Private Sector: Know thy financial adviser

Don't pick a person or firm before asking the right questions

Tuesday, February 10, 2004

What should you know before selecting a financial advisory firm? What should you consider before seeking investment guidance? With the recent "pay to play" or revenue-sharing practices between fund companies and brokerage firms coming right on the heels of the scandals in the fund industry including market timing and late trading, the investment industry is having a rocky start to 2004.

With daily headlines announcing the improprieties of the fund and financial advisory indwustries, how are investors supposed to choose an adviser and trust his/her advice?

This new era brings about an increased responsibility for both the investor and the financial advisory firm. It is your money and your future. Are you ready to do your research?

Below are some suggestions as to how to begin investigating financial advisory firms before you make a decision that will bring you peace of mind. The four main areas you should understand completely before working with a financial advisory firm include its procedures regarding objectivity, research, proprietary products and firm access.

Objectivity

Objectivity is essential to the advisory process, and financial advisers cannot be objective when their compensation and lifestyle are dependent on certain funds being sold. This creates an inherent conflict between the adviser and the investor. That is why it is imperative to ask how the financial advisers are compensated.

Is it through commission? If so consider this: The funds for which they receive a commission or a higher commission will undoubtedly be the funds they recommend to you even if the funds' compositions and histories do not best meet your needs.

Is it through revenue sharing? Perhaps the firm owns no proprietary products but sells a heavy concentration of a few companies' funds to its clients. Ask why. Are the mutual fund companies "paying to play" or offering the financial firm part of their revenues if they promise to promote and sell their fund above all others?

Is there a bonus structure in place? If so, is the amount contingent upon certain favored company funds sold? Amounts of funds sold? You have a right to know.

With all the industry deals being made, it is becoming harder to decide if your financial adviser is recommending a fund because it will result in long-term results for your financial goals or if he/she is looking forward to a bigger bonus or commission check. You deserve to know, and through proposed regulations of the Securities and Exchange Commission, identifying financial firms offering objective advice will be less complicated.

Regulators who have thus far been consumed with recent mutual fund company transgressions will now focus on revenue-sharing practices between financial firms and fund companies and commission-based payment structures. The Securities and Exchange Commission is leaning toward a full disclosure policy by which all financial planning and advisory firms will be mandated to report how they pay their consultants.

Additionally, under existing SEC rules, brokers are technically required to disclose revenue-sharing payments. Industry lawyers, however, have maintained that this disclosure statement can be made in a fund's lengthy prospectus. SEC is proposing a rule that would require mutual fund companies to spell out the compensation and incentive methods of advisers not only in the fund prospectus but also in confirmation statements received by investors. In addition, firms and funds may have to disclose this information in all sales and promotional materials.

Research

OK, you know about the scandals. Do you know the research methods your current or prospective financial adviser is taking to ensure your money will not be invested in tainted funds?

As we begin a new year on the heels of industry improprieties, financial advisory firms should be employing appropriate research methods to discern the focus of investment companies. Likewise, as an investor, you assume part of the responsibility by demanding these research processes be in place at your financial firm.

Many advisory firms are satisfied to limit their research to quantitative past performance numbers -- they are readily available, easy to relate to and easy to sell. However, past performance numbers in and of themselves lack predictive value. Consider asking these questions of your current or prospective financial adviser:

Is your firm diligently researching fund companies you recommend to clients?

Do you employ a well-reputed research company to investigate the ethical views and values of funds you use in client portfolios?

Do you research key personnel at the investment product companies you use in client portfolios?

Do you request fund company policy details on market timing, IPO allocations and procedures put in place to ensure compliance?

How many of the fund companies identified to date in the scandal have you used in client accounts?

What part of your research process changed after the scandals broke?

In today's industry climate, you deserve to know how your financial advisory firm is preparing for tomorrow.

Proprietary products

As discussed before, proprietary products, by their very nature, encourage fund favoritism. It just makes sense that if a firm owns investment products then those are the products that firm will favor in recommendations to clients. Ask your current or prospective financial adviser:

Does this firm own investment products?

In how many of your client portfolios are your proprietary products represented as opposed to other investment vehicles?

Are financial advisers compensated in any way for selling your firm's investment products?

How do you ensure objectivity and variation of investment products sold?

You deserve to receive unbiased, objective advice. Ask the right questions.

Firm access

As a client, you need to know what resources are available to you. For example, some firms take a group approach to client management while others designate only one individual. Sometimes you will be given one point of contact but will have access to a wide range of professionals. You need to decide what is the best management structure for you. Some questions to ask before deciding upon a financial advisory firm:

Will your financial advisor be the sole manager of your assets and investments?

Does your current or prospective firm offer a team-management approach?

How many experts will weigh in on the financial management strategies for your life goals?

How are these employees qualified?

Are they financial advisors? Advisers? Insurance personnel? Investment analysts?

How often will your portfolio and management strategies be reviewed and by how many professionals?

You deserve to know the history of those handling your future.

It is your money. It took you a long time to accumulate your assets. Don't rush into a decision about who will be managing these assets. Consider the entire firm, not just your financial advisor or the person with whom you meet, before making a decision. Understand its structure and values. Review its policies on researching investment products and ensuring comprehensive objective financial advice. It is your future -- you need to ask the right questions.

As why you need a financial adviser at all, in the '90s everyone was making money with his investments. In today's much more uncertain marketplace, it is imperative that individuals seek professional financial planning advice from experienced, trusted professionals who use their expertise to guide you toward reaching your financial goals.