receive.  With suitability, the line between salesman and advisor is blurred.  If somebody is paid a commission or receives a kickback for selling a product, the investor should know about it.  The crazy thing is, far too many people don’t understand the ways their advisor makes money and how it may be affecting them.

Here’s a quick example.  In recent years, there has been a positive move in the finance industry away from commission based compensation (although ~50% of the industry is still commission based).  But did you know, that although many advisors who work for banks and brokerages don’t make commission, they receive kickbacks from “product partners.”  These product partners are typically fund companies who pay advisors for using their funds in client portfolios.  Bit of a conflict, no?

For access to Morgan Stanley customers, a fund family must pay the firm at least $250,000, and up to 16 basis points (0.16%) of your investment in its funds.

The other big brokers love you, too. Wells Fargo pays up to 20 basis points for shelf space—a practice called revenue sharing; for UBS, up to 20 basis points; and for Merrill Lynch, a unit of Bank of America, up to 10 basis points. And there are extra payments. For $350,000 to $750,000, fund families can (and do) make special presentations to your broker and headline Morgan Stanley conferences. JPMorgan, Invesco, Goldman Sachs, and DWS Scudder have all done so in hopes that your broker might be predisposed to their funds when building your portfolio.

Many distributors have such legal, pay-to-play arrangements—at Schwab, the annual fee can reach 0.45% of average assets, but the minimum monthly fee doesn’t exceed $2,000 a month, about a tenth of Morgan Stanley’s rate. Smaller platforms charge less: LPL Financial charges up to 15 basis points and Edward Jones up to 7.5.

– Barrons 2014

Is Suitability Defensible?

When I take a stance on an issue I try very hard to understand how those on the other side would defend it.  In all honesty, I cannot come up with one credible argument against the fiduciary standard.  What I hear most often is, “We’re going to lose money going from suitability to fiduciary.”  That’s a shame.  Your clients will be better off though.

Ensuring those who offer financial advice are acting in their client’s best interest is a very worthy goal.  I don’t think most ordinary people can safely navigate the complex financial world when financial salesmen masquerading as “advisors” are trying to sell them garbage products every time they turn a corner.  They need somebody to look out for them and that’s what being a fiduciary means.

Every investor should understand exactly how their advisor gets paid.  If the advisor can’t give you a straight forward explanation and justify their cost, head for the door.

Further Reading

When Fund Companies Pay to Play, So Do You, Barrons

Lessons from an Old World Financial Advisor

Understanding Incentives is Key

Tim Brennan

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