Meyer Wilson

Recovering Losses Caused By Investment Misconduct

How Individual Investors Can Guard Against Excessive Fees and Self-Serving Brokers

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 misleading.

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 sharing."

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 of intentions.”

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 your interests.

For more information, watch Attorney Courtney Werning's video below on how brokers get paid:

Categories: Investment Fraud, News

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