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Discounters’ Incentives May Be News to Clients

By Murray ColemanThomas Coyle January 11, 2018

Some discount brokerages may be tricking customers into thinking they’re getting disinterested advice when their advisors are actually incentivized to steer clients into more expensive products, according to the Wall Street Journal.

When brokerages such as Schwab, Fidelity Investments and TD Ameritrade say their advisors don’t get commissions on sales, they create the perception among consumers that their advice is impartial, the Journal contends, echoing the views of former employees of these firms.

“You’re omitting certain facts that the client would probably appreciate understanding before you launch into a sales pitch on why you think this product is better,” is how Jeff Weeks, a former branch manager for Fidelity, describes verbal disclosure practices at his old firm.

Weeks is now a principal of ATX Portfolio Advisors in Austin, Texas.

Another ex-Fidelity advisor, Sean Gray, gets more granular with the Journal. “If I was sitting in front of someone and there were 20 different avenues we could choose from,” he tells the newspaper. “And we could choose Fidelity’s managed accounts — that is what paid us more — in my mind, that created a conflict.”

Gray, now a wealth manager with Redwood Wealth Management in Alpharetta, Ga., further tells the Journal this practice is “one of the reasons” he left Fidelity in 2016.

Sales incentives at Fidelity can help FAs reach “Achiever” status, resulting in bonuses worth “tens of thousands of dollars a year,” the Journal writes. At Schwab, discount-channel advisors vie for awards such as trips to places like Florida and Hawaii; for advisors, performance is measured partly by sales volume in certain products.

Meanwhile discount brokerages tell the Journal they disclose how their advisors are paid on their website but don’t require staffers to reiterate that information verbally to customers.

And the discounters — several in business since the mid-1970s to provide lower-cost securities trades, and still seen as low-cost alternatives to full-service brokerages like Morgan Stanley and Merrill Lynch — “have extensive policies and procedures designed to make sure their representatives, often called financial consultants, act in clients’ interests and don’t unduly push any product or service,” the Journal says.

As Andrew Tappe, executive in Fidelity’s personal investing unit, tells the newspaper, “The internal controls we have in place flag” FAs who operate improperly.

And Schwab’s branch chief Joe Vietri tells the Journal, “We never want a financial consultant to feel they have to sell one product over another from a compensation standpoint. Our whole business is rooted in trust and in always doing what’s in the best interest of the client.”

In particular, former discount-brokerage employees tell the Journal they were urged to highlight relatively expensive managed accounts, even when lower-cost products might have met their needs.

“When new clients come to us with retail accounts at these firms, their service level tends to be very low and their portfolios are full of proprietary funds.”
James Gambaccini
Acorn Financial Services

Retail investors may be surprised to discover many large brokerages heavily incentivize advisors to clear their own products, but it’s no secret to independent wealth managers — most of whom deal with discount brokerages as custody providers and investment-platform sponsors.

“When new clients come to us with retail accounts at these firms, their service level tends to be very low and their portfolios are full of proprietary funds,” James Gambaccini, managing partner of Acorn Financial Services in Reston, Va., tells FA-IQ. His firm manages about $860 million.

Gambacinni’s independent RIA deals mainly in fee-only products, but when it needs to conduct transactions though a broker-dealer, it works with Atlanta-based Strategic Financial Alliance. Acorn also uses TD Ameritrade, Schwab, Fidelity and Pershing as custodians.

In most cases, Gambaccini’s clients notice a greater spreading of their wealth once Acorn’s advisors finish reallocating assets to a broader range of investment options, he tells FA-IQ. “It’s certainly noticeable to people that we aren’t filling their portfolios with one company’s funds,” Gambaccini says. “And we make a point in the investment planning process to explain how greater diversification, not less, can help them over time.”

Evan Schmidt of Schmidt Financial Group in suburban Seattle tells FA-IQ that reducing potential conflicts of interest when aligning with custodians should be a top priority for advisors.

Schmidt Financial Group, an independent RIA with $400 million under management, makes a point of reviewing such issues as part of its ongoing due diligence on custodians, he says.

James Gambaccini

Schmidt and his colleagues use Pershing — at root an institutional clearing firm rather than a discount brokerage, and a firm not mentioned in the Journal article — as their primary custodian. “We’ve been very deliberate in forming any outside partnerships to keep our business at arm’s length from trailing commissions and things like 12b-1 fees,” he says.

A trailing commission is money a client pays to an advisor each year that client owns an investment. A 12b-1 fee is a marketing fee on a mutual fund.

Schmidt believes extra brokerage incentives not made clear to investors can only fuel more growth in the independent advisory marketplace. “A big reason why so much money is moving to fee-only independents is due to all of the conflicts of interests and opaque incentives people are finding within the brokerage industry,” he says.