Beware of the Advising World's Wolf in Sheep's Clothing

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When I first decided to start my own Registered Investment Adviser (RIA) firm, my longtime peer and friend responded incredulously, “You’re going to walk away from all of your trail commissions? Are you crazy?”

Maybe I was crazy, but I was about to embark on a new business journey and had decided to voluntarily leave quite a bit of money lying on the table. I was dropping my Series 7 license, so the trail commissions on eighteen years of mutual fund sales were going to stay with the firm I was leaving. Later that year, I received a Christmas card from the CEO and thought to myself, “he should send me Christmas cards for the rest of my life!”

Not only was my trail commission going away, but without a Series 7 license, I would no longer be eligible to sell securities at all. Securities include things like stocks, bonds, mutual funds, variable annuities, variable life insurance, and non-traded REITs. These can all be high-profit products with large up-front commissions when sold to a customer for the firm. I had moved on from selling securities with any regularity a decade prior, but the relatively small trail commission still represented a relevant revenue stream for me. I had decided to voluntarily cut that revenue stream off upon starting my firm.

Why would I do this?

Under regulations that have been around since just after the Great Depression, marketable securities (stocks, bonds, mutual funds, and their related products) can only be transacted through member firms. Member firms are traditionally members of the stock exchanges, but most retail firms now operate under one Self Regulatory Organization (SRO) called FINRA. FINRA licenses salespeople for its member firms. These salespeople are called Registered Representatives. You may be unfamiliar with the term “Registered Representative” as these representatives generally prefer to call themselves “Advisors” or “Financial Planners” because these titles better validate their consultative sales process.

In contrast, Registered Investment Advisers (usually a firm, not a single person) are regulated differently under a different congressional act called the Investment Advisers Act of 1940. RIA’s are regulated directly by the SEC or their state, depending on size. RIA’s employ Investment Adviser Representatives (IARs) that provide financial advice as a service.

A Recap of the Difference

Registered Representatives sell products and Investment Adviser Representatives provide advice. Who would you rather work with; someone selling you a product for their firm, or a true adviser working for YOU providing advice as a service?

All other things being equal, most of us would likely prefer advice, but unfortunately, it’s not that simple.

First of all, Registered Representatives sell their products using a consultative approach that is difficult to distinguish from real, actual, unbiased advice.

Secondly, since there is little to no regulation regarding what Registered Representatives call themselves, it’s very difficult to distinguish a securities salesperson selling products from an adviser providing advice.

Finally, and this one is the kicker…….A REGISTERED REPRESENTATIVE AND AN INVESTMENT ADVISER REPRESENTATIVE CAN BE THE SAME PERSON! Amazingly, the regulators allow a member firm (or broker/dealer) to also be a Registered Investment Advisory Firm, and their salespeople can hold themselves out as representatives of both.

We call them hat switchers because the regulations allow representatives to take off their salesperson hat and provide advice for a fee, say, in a managed account, then remove their fiduciary advice hat and sell a lucrative, high-commission annuity for the firm. They can switch between hats at any time, multiple times, and even in the same meeting; all without the client having any clue as to what’s going on.

The Trouble with Hat Switchers

Do you think this sounds conflicted? If so, you’re not alone. In recent years there has been a huge wave of money movement from these member firms, like Wells Fargo, Merrill Lynch, UBS, Edward Jones, and LPL to stand-alone RIA firms, like mine, that are generally smaller and not as well known to the investing public.

When I started my RIA firm, I wanted to completely separate myself from many of the industry norms, as the hat switching explained above. Since that time, as more and more money and clients have moved away from the large financial services firms, their salespeople have followed.

A few make the move for the same reasons I did, but most are maintaining their securities licenses in low-key broker/dealer relationships. Beware, this RIA is the same conflicted hat switcher he was when employed at Ameriprise or LPL: a wolf in sheep’s clothing. If you or a loved one is evaluating advisor relationships, here are a few key questions to ask:

  • Are you affiliated with a broker/dealer or brokerage firm?
  • How are you compensated?
  • Do commissions make up any part of your compensation?

You don’t have to understand every nuance of investment regulations, but asking questions like these will help you understand how a financial planner is compensated. I’m also happy to discuss the differences and explain the benefits of Schulz Wealth’s structure in more detail. You can set up a time with me here or pass along my contact information to a friend or family member who may need unbiased financial advice.

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