How is it possible for an RIA not to work in your best interests?

I have always been a big fan of Socrates and the Socratic method of arriving at decisions. Socrates would always ask questions of people to try and get them to justify their positions. In all cases, Socrates would act less informed and question his pupil repeatedly to teach them that they were actually ill informed and the position that they have taken was without merit. Most times these people took the advice of someone else and did not really have a position of their own. With this in mind, let us ask some questions to see if we can arrive at the answer of how it is possible for an RIA (registered investment adviser) not to work in your best interests.

I have to wonder about some of these big registered investment adviser firms out there who are getting other registered investment advisers to outsource their investment management to their mega firm. There are several of these big independent firms that manage billions of dollars of other investment advisers' clients. The thing that goes against the grain for me is all of the extra fees involved.

I was looking at the Form ADV 2A and 2A Appendix of a large $14 billion dollar firm which is growing like a weed and attracting a lot of registered investment adviser money. In effect, it is the feeder fund concept that several registered investment advisers got into hot water about in regard to Bernie Madoff. They referred their clients to Bernie Madoff and did not do their due diligence. That is another story altogether. Today, I wanted to forget about the feeder fund aspect for a moment and just focus on the fees.

This big $14 billion dollar registered investment adviser firm has several different programs available, such as mutual fund asset allocation, ETF asset allocation, strategic ETF asset allocation and so on. Their fees are as high as 1% on some of these accounts for smaller investors with less than $250,000. Then, you have to add whatever the adviser who referred the client to them charges on top of that figure which is usually in the 1% - 1.5% or more range. Do not forget the actual expenses of the investments themselves. According to the Investment Company Institute's latest FactBook, the average equity mutual fund has an expense ratio of 0.99%.

So, if the big mega firm charges 1%, perhaps the adviser goes easy on you and only charges 1%, then you are in the mutual fund portfolio that charges another approximate 1% in expenses. It doesn't take a smart fellow to figure out that this is about 3% a year. I've actually seen worse than 3% believe it or not.

It is great for the adviser who refers his client to this big fourteen billion dollar outsourcing firm. The adviser no longer has to mess with a bunch of back office headaches and can probably cut his overhead. Further, it probably frees up more of the adviser's time. They do not have to worry about how they are going to invest their client's money any more. They hired someone to take that off their plate. Did you notice how beneficial it was for the adviser?

Conversely though, how beneficial is it for the client? Could another adviser not offer a similar mutual fund asset allocation portfolio that they manage for 1 - 1.5% instead of outsourcing to the big mega firm? It would seem to me that the client would reap the benefits of a 1% savings if this was the case.

What about if the adviser managed a portfolio of ETF's on behalf of the client? ETF's have lower expenses and may actually save the client another 0.50 to 0.75% in expenses if the adviser managed these ETF's on behalf of the client, instead of outsourcing it to a mutual fund portfolio at the big 14 billion dollar mega firm.

But, there is a problem by going with a local adviser who picks the investments his or herself. What happens to the client's money if the adviser is injured or disabled? This obviously presents a problem. Sometimes this is the advisers justification for going to the big mega adviser. This does make some sense, however I beg to question if there are other big mega advisers who perhaps charge a more reasonable fee for outsourcing money management to them? The answer is yes. I can think of one in particular that charges a maximum of 0.41% for their money management expertise and that fee grades down from there depending on the total assets managed. They are a big mega money manager who does an excellent job. So, with this alternative, you may be able to get a client's portfolio of ETF's to be roughly around 1.5% to 1.75% all in. This alternative would save the client of the other big fourteen billion dollar mega firm about 1.25 to 1.5% a year, would it not?

So when the title of this blog asks how can an RIA not work in your best interests, then I have provided an answer. When an RIA knows full well that he can find a comparable mega firm for significantly less per year, but chooses to still use the higher priced mega firm, then this is a undisclosed conflict of interest. Unless of course, they explain that there are other mega firms who may charge lower fees in their disclosure documents and you as a client know this and agree to this in writing.

Also, if an adviser can manage the money themselves for their clients instead of outsourcing it, then they will save the clients money in fees. Granted a backup plan is necessary if something were to happen to the adviser, but this can be planned like anything else. A local adviser should have a repeatable process of investing that most any other adviser can look at and implement. (We do.) If not, then you probably do not want to do business with that adviser. Especially if they are just shooting from the hip.

