August 20, 2015
August 20, 2015
At the recommendation of a colleague, I recently met with an insurance broker who specializes in bundling personal insurance coverage for high-net-worth individuals. At the end of what I felt was an informative meeting, he asked me what our revenue sharing requirements were for clients sent his company’s direction. I was pleased to clarify that BOS only receives revenue from clients in exchange for advice. After a short pause, he seemed somewhat relieved to hear it – either out of respect for our approach or an unexpected escape from fee negotiations.
BOS and registered investment adviser (RIA) firms like it were built under the provisions of the Investment Advisers Act of 1940, which requires fiduciary standards of care and transparent disclosure of conflicts of interest, whether actual or perceived. At BOS, we believe that as fiduciaries, we cannot deliver advice while metaphorically standing in our client’s shoes if encumbered by dueling incentives. We strive to eliminate all potential conflicts of interest but carefully disclose, in our Form ADV, potential conflicts of interest for our clients’ review. Such standards differ from the regulatory framework applicable to investment banks and broker-dealers (collectively, broker-dealers), which are generally regulated by the U.S. Securities & Exchange Commission (SEC) and overseen by the Financial Industry Regulatory Authority (FINRA) and required to make recommendations that are “suitable,” a relatively low bar from a legal perspective. While regulators and some politicians have expressed interest in applying higher standards of care to broker-dealers, which still manage the overwhelming majority of global investment assets, the broker-dealers continue to lobby against such proposals tenaciously with long running success.
In defense of broker-dealers, conflicts of interest are a tricky matter. Clients might understandably be upset to learn that their advisor received a kickback or some other form of compensation in exchange for recommending a certain investment product, arranging a specific type of loan, or introducing one insurance broker over another. But such cozy relationships, often operating under the same corporate roof, can also be convenient and less time consuming for the customer. One phone call, followed by comparatively less paperwork because the bank “knows you” can be attractive to a busy client with a keen desire to get things done.
Such conflicts are also not especially uncommon. As consumers, we have to navigate potential conflicts all the time, whether we choose to be aware of them or not. When our doctor prescribes us medication, our mechanic says the engine needs a new valve, or our contractor recommends an electrician he’s worked with in the past, we are generally unaware of the underlying relationships and whether or not the pill manufacturer, the parts dealer, or the electrician are kicking back cash or other favors. We can ask probing questions, demand alternatives, or get a second opinion; but we typically revert to trusting the advisor upon whom we rely for advice concerning something outside of our expertise.
Clients of broker-dealers face this same dynamic, and must trust the advisor to deliver prudent advice despite embedded organizational conflicts. Such reliance on the ethics and behavior of the manager over the employer is sensible but can run into hurdles. One such hurdle is the corporate structure, formed by those with voting power and influence, who may, collectively, force poor behavior onto the otherwise ethical employee. Another could be moral culpability as a result of personal financial stress, corporate indoctrination, or otherwise.
At BOS, we strive to avoid conflicts, actual or perceived. We’re persuaded to think that conflicts of interest could impair the quality of our advice or compromise our fiduciary duties, so we have established policies and procedures to guide us in identifying and navigating potential conflicts. And while we believe that our employees will act ethically and in a manner consistent with our core values, we embrace the regulation and enforcement provided by the SEC to help ensure accountability.
The decision to work with a broker-dealer over an RIA is not necessarily a bad one. What’s important, in our view, is for investors to understand the differences and implicit trade-offs in order to make an informed choice. Our clients chose BOS for varying reasons, but we suspect our transparency regarding conflicts and our fiduciary approach were two important factors. We’d guess that future clients will be no different.