The Banality of Bad Behavior in the Financial Planning Business
My eye was caught by a headline in registeredrep.com: “When Bad Firms Happen to Good Advisors.”
Some well-regarded experienced financial planners, the story said, signed on with the most recent mini-Madoff–Sir Allen Stanford and his Stanford Financial Group. Then they got burned.
Interesting story, I thought; even really good, ethical planners got sucked in, it seemed. Here is Bob Hogue, a Houston planner looking to move from Bank of New York:
Stanford offered service providers he knew well: Lockwood Financial’s platform of money managers, with which he had already built his business on, top-notch client and data management technology provided by Odyssey Financial Technologies (a leading European vendor), and a custodial relationship with Pershing, the custodian he was already using. Adding to the appeal, Pershing guaranteed easy transition of client data, no change in account numbers, if Hogue and the three FAs in his Dallas office moved to Stanford. “There weren’t any other firms offering all that,” says Hogue. He and the three other Bank of New York financial advisors joined Stanford’s Dallas office in November, 2007.
There was all the hooplah, too—yacht cruises, fabulous food, beautiful facilities. But Hogue et al weren’t seduced by that.
Or were they?
What Passes for Good Behavior in the Financial Planning Business
Stanford advisors got incentives for selling the CDs, including a 1 percent commission and, depending on the size of the sale, eligibility for a 1 percent trailing fee for each year on the CD’s contract, as well as trips and bonuses and invitations to the annual sales meeting, awarded based on how much money an advisor funneled into Stanford International Bank. [italics mine]
Wait a minute. What do CDs yield– – 3-4%? At those rates, commissions would eat up half the owner’s yield. We cry “usury” at credit card charges in the 20% range–how about 40-50%? And on a CD?
And, if these CDs were in fact yielding higher—7%, 8%–then they were far outside the normal risk range of the usual buyers of CDs.
What kind of a financial planner rakes 50% off the top of a “conservative” product that his customer could buy for nothing at an FDIC-insured bank? Or sells a highly risky product to people looking for conservation of wealth?
According to registeredrep.com, apparently the answer is “good advisors.”
50% fees on CDs? Good? In what dictionary? Let’s get real.
What Good Behavior in Financial Planning Should Look Like
A financial planner friend tells me that when she gets calls from wholesalers pitching products for her to sell, after they describe their new product, their next line is typically “let me tell you how much commission you can make on this.” When she says, ‘never mind that, what’s the yield for the customer?’ the response is usually, ‘uh, hang on a minute, let me look that up.’
That’s the normal pitch. Wholesalers are not stupid. This means: the average financial planner is not in it for you, they’re in it for themselves; that’s why the wholesalers lead with commissions, not benefits to clients.
The same planner tells me she often finds clients who have been put 100% into a variable annuity product, for example, when they have near-term needs for retirement or college expenses. “It makes no sense,” she says. Until you check out how the previous planner made 5%, 6%, 7% commissions up front by selling them this concoction. Then it makes a ton of sense. For the advisor.
Earth to registeredrep.com–bad advisors do this, not “good” advisors! This is the banality of evil. The incessant trickle-down of selfish, anti-customer, opaque behavior eventually makes routine, daily ripoffs get termed “good.”
Madoff and Stanford are anomalies. But the daily, garden-variety, grinding low-ethics, customer-hustling, devious behavior is all too common. See, for example, Michael Zhuang’s comment on a blogpost of just last week.
Can Ethical Behavior Be Increased in Financial Planning?
There are many ethical, customer-focused, honest, trustworthy planners. I know some of them, they do exist. They are as good professionals as in any industry. And there are seedier, greedier industries out there.
But so what? Since when is “he’s worse” an excuse for unethical behavior? Just last month the SEC charged a former President of NAPFA, one of the industry’s two professional associations, with kickbacks. (Well, at least he wasn’t a Madoff….)
What can you do as a consumer? Search hard for the good planners. Don’t let yourself get snow-jobbed. Ask a lot of questions. Do not be intimidated. This is still a caveat emptor business. So caveat.
