Ethical Standards You Should Expect From Financial Advisors

Investopedia

"Ethics is one of the great differentiators between independent advisors," says Robert Stammers, director of investor education at the CFA Institute. "Unlike the medical profession, financial advisors do not have the equivalent of a Hippocratic oath that defines how they should approach client management." So how can investors find an ethical financial advisor? In this article, we'll describe how you can choose wisely if you know which entity regulates your advisor, which professional designations to look for, the warning signs of a bad advisor and the signs of an advisor who will put your interests first.

Know Which Entity Regulates Your Advisor
The two regulatory organizations that oversee financial services are the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC), explains Alan Moore, a fee-only financial planner for Serenity Financial Consulting, which has offices in Bozeman, Mont. and Milwaukee, Wis. "FINRA regulates the sale of financial products, such as insurance policies, annuities and mutual funds; the SEC regulates the giving of financial advice," he says.

Financial advisors regulated by FINRA are required to use the "suitability standard." These advisors are bound to sell the best product for you based on your answers to questions about your age, other investments, annual income, liquid net worth, investment objectives, investment experience, time horizon, risk tolerance and other factors.

The suitability standard means that advisors "are permitted to sell a product based on the size of the commission they will receive or based on bonuses paid by their company, just as long as the product seems suitable," Moore says. "FINRA-registered advisors actually have a fiduciary duty to their company, not their customer."

"Imagine going to a doctor and they recommend you take a drug, only to find out that they get kickbacks from the drug company every time they recommend it. While the doctor may say they are helping you, it leaves you wondering who they are really working for," he says.

SEC-regulated advisors are bound by the "fiduciary standard," which requires them to act in their clients' best interests. You want to choose an advisor who is bound by this standard. Registered investment advisors (RIAs) are; broker-dealers are not.

Some advisors are only regulated by one of these entities, but things get murky when an advisor is regulated by both FINRA and the SEC. "Their ethical standards depend on the service they are providing their customer or client," Moore says. "When advising on asset allocation, they must uphold the fiduciary standard, but when they sell the investments within the recommended allocation, they must uphold the suitability standard."

"Professional ethics in the financial services profession is incredibly convoluted, and most advisors don't even understand them, so consumers are almost always confused," he adds.

Look for Advisors with Well-Known Professional Designations
If your advisor is purely SEC regulated, you're in the clear, but you need extra protection if your advisor is partially or entirely regulated by FINRA. That's where professional designations like the CFP® come in handy. A Certified Financial Planner (CFP®) must uphold the fiduciary standard even if he or she is FINRA regulated. Finding a good financial advisor starts with finding one that has chosen to uphold a fiduciary standard with all of their clients, 100% of the time, Moore says.

Robert Stammers, director of investor education at the CFA Institute, is a Chartered Financial Analyst (CFA). All CFA charterholders are bound by a code of ethics and professional standards, and they are required to attest annually that their actions have been bound by those standards, he says.

Other credentials to look for are Personal Financial Specialist (PFS) and Chartered Financial Consultant (ChFC), recommends the National Association of Professional Financial Advisors (NAPFA).

Warning Signs of a Bad Advisor
If you see any of these behaviors in your advisor, it might be time to look for a new one:

  • Changes in Performance Reporting: "Advisors that change the way performance is reported to the client may be covering up poor performance or worse," says Jonathan Citrin, founder and executive chairman of Birmingham, Mich.-based CitrinGroup, a registered investment advisor that offers portfolio management, investment planning and wealth management services. "Clients must pay attention to more than the rate of return on a given report," he says. Because there is no standard for performance reporting, there is a lot of room for manipulation, and many advisors switch between different formats of performance reporting so they can choose the format that makes them look best, he says. "For example, if I knew that my performance in 2011 was not good, I could only show you reporting back to January 1, 2012," says Citrin. "Or if I knew that the S&P 500 was doing better than I was, I could switch to a different comparative index that does not make me look bad."
  • Product Pushing: "Advisors that sell a product rather than their fiduciary advice are at great risk for unethical behavior," says Citrin. Steer clear of an advisor who pushes any product, regardless of what it is.
  • Fortune Telling: "Advisors that claim to know the future - where interest rates will go, how the market will fare in the next half year, if gold is a good buy at current levels, etc. - are to be avoided," Citrin says. An advisor should be ethical enough to admit that markets are unpredictable.
  • Flashy Behavior: "Advisors with a flamboyant office, who use industry jargon and smell like money are promoting more than advising," says Citrin.
  • Incomprehensible Jargon: If an advisor communicates in a way that is too complex for you to understand, stay away, Citrin says. You should feel comfortable with your advisor. "An advisor's inability to explain their investment philosophy, their investment process or any fee arrangements, in a manner that can be easily understood" is a warning sign, says Stammers.
  • Inadequate Past Performance Compared to Benchmarks: Investors can compare the returns a financial advisor has achieved to those of benchmarks like the S&P 500, the Barclays Capital Aggregate Bond Index and others that resemble the advisor's investment holdings. "Past performance in relation to the performance of the market or other benchmarks can help to identify those [advisors] that have investment management skills and ones that do not," Stammers says.
What to Expect from a Good Advisor
As discussed earlier, a good financial advisor will be held to a fiduciary standard that requires him or her to puts the client's interests first. He or she will also have well-known and highly respected professional designations such as CFP, CFA, PFS and/or ChFP and be compensated with fees, not commissions. Here are some additional characteristics to look for in a good advisor.
  • A Comprehensive Understanding of Your Situation: The advisor should thoroughly discuss your needs and circumstances with you, then carefully match products and services with your situation, says the CFA Institute's Statement of Investor Rights, a list of 10 principles intended to help those who buy financial service products demand the professional conduct they deserve.

  • A Manageable Client Base: Make sure the advisor does not have so many clients that they will not be able to devote sufficient attention to you, advises the NAFPA.

  • A Solid Business Continuity Plan: If your advisor retires, changes professions or passes away, he should have a plan for who will take over the management of your account.

  • Lack of Pressure: Your advisor should give you all the time you need to make decisions. You shouldn't feel like you're on a deadline.

  • Clear Communication: Your advisor should prepare an investment policy statement that explains the plan for your finances in language you can understand, recommends the CFA Institute. All communications from your advisor, including the explanation of fees, should also be easy to understand.

  • A Clean Disciplinary History: Check the SEC's Investment Advisor Public Disclosure website, FINRA's BrokerCheck website and the North American Securities Administrators Association's Check Out Your Broker website, recommends the NAPFA. While you want to hire someone who is SEC regulated and therefore a fiduciary, they might have been registered with another regulatory authority in the past, so you should check all three places to confirm that they have a clear disciplinary history.
For additional recommendations on choosing a financial advisor, see the NAPFA's Pursuit of a Financial Advisor Field Guide.

Once you've hired someone you think meets these standards, make sure to evaluate your financial advisor on an ongoing basis. Are they meeting your needs? Have they done what they said they would? Has the advisor charged you the fees they said they would and nothing more? Is your advisor available when you need them? Do they respond to your questions quickly and satisfactorily? If you have experienced problems in any of these areas, discuss your concerns with your advisor. If their response is not satisfactory, it's time to look for a new advisor.

The Bottom Line
"It is an unfortunate reality that investors must tread very carefully when picking and sticking with an advisor," Citrin says. But with a little insight and common sense on top of the law, you may be able to avoid the unethical actions of some professionals that give the finance industry a bad reputation.

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