We are all faced with plenty of scenarios in life where potential conflicts of interest should make us question whether our interests are being compromised by those who are supposed to be serving us. One obvious example is a politician wrestling with truly serving his or her constituents versus taking actions that will merely win votes for the next election.
Recently, a Hong Kong stockbroker exploited a classic conflict of interest in order to perpetuate a money making scheme at the expense of everyday investors. The gist of the story is that the stockbroker, Sky Cheung, was simultaneously employed as a financial columnist at a popular Hong Kong newspaper when he used his strategic positions to buy particular stocks and then write positively about them in his widely read column.
When his favorable commentary on the individual stock picks hit the press, the stock prices would responsively rise, allowing Cheung to quickly cash out on his artificially created margin. Regulators typically frown upon this use of comparative advantage, so Cheung tried to keep it under wraps by using his wife’s trading account. After finally being exposed, he was fined the amount of his profit and his brokerage license was suspended.
While manipulating markets by abusing consumer trust is definitely a devious practice, it is Cheung’s vocational position itself that raises an analogous concern for the more subtle (and less egregious) conflict of interest raised by banks and their advisors on a daily basis.
Banking on Incentives
Banks (particularly the larger ones) usually offer a range of financial services and products via employees who function as financial advisors (e.g. Wells Fargo Advisors, Regions Private Wealth Management, Chase Financial Advisors). These employees are incentivized to sign you up for their employers’ own investment offerings, regardless of whether or not they are the best deals for you, the consumer.
For example, Wells Fargo states on its website: “The combination of the portion of the Underwriting Compensation payable to WFA (Wells Fargo Advisors) and the selling concession payable directly to FAs (Wells Fargo Advisors) may incent FAs (Wells Fargo Advisors) to recommend these securities over other securities.” Such incentives are universal in the big banking world.
A given bank’s financial advisor isn’t economically incentivized to show the consumer the range of potentially better-suited account possibilities at other financial institutions, but rather to narrowly steer the consumer’s investment and earn the commission.
This conflict of interest between a bank’s bottom line (and an advisor’s pocket) and its fiduciary duty to the consumer is similar to Cheung’s story in that both he and the bank are leveraging their advisory positions to create consumer behavior that ultimately serves their own interests.
In neither situation is the consumer forced into an alley with no alternatives, to be fair (Hong Kong investors could have bought another stock just like banking consumers could choose another product), but without the fuller picture of the market that their advisor is expected to be providing them, these consumers are more likely to go along with the advisor’s recommendation.
Learning about the pay incentive structure a given bank has with its financial advisors is important before committing to any investments or services. An underlying conflict of interest could cost you large portfolio returns or basis points on interest from deposit accounts, and this could mean hundreds or thousands of dollars.
Knowing Your Options
If you feel it uncouth to directly ask a bank’s advisor how (and how much) they are being compensated, utilize Bloomberg’s Mutual Fund Screener to get a preliminary peek at how a potential investment fund with a bank’s financial advisor would stack up next to other independent funds on the market. It could reveal just how lopsided an advisor’s incentives are if you find a disparity between the value of what he or she is offering and what else is on the market.
On the banking side, don’t just settle for any savings account thrown your way for your liquid cash assets, but take a look at the spectrum of current savings account rates, CD rates, and IRA rates being offered nationwide.
These tools will help you navigate the bank-consumer conflict and put you on similar footing before making financial decisions.
Inherent conflicts of interest in the banking world make the “fee-only” financial planning movement attractive for consumers seeking an independent, uninfluenced approach to choosing particular investments. Fee-only advisors generally have no commission connection with the products they sell (which is not to say that they are conflict-free either!).
Regardless of the route you ultimately take, acknowledging conflicts of interest that are built into certain relationships will help you manage your expectations and make more informed financial decisions that could earn you some additional return.