The Conflict Question

Call it the third rail of the wealth business: conflict of interest.

It’s the mantra independent registered investment advisors constantly evoke when attempting to distinguish themselves from their brokerage firm brethren: we are fee-based, don’t sell proprietary products and are therefore pure as the virgin snow. We have no conflict of interests. None. Zero.

But could this endlessly repeated claim turn out be an Achilles Heel for the swelling number of RIAs who are so sure their business model is the Next Big Thing?

This elephant in the room was broached at last week’s MarketCounsel Summit inLas Vegaswhen Knut Rostad of the Institute for the Fiduciary Standard publicly asked Elliot Weissbluth, chief executive of High Tower Advisors, if he really had “zero” conflicts of interest.

Weissbluth replied that if a business is making money from a client in two different business lines, there’s a conflict. HighTower, he continued, has “structured out the business conflicts” and does not get paid twice.

But that hardly ends the debate. There is, in fact, a growing chorus of critics who are pointing out potential conflicts, or, at the least, deficiencies in the standard RIA business model of getting paid by a fee based on a percentage of assets under management.

During the summer, Charles Ellis, author of  the investing classic “Winning the Loser’s Game: Timeless Strategies for Successful Investing”  argued in the Financial Analysts Journal  that investment management fees “should really be based on what investors are getting in the returns that managers produce.”

Clients  who take a car in for repairs are unlikely to allow a mechanic to charge them merely for just keeping the car in his garage, Ellis argues, so why would a client who can mach the market’s performance  by buying  an index fund for merely five basis points pay an advisor much more to simply do the same thing?

According to Bert Whitehead, founder of the Alliance of Cambridge Advisors, conflicts are “inherent” in assets under management pricing.

AUM compensation poses conflicts, Whitehead contended in an Investment News op-ed, when wealth managers weigh in on decisions that could directly affect their own revenues, such as advising clients on whether or not to invest in real estate or buy an annuity; make a sizable charitable contribution or roll over a 401(k) from an employer’s fund manger (especially if costs are equivalent or lower) to their own firm.

While conflicts in the old commission model were “right there in your face to see,” says industry guru Chip Roame, managing partner of Tiburon Strategic Advisors, “nearly any model you develop has conflicts of interest, [including] fee models. The most obvious is when a client wants to withdraw funds from you and pay off his mortgage: do you say yes or no?”

Then there’s the extremely sensitive matter of what wealth managers might be getting from third-party fund managers and what is being disclosed, a conflict of interest if there ever was one.

Are financial advisors getting in-kind compensation such as research support or other benefits?  Are they using an outsourced product platform that may have other conflict issues? Are they getting some sort of payment or “retrocession deals” that are hidden or embedded costs within a product’s fees? Or are they getting old-fashioned under-the-table kickbacks, more politely know as “finder’s fees?”

The lack of transparency regarding public disclosure of fee data and portfolio performance was highlighted in an analysis of the websites of 40 of the world’s largest wealth managers done last year by the Swiss-based research firm MyPrivateBanking.

Only 18 per cent of the wealth managers offered precise, quantitative data on fees, the study found, and just eight per cent published at least a three-year track record of the performance of their discretionary accounts.

As for the advice part of the “value proposition,” Andrew Haigney, managing director at EL CAP Investment Consultants, has argued in Registered Rep that while clients are paying for investment advice every day, “the advice rarely changes. It’s akin to hiring an attorney to write a simple will and keeping the attorney on permanent retainer, paying him a yearly percentage of the value of your estate.”

Of course, RIAs can always charge clients flat retainer fees, or by the hour or even, as Ellis suggests, based on performance. But few do, and from a business point of view, have good reasons not to. Independent advisors will also have plenty of valid counter arguments against charges of conflicts of interest.

But that doesn’t mean that none exist. And it won’t stop a new breed of competitors from exploiting any vulnerability RIAs may have.

In fact, at the most recent Tiburon CEO Summit inNew Yorkthis spring, Roame warned industry leaders not to be too complacent. A whole new crop of Internet-based firms such as Betterment, Goalgami, Personal Capital and Wealth Front are on the horizon, he said,  with impressive offerings that have great appeal to a generation that have grown up on the Web.

These new competitors are leading with ETF and DFA offerings, and offering state of the art simplicity and transparency when it comes to investment management.

With no conflicts of interests, unlike their competitors, they will undoubtedly claim.



259 thoughts on “The Conflict Question

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