By Mark Smith
Learn more about Mark on NerdWallet’s Ask an Advisor
I am proud to be registered as an investment advisor and working under a fiduciary standard. This means I have to put my clients’ best interest first. That is a good standard under which to operate and jives quite well with the Golden Rule, which has been around quite a bit longer than the fiduciary standard of my profession.
Part of this duty is to avoid conflicts of interest with clients. If a conflict of interest is unavoidable, it needs to be disclosed. Again, a good standard so that everything is done in the light of day. However, sometimes things that are determined to be conflicts (or potential conflicts) and therefore disclosed, are, in my view, not necessarily conflicts.
The best example of this concerns my Form ADV. This is a disclosure document that all investment advisors must give to new clients which describes various aspects of the advisor’s business model. If an investment advisor is also a licensed insurance agent as I am, it is considered a conflict of interest and it is disclosed in the ADV. Whenever I review my ADV and see that disclosure, I always question if this is a conflict of interest in reality.
Though most of my revenue is derived from fees for financial planning and investment advisory, I have maintained my insurance license for several reasons. First, clients will sometimes need risk management products such as life insurance and long term care insurance as determined by their financial plan. They can then use someone else or myself to place such products. It seems to me that if they go to another insurance agent who is not likely to know and/or keep up with the client’s planning situation, then there is likely to be less coordination between the planning and the product(s). Also, I tend to get somewhat separated from this aspect of their planning since I don’t have direct access to the information, creating a less than optimal situation for the client.
Second, I find that maintaining my insurance license, including the continuing education requirements, keeps me more abreast of product and industry changes. I am therefore in a better position to know what is available, what is changing, etc. in order to offer better advice.
The conflict that regulators are trying to disclose is mainly surrounding compensation. For example, say a client has $500,000 of investment assets to put under my advisement. If I put all the assets in an investment account to which I apply my fee schedule as an investment advisor, there is no “conflict.” However, if I also recommend and sell them life insurance to protect against the financial risk of premature death, then there is a conflict. I don’t see that as a conflict.
A more direct conflict involving an insurance product is the sale of annuities. From the facts above, say I recommend the client take $100,000 from their assets and buy an annuity because their financial plan shows doing so will produce a higher probability of a successful outcome. I now have a $400,000 account from which I am being paid my advisory fee and I was paid a commission for placing the annuity. Again, the “conflict” is that I am now being paid commission for selling a product instead of giving advice for assets under management. Since commissions are usually paid in a lump sum on such sales, this could bias my recommendation so that I can be paid more up front. This is true and therefore needs to be disclosed. However, there is more to the story regarding conflicts that must be understood.
Let’s now say I am NOT licensed to sell insurance products, but the plan from above indicates the purchase of an annuity. Now I have a conflict in that if I recommend the client remove $100,000 from my management, I will lose the compensation associated with those dollars. I submit this is just as big a “conflict” as being licensed and then selling the product. In fact, I believe it is a larger conflict.
(Side note: Another common conflict in my business that does not explicitly require disclosure is recommending mortgage options. Say the above client wants to buy a new house. They can finance a large part of it and put less down, which requires less funds to be withdrawn from their investments. Or they can put down more. See the conflict? The way I resolve this is (1) tell them I have a conflict, (2) show them how various scenarios play out in their financial plan, (3) discuss the non-financial aspects of debt, and then (4) let them decide.)
Let me remind you at this point that under either “annuity” scenario above, I am required to act in the best interest of the client because of my fiduciary duty as an investment advisor. However, I believe it is best to operate in a business model which best allows me to (1) meet my fiduciary obligation and (2) receive compensation for the ongoing service being rendered. If I refer the client to another agent, the client is in the same position financially, but I am being compensated less since the amount has been removed from my management. Also, as already noted, this introduces yet another advisor and tends to put a barrier between me and the client since I don’t have direct access to that part of the client’s financial picture.
There are many (endless?) scenarios where conflicts can arise and regulated disclosure can only go so far to address this issue. Therefore, I recommend the following three points when selecting an advisor to work with, all of which have to do with trust. You should be able to trust the advisor’s:
- Ethics – you trust them to do the right thing and to work in your best interest.
- Competence – you trust that the advisor is educated and experienced to deliver sound advice.
- Business structure – you trust the advisor’s operating model is structured in a way that best allows him/her to meet their obligation to work in your best interest, stay informed, and be compensated for their work.
The first two can usually be dealt with by asking for referrals from other trusted advisors and friends. The third is quite a bit harder for most consumers to assess. Therefore, this article has focused on this third element of trust that has, in my opinion, received much less attention than the first two and is inconsistently dealt with by regulators.