But–if you run a financial planning firm, you can make a real difference. Dare to be above average. Look at client-focused behavior in other industries. Talk to highly successful firms who are known for straight dealing. You know who they are in your business–emulate them. Read up on trust. Conduct focus groups. Talk to your critics. Steep yourself in the literature on how short-term anti-customer behavior kills long term shareholder wealth. Dare to do good!
Call me naïve, but I still believe that a critical mass of people in the financial planning business know the difference between today’s norm of selfish, short-term anti-client mindset and the longer-term client-focused strategy that is possible, and that in fact creates loyalty and mutual profitability.
If I’m right about that, then it just takes some concerted courage by a few to speak up and start making a difference. And if you’re still reading, maybe you resemble that remark.
Great article…. let me reassure you that there are planners out here with a practice focused on the client’s best interest. We’re just the quiet ones who don’t like to toot our own horns. But maybe we need to start.
Good for you Erin, and I know there are lots more like you out there. I think you’re right, the horn-tooters out there tend to give horn-tooting a bad name, and that client-centric folks need to speak up more. Not in terms of hyping and advertising, but in terms of speaking out in industry forums about the need for better practices. I encourage you to speak your mind.
Thanks for taking the time to comment, and keep up the good work.
I lump some of this into an issue of structural compliance. You need to focus on whether the compensation and motives of the parties are aligned. You need to be aware of the misalignment and deal with it.
One example I wrote about was sub-prime lending at Countrywide. Loan officers were paid more for originating sub-prime loans than conventional loans. [My post: Did Compliance Programs Fail During the Financial Industry Meltdown?] After all, sub-prime loans generated more revenue. The structural compliance failure was not taking into account the risk of the transaction as part of the compensation.
For financial planners, it is a focus on short term gain over long term success that leads to bad decisions. Of course, this is true for many business decision failures. There is also the failure on the part of the client to recognize that there is a disconnect. If the adviser is getting paid more for short term transactions instead of long term value creation, they are going to folow the money.
Even the most ethical can be lured by a product that pays a good commission and has long term value creation. That was the success of Stanford. Good commission for an apparently good product.
Good companies will recognize where there are structural weaknesses, monitor activity and deal with transgressions.
Thanks for commenting. You know a lot about this business and I value your opinions. I also completely agree with you that short-term orientation is very much at the root of things wrong here.
But I feel there’s something not quite right in your suggestion that the solution therefore lies with alignment of long term and short term incentives. I think you’re missing the whole realm of the ethical–the question is not that incentives need to be aligned–the question is, ‘why aren’t the people in charge doing anything to align them?’
No argument that good management will not incent good people to do bad things. And therefore in a mechanical way, the "answer" is "change the incentives." But that’s like saying "take away the machine guns from children." Themore relevant question is, "who handed out machine guns to kids in the first place?"
Angelo Mozilo is the one who put those crazy incentives in place at Countrywide, right? Saying that he shouldn’t have done so is sort of obvious; the question is, why did he, and how do we prevent that happening in future? Misaligned ncentives are just the final tools by which unethical leaders do their dirty work.
By focusing on the alignment debate, we risk reducing all ethical issues to mere behavioral discussions–how we get the rats to move the other way in the maze by altering the amounts and types of cheese.
The trick is not to motivate the rats–the trick is what do you do about the lack of ethics on the part of the rat-master.
A live example. I linked in the post above to the article where the SEC is suing the former President of NAPFA for having accepted kickbacks. In that same article, the current President of NAPFA is quoted. What a great opportunity for the current President to say, "We deeply deplore those actions. This is not worthy of our profession. We reject the attitudes and beliefs that led to those behaviors, and I assure you we will not countenance, and will aggressively root out, such behaviors in the industry under my tenure."
Well, you’d be disappointed; the current President of NAPFA is quoted in the article only as saying basically, "well, at least he wasn’t as bad as Madoff." I’m not kidding; go read it yourself.
