Conflicts of Interest in the Investment World



Conflicts of Interest in Your Portfolio?




What is a conflict of interest?


According to Merriam Webster, a conflict of interest is defined as:  a conflict between the private interests and the official responsibilities of a person in a position of trust.  In my experience in business, those in the legal profession seem to have the best understanding and provide the most disclosure on conflicts of interest.  For example if you hired an attorney to help you resolve a dispute with a company and the attorney had previously represented that company, then the attorney would be “conflicted out” from representing you.  Because the attorney had previously represented the company that you are now involved in a dispute with, he or she would essentially be on both sides of the fence if he/she were to represent you and would not be in a position to provide you with unbiased advice.  Also, the company in question would be extremely displeased that the lawyer they had hired in the past to represent them had now become an adversary on the other side of the table against them!


How do conflicts of interest show up in the world of investments?


If you are a client at a major Wall Street bank/brokerage firm, you are automatically exposed to significant conflicts of interest.  You are a client because you are looking for advice.  However, what you receive may be something very different.  These firms are in the business of selling products and producing a profit.  These products can be in the form of traditional brokerage services or investment advisory services (wrap accounts).  Advice from their salespeople (also called stockbrokers and financial advisors) is typically considered incidental to the sale of products they are promoting or helping you buy.  In other words, broker dealer firms are there to facilitate a transaction on behalf of the customer, with the focus on the transaction and not the advice.  While this may seem confusing, and it is, it gets even more confusing because many of the advisors at these firms are dual registered as both advisors and brokers.  Additionally, they may also be insurance licensed.  If you look closely at the business card of many of today’s stockbrokers, you may see the words:  advisory and brokerage services. Thus, providing objective advice to clients is exceptionally difficult for the salespeople employed at these firms.  The reasons can be attributed to three main factors:


  1. 1.Pressure from management to show certain products to clients (if deemed “suitable”).


  • When I worked at a major firm, I would receive multiple emails, daily, encouraging me to show certain products to clients if I considered the product to be “suitable” for my clients.


  1. 2.Pressure from management to produce revenues (i.e. fees and commissions from client accounts).


  • Managements’ bonuses are tied to many factors; one of those factors is overall commissions and growth in commissions.


  1. 3.Higher and lower commissions and fees on different products.


  • For example, annuities may pay a 7% commission while a structured note only pays 3% and a wrap account pays 2.0%.

In my opinion, while all three factors are bad, reason three has the most influence.  Salespeople at big Wall Street firms are typically not fiduciaries.  They are stockbrokers and thus they merely need to establish suitability for clients and can then sell the client whatever “product” they deem suitable.  So long as the products chosen are suitable, the advisor has done his or her job.  It matters not if the advisor shows and sells a client the most expensive, highest commissioned product as long as the product is suitable.  This type of sales culture produces obvious conflicts of interest.  Is the advisor selling the client products laden with the biggest commissions so he or she can maximize his or her paycheck?  Or is the advisor looking out for the clients best interests and selling them the best products with the cheapest costs & best return opportunities, irrespective of the advisor’s commission? 

To demonstrate just how deep the conflict can be, let’s consider an example.  Suppose that a woman named Sue recently sold her company and has decided to retire.  Her husband, Bob, a recently retired executive, has a pension that provides for most of the couple’s living expenses and they have no debt.    


Hypothetical Clients Sue & Bob


Age:                                                   65 years old

Children:                                             3                     

Grandchildren:                                    4

Total Investable Assets:                      $5.0 million dollars

Net worth:                                          $6.50 million dollars

Pension & Soc Security:                     $100k annually

Goal:                                                  $150k annually in portfolio income


To keep this example simple let’s just focus on what can happen when Sue and Bob walk into the office of a dual registrant, insurance licensed salesperson at traditional Wall Street Brokerage firm. 


Example options A & B (in terms of payment to the stockbroker):


  1. A.The stockbroker shows the clients a $1m variable annuity with a 7% commission and a $4m investment in bonds, limited partnerships & structured notes at an average of 3% commission.


Result is an immediate non-transparent commission of $190,000 to the stockbroker.


  1. B.The stockbroker shows the clients a $5m balanced wrap mutual fund advisory account at a 1% annual fee (paid at .25% quarterly)


Result is an immediate fee of $12,500 to the stockbroker.


You don’t have to be very good at math to see that by changing the product mix, the stockbroker can dial up or dial down how much he or she gets paidDoes the stockbroker want to get paid $190,000 or $12,500 this month?  What a dilemma! To add insult to injury, in many cases, especially with annuities and investment bank products, the commissions are not transparent and difficult to gauge.


This payment scheme should certainly cause you to think twice about where you get financial advice.  Caution should be exercised with dual registrants, especially those who are also insurance licensed.  Do your homework.  Ask lots of questions.  Be critical of anything with a huge prospectus – these investments generally enrich the stockbroker completely at your expense.


There is a better way to receive investment advice – work with a fee-only advisor who is subject to the Investment Advisers Act of 1940 and operates as a fiduciary for clientsA fiduciary has a legal duty to act in the best interest of the beneficiary (client).   The fiduciary duty is a much higher standard than that of a stockbroker (Securities Act of 1934), which only requires suitability be established before products are sold.  A fee-only investment adviser can offer you transparent, easily understandable pricing that is not attached to product sales.  There is a great comfort that comes in knowing your advisor is putting your interests ahead of her interests and not merely selling you products for commission. 




Ethan S. Braid, CFA


HighPass Asset Management

800 – 672 – 7916

About the author of this article.


Ethan S. Braid, CFA is the founder of HighPass Asset Management – an independent, fee-only, registered investment advisory firm with a fiduciary duty to the clients it serves.  Mr. Braid has been passionate about managing client investment portfolios and providing customized financial planning advice since he started working in the investment industry 13 years ago. Mr. Braid earned a BS in Finance from Robert Morris University, an MBA from Cleveland State University and he is also a CFA Charterholder.


Mr. Braid is devoted to being an expert in the field of wealth management for high net worth individuals and families and for many years, has read one book per month on subject areas such as:  estate planning, retirement planning, investment analysis, mergers & acquisitions and behavioural finance.  Mr. Braid also has a passion for business history with a focus on the late 19th & early 20th centuries.


When Mr. Braid is not helping clients, he enjoys: cooking, wine, exercise, his yellow Labrador retriever, fly fishing, hiking, travel, playing guitar and duck hunting.