Be Cautious About Referrals from Your Financial Advisor

by DAVID NOVAK

A mentor once told me, “Life is all about incentives.” Nowhere is this truer than in the investment business.

I recently read a Wall Street Journal article that had my jaw on the floor. It detailed how a major brokerage firm was in the process of changing its compensation structure for its financial advisors. While this is relatively common and not especially noteworthy, it was the details that really grabbed my attention.

As the article stated, “pay could move up or down based not just on revenue, but also based on asset and liability growth, the number of new clients the broker brings in and referrals to various parts of the bank.” In terms of referrals, brokers were required to make two referrals to the bank each month, or their payouts could be reduced up to 2%. The policy was also able to be applied retroactively,
essentially resulting in pay clawbacks from brokers.

This was shocking to me for two reasons. First, all of us are no doubt familiar with a large, well-known bank that found itself in major hot water for its cross-promotional incentives, which resulted in bank employees opening fake accounts for clients, among other abuses. In the wake of that scandal, why another firm would essentially double down on a similar strategy is beyond me.

The other reason this compensation strategy is so astonishing is that it comes in the wake of a years-long effort to implement a fiduciary standard in our industry. We have devoted previous articles to the fiduciary standard, which in a general sense was designed to require financial advisors to put client interests ahead of their own and make things like investment costs and brokerage firms’ payments to recruit advisors much more transparent.

While the implementation of the fiduciary standard is uncertain, this new compensation policy seems pretty clear to me to have zero regard for the
best interests of the client. Just because the bank rolls out its new whiz-bang
product doesn’t mean that advisors should be bound to recommend their
clients devote hard-earned money to it. As one of the firm’s advisors was
quoted in the article, “There’s a fine line between encouraging referrals and
forcing them.”

Consider yourself warned the next time you receive a referral from your advisor at a large brokerage firm. Rather than considering your best interests, he is likely prioritizing his own pocketbook.


David Novak, CFP® is a Certified Financial Planner™ at 
Novak & Powell Financial Services in Pinellas County.
Please note: he is not an attorney and this article
should not be construed as one offering legal advice.
For information about investment decisions and
financial planning, contact him at (727) 451-3440.

 

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