By: David Meyer
In an increasingly complicated and volatile investment environment, individual
investors have a greater need than ever to protect their hard-earned money
against investment industry sales practices which can be both opaque and
The advice investors receive from financial advisors and planners about which
mutual funds to purchase may be tainted by a little-known practice called "revenue
Revenue sharing comprises the cash payments made by mutual fund companies
to selling agents, who promote their proprietary mutual funds to investors.
Fund companies pay brokers, advisors and financial planners revenue sharing
that historically ranges from 0.25% to 1.5% of invested assets
per year to promote their funds over the competition. Revenue-sharing payments
vary depending on a mutual fund's share class.
While this long-standing practice is legal, many financial professionals
commonly fail to tell their clients why they are recommending one very
similar fund over another, even though the revenue-sharing practice is
printed in the fund prospectus. This failure to verbally disclose is often
tied directly to the amount of revenue sharing the broker directly receives
from the fund company to promote its funds. I believe the failure to fully
disclose revenue sharing relationships creates an ethical
conflict of interest.
The issue of revenue sharing in 401(k) plans was addressed by the Department
of Labor's (DOL) when it enacted
fee disclosure regulations that went into effect in 2012, largely to shine a light on 401(k) plan
fees and expenses and to limit revenue sharing. While disclosure is required
with other types of investment accounts, revenue sharing is not limited.
Pushing the Fiduciary Standard
In another long-awaited action to protect individual investors, the Securities
and Exchange Commission recommended in 2011 that anyone advising retail
investors adhere to a universal standard of
fiduciary duty. The
SEC's proposed fiduciary standard recommends that brokers "act in the best interest of the customer
without regard to the financial or other interest of the broker, dealer,
or investment adviser providing the advice." However, no final rule
enactment decisions have been made.
Currently, registered investment advisers (RIAs) must adhere to a fiduciary
duty, which requires that they act in the best interest of their clients
and disclose all material conflicts of interest. Although broker-dealers
act as a fiduciary on a case-by-case basis, the minimum standard under
which they operate is lower —the suitability rule requires only
that they ensure that investments conform to a client's needs, timeline
and risk appetite.
Groups representing brokers have expressed concern that a universal fiduciary
duty standard would undermine the broker-dealer business model (which
is based on sales commissions), raise costs, and deny affordable investment
help to middle-income clients. Brokers also assert that their industry
is already subject to tough and consistent regulation by
Financial Industry Regulatory Authority (FINRA), which examines their operations more often than the SEC and state oversight
boards review RIAs.
Beware of "Objective" Advice
These arguments may seem obscure and confusing to investors who were led
to believe they were receiving objective counsel. However, for quite a
while, stockbrokers and financial planners have made it common practice
to force underwritten stocks and mutual funds on investors. These investments
are underwritten by their own companies which means the brokers get more money.
Because brokers receive additional compensation for investing clients in
these vehicles, investors cannot assume that the advice they are getting
is objective or that brokers are not putting their personal financial
benefit ahead of their clients' interests.
To justify these practices, stockbrokers claim that these apparent conflicts
of interests are actually included in documents and disclosed to investors.
On the contrary, according to Knut A. Rostad who is the chairman of the
Committee for the Fiduciary Standard, “that disclosure is, at best,
insufficient for addressing conflicts of interest. Indeed, there is convincing
evidence that disclosures are frequently confusing and misleading for
investors, even when made under the best circumstances with the purest
To help the brokers even further, a large portion of investors do not even
read – or attempt to read and do not understand – these disclosure
documents. Brokers often intentionally bury these disclosures deep in
the documentation in hopes that investors never stumble upon it.
What Investors Should Do
Whether or not the SEC decides to implement new standards for broker-dealers,
investors who want unbiased advice from their brokers may benefit by taking
the following steps:
- Wondering if your broker is getting a commission or other incentives off
the investment they are selling you? Just ask! Don’t be afraid to
confront your financial advisor and ask them about what and how much they
would get from your investment.
- Ask your broker to recommend some alternative investments. It is a good
idea to find out if there are similar investments out there that would
be suitable for your investment needs. Most investments on the market
today are not unique, so ask your broker if there might be a better option for you.
- It may be beneficial to ask your broker if he or she gets revenue from
mutual funds you purchased. If he or she is receiving revenue, you have
every right to ask for a portion of this. It is because of your purchase
that there is even any revenue, so you might be entitled to it.
- Ask your advisor if he or she considers revenue sharing a conflict of interest.
Ask how your need for objective advice can be balanced against the receipt
of revenue-sharing payments. (Note that even independent financial planners
take revenue-sharing money, so do not assume that your rep is objective
unless you specifically ask about revenue-sharing deals.)
- Another way advisors can make money at your expense is by excessive trading.
If you see a lot of buying and selling in your account and don't understand
why it's taking place, you should ask for an explanation. You are
paying commissions on every trade, and you may also end up with a higher
tax bill if you have a lot of short-term gains.
- If you don't get acceptable answers that put your financial interests
ahead of the advisor's need to receive fees, it is time to act. Find
a new rep or transfer your assets to a new no-load fund company. Do not
remain with a rep who does not put your interests first.
Whichever type of financial professional you have (broker, RIA, or financial
planner), remain vigilant about protecting your own interests and getting
the best objective advice possible. Don't rely on the SEC, brokerage
firms, mutual fund companies or other large financial institutions to protect
For more information, watch Attorney Courtney Werning's video below
on how brokers get paid: