Increasing life expectancies and the shifting of responsibility for retirement income to the employee have combined to make financial planning one of the fastest growing professions in the United States during the past five years.
The industry is not yet well-regulated, however, and just about anyone can claim to offer financial planning or financial advice — and many do. Unfortunately, too many financial advisers out there today are really just paid sales people who are more interested in furthering the interests of the investment product producers who pay them than they are in advising their customers.
When it comes to regulated activity, financial advice may be categorized as either investment related or non-investment related. Investment advice generally covers activity that is speculative in nature and involves some risk of principal loss. Non-investment-related advice includes non-risky activity such as budgeting and financial analysis.
Investment advisers come in two forms: registered investment advisers (RIA) and their representatives, or broker-dealers and their representatives. Large RIA firms are regulated by the Securities and Exchange Commission, while smaller firms answer to state agencies under the auspices of SEC. What they have in common is the privilege to provide financial advice to clients in exchange for fees. and a corresponding fiduciary obligation to act in the best interests of their clients at all times. In addition, RIAs are required to disclose to their clients, in a written statement, all conflicts of interest before rendering any financial advice. In other words, RIAs work for and are responsible to protect the interests of their clients.
Broker-dealers — think stockbrokers — on the other hand, are regulated by the National Association of Securities Dealers (NASD). This registration permits these firms and their representatives, referred to as registered representatives, or reps, to sell securities in exchange for commissions. Registered reps typically work in three-party relationships, where they provide recommendations to clients but are employed by and paid for these recommendations by producers of investment products when sales are realized. Broker-dealers and their representatives have no fiduciary obligation to their customers, and are usually under a contractual obligation to advance the interests of their employers ahead of those of their customers. Conflict of interest is inherent in the relationship between the stockbroker and the investor, although this conflict need not be disclosed.
In addition to the regulation of investment advice and sales activity, an adviser may be subject to state insurance sales or advisory regulation. These state regulations can be coincident with investment regulation. For example, the sale of an insurance policy that is also considered an investment product, such as variable life insurance or a variable annuity contract, requires that the adviser carry both NASD registration and the appropriate insurance sales license, and so is regulated by both the NASD and the state. In this case, since commissions — and not client fees — are paid, neither the activity nor the adviser are subject to fiduciary standards, and the customer’s interest may be subordinate to those of the adviser or the insurance company.
Is all of this confusing? You bet it is. According to a recent study conducted by TD Waterhouse, 58 percent of investors incorrectly believed that both stockbrokers and RIAs have a responsibility to act in their best interests. Also, 63 percent of investors mistakenly assumed that both stockbrokers and RIAs are required to disclose all conflicts of interests before providing financial advice.
When it comes to financial advice, confusion is the rule, and many financial advisers are ready and willing to capitalize on this confusion. Many of the largest financial services firms actively support regulation that, not coincidentally, perpetuates investor confusion. A case in point is the so-called “Merrill Lynch rule,” a regulatory exception allowing broker-dealers to provide financial advice to their customers in exchange for fees without registering as investment advisers and accepting fiduciary responsibility held by RIAs.
Even the most prestigious trademark in the world of financial advice, Certified Financial Planner, or CFP, offers little real protection. While CFP licensure indicates a high degree of competence and a commitment to standards or ethical practice, it does not create fiduciary obligation to the client. A stockbroker who is also a CFP licensee may legally act to fulfill a sales quota at the expense of his client or fail to disclose conflicts of interest without violating regulatory standards.
All of this is important for federal employees, since the landscape of the financial services industry is changing. Stockbrokers are finding it increasingly difficult to generate commissions from securities sales. In order to survive, they are looking for more creative ways to generate revenue. One major target of interest is the massive value of assets held in Thrift Savings Plan accounts. Many of the major financial services firms have begun, or are planning, to target the TSP accounts of retiring feds for rollover to IRAs from which the firms and their reps will subsequently be able to draw additional revenue. Once in a retail IRA, these funds are subject to a variety of commission and other charges, some of which require careful research to uncover and understand.
When it comes to financial advice, bad advice is often worse than no advice at all — and unsolicited advice is, more often than not, bad advice. Before taking any advice, understand the rules of the game, do your homework, and when in doubt, keep your money in the TSP, where low costs and no-fee transactions give you a decided advantage over the long run.
Written by Mike Miles
For the Federal Times
Publication March 13, 2006