So, the bottom line is when you are advised to go with a big fourteen billion dollar mega firm, you might want to shop around for other mega firms if this is the direction you want to go in. You could save yourself a lot in fees and get a comparable service, if not better.

If you want a big mega firm managing your money for a reasonable fee, then let me know. I can help. Of course, you will receive full disclosure in advance. This offer is only available for clients in states that we are licensed in or maintain an exemption from licensing. Contact me at rick@marianfs.com for full details.

A Fiduciary Standard Watered Down

There is no doubt that the fiduciary standard for anyone who renders investment advice would be a good thing. However, in the Obama Administration's White Paper, on page 72 to be exact, there is a statement that concerns me greatly. It reads:

prohibiting certain conflicts of interests and sales practices that are contrary to the interests of investors.

You can read it here: http://www.financialstability.gov/docs/regs/FinalReport_web.pdf

What bothers me is the word "certain" in that statement. My interpretation, based on my experience, would mean that selling from broker/dealer inventory would be one of the conflicts of interest that they are referring to. Broker dealers currently are allowed to buy stocks of various companies and keep them in inventory. They typically buy companies that are widely held. When their customers want to buy that same stock, then the broker/dealers sell them the stock from their inventory. The broker/dealer may have bought the stock at a lower price and sold it from inventory to the client at a higher price. If they do not have the stock at a lower price, then they let the customer buy it outside of their inventory. The do not normally sell their inventory positions at a loss. It is easier for them to let the client buy it from the exchanges. Obviously, they stand to make more money by selling from inventory.

I believe that broker/dealers would gladly give up selling from inventory for the ability to be a fiduciary under the forthcoming watered down rules. What we will see, in regard to the fiduciary standard, is that broker/dealers and their FINRA registered representatives will be able to continue doing business as usual. They will only have to disclose their conflicts of interest, then they can continue selling commission based products instead of fee only investment advice in a client's best interest.

The tactic being pushed to the media from Mary Shapiro, SEC Chairman is that broker/dealers and investment adviser's services are "substantially identical" as far as the public is concerned.

See this article from Financial Planning's web site for comments from Mary Shapiro:
http://www.financial-planning.com/news/schapiro-fiduciary-standard-sec-2662329-1.html?ET=financialplanning:e447:1882177a:&st=email

This could not be further from the truth. Besides, the fact that the consumer is not able to distinguish between a FINRA registered representative and an investment adviser is because of the "solely incidential" rule. The solely incidental rule, sometimes called the "Merrill Lynch" rule is the rule that opened the flood gates allowing FINRA registered representatives the ability to wear two hats. When they want to sell products, they slide the brokerage agreement in front of the client, all the while neglecting to mention any conflicts of interest. By wearing the FINRA hat, they do not have to disclose conflicts of interest. They can also wear the hat of an investment adviser. This is why they are known as dually registered (wearing the more profitable FINRA hat at the time of the transaction, of course.)

You rarely see a dually registered FINRA sales person as a 100% fee only investment adviser. They have to hit their sales quotas to keep their offices. Most FINRA broker/dealers have as their sales quotas upwards of $250,000 in revenue per year and higher. If you do the math, then you will see that in order to produce $250,000 in revenue as a 100% fee only advisor for the FINRA broker/dealer, then this means that this FINRA registered representative would have to bring in net new assets each and every year of $16,666,666.67. This is using 1.5% as the annual fee for the calculation. ($16,666,666.67 x 1.5% = $250,000.) Let me assure you, very few FINRA registered representatives can do this each and every year. I can promise you that FINRA broker/dealers are not going to lower their yearly sales quotas.

As a result, my educated guess is that we will see a watered down fiduciary standard that allows FINRA registered representatives to still wear two hats and still "pretend" to do things in a client's best interest. It will be even worse if FINRA itself is allowed to be the regulator of registered investment advisers. That would be the nail in the coffin for consumers of financial services. Wasn't the goal here to protect consumers?

You can read more about it in my book, Keep Your Assets. Take My Advice.