That’s what we need to be talking about. Where’s the leadership, where’s the high ground, where’s the ethical behavior that prevents such stupid, short-term, misaligned endeavors being undertaken? It’s not about alignment, it’s about finding people who can recognize when they’ve got an alignment problem, and then do something about it.
Or so it seems to me.
You are right. The key is identifying where things are out of alignment and doing something about it.
But that is a two-step process, first you need to recognize the misalignment. I think many of the problems in the financial meltdown came from not recognizing the misalignment. I am sure there were also plenty who saw the misalignment and chose not to do anything about it.
Failing to recognize the mis-alignment is a business failure. Failing to do anything meaningful about the misalignment when you have the power to do so is an ethical lapse. Obviously, purposefully causing a knowing misalignment is an also an ethical failure.
I think our disagreement (as small as it is) is that I believe the failures are much more because of the failure to recognize the misalignment than the ethical lapse of not doing anything about the misalignment.
To circle back to the concept of trust, I think that to develop trust you need to focus on finding those misalignments and fixing them. If they are not fixable, you need to let your customer/client know about the potential for conflict and let them make informed decisions.
Charlie, for your readers who want to perform their own due diligence when chosing a financial advisor, the NAPFA Financial Planning Diagnostic provides a list of questions to ask a prospective financial advisor. (Yes, the same NAPFA you mention in your article above; the irony isn’t lost on me and I’m sure it won’t be lost on you.) But the list itself is very good. A good advisor should sail through the answers; I would expect anyone less than a sociopath who was a crooked advisor would reveal themselves by their truthful answers, by balking at the questions, or by their discomfort in answering with lies.
If you take a close read, the subtext of the questions lines up very well with your article.
Credit where credit is due: I believe I discovered the list some time ago through Getting Clients / Keeping Clients, the blog of US/Canada financial advisor Dan Richards.
Consumers should ask any financial planner, "Will you serve as my fiduciary? Will you look out for my interests above all else?" Any decent financial planner will answer with an emphatic, "Yes" and use those great questions as an opening for a candid discussion of compensation, methods, procedures, and press the potential client to disclose any special requirements that the planner needs to be aware of to, in fact, serve the client better than he could ever serve himself.
Thanks for another good article, Charlie!
Since you’re unlikely to beat the market, what value am I getting from you, the financial planner, that is worth your fees?
I’m not sure that’s a fair question for people to ask financial planners. For one thing, it assumes the sole asset management role is to beat the market. If you’re 50 with 3 kids about to go off to college, or 62 and about to retire, you may very well not want your planner to manage your assets in a way that matches the market–you may want to be a lot less risky and liquid in the coming few years.
Secondly, a lot of planners do a lot more than just manage assets. In fact, particularly in recent times, if all a planner is offering is asset management, they’re having to face questions even tougher than yours.
But there are good answers: the planning function itself is one. How to help people determine their risk profiles, hence their portfolios vis a vis risk and the expected market return.
More broadly, good planners will have a competent point of view on broader issues, ranging from insurance needs and health care plans to broader issues of life planning, which helps people articulate not just how to accumulate or spend wealth, but why and when to do so, in line with accomplishing broader personal goals.
Put it this way: a good planner will have a ton of answers to your question; a poorer one will probably get peeved at you.
Come to think of it, maybe it’s not such a bad question after all.
I never worked as a financial planner, but I took a chunk of the training at one point. As you say, it’s a good question. Since you can’t beat the market (unless you’re one of very few people, I do know a couple people who do it regularly, but getting them to manage your money is damn near impossible), what value do you add? The risk management, balancing side is part of it. Tax can be part of it (usually in the sense of income shifting), and so on. And as you say, if they get angry, well that means they’re not particularly good, because they don’t know what value they add…
Suppose you are looking for a financial planner to manage your business and want to avoid unethical behaviour. In that case, this page has all the information you need to find a financial advisor which has good action and is ethical.