Can I Trust My Stockbroker?

January 18, 2024

Q: I’ve been working with the same stockbroker for the past several years. My performance wasn’t very good last year, and this year is off to a rocky start. I wonder if the arrangement is as good for me as it is for him. How do I know if I can trust my stockbroker?

A: I’m not sure whether your real concern is your broker’s trustworthiness, or the quality of his advice. Either would be ample reason to look for a new financial advisor, but you should clarify your thinking first. Anyone with skill and discipline can improve their performance, but adjusting moral character is a different matter.

Many people are skeptical of stockbrokers. Back in 2015, a nationwide opinion poll reported on by the Wall Street Journal showed that more people trusted Uber drivers than stockbrokers. Professions that scored less trustworthy than stockbrokers in the poll included advertising executives, used-car salesmen, and members of Congress. I’d love to see an update of that poll, but I’m not sure those professions would fare much better today.

Concerns about brokers aren’t necessarily misplaced. A 2016 study from the Becker Friedman Institute for Economics at the University of Chicago looked at employment histories of brokers registered with the Financial Industry Regulatory Authority (FINRA) in the United States between 2005 and 2015. Of 1.2 million brokers, nearly 93,000 had a misconduct-related disclosure on their record, and one-third of those were repeat offenders. Past offenders were five times more likely to engage in misconduct than the average broker. Certain firms featured significantly higher rates of broker misconduct, suggesting that some corporate cultures encourage, or at least tolerate, bad behavior. As such, even though you are researching an individual, you should look at their firm as well.

FINRA’s Broker Check website (https://brokercheck.finra.org) will tell you a lot about your broker and his firm. When you pull up the website, it will give you the opportunity to choose between an individual or a firm. When you select “individual” and enter a name, the website will tell you your broker’s years of experience, work history, licensing exams passed, and whether or not there are any disclosures.

Before I go further, I want to acknowledge that most brokers are ethical and knowledgeable. However, brokers are saddled with an inherent conflict of interest in that they or their firms earn commissions for selling financial products. A “fee-only” advisor, on the other hand, is paid only for services rendered, not for products sold. When I started my business 23 years ago, I avoided that conflict of interest by becoming a fee-only advisor. I have never regretted that decision.

Several key differences distinguish fee-only advisors from brokers:

Fiduciary Duty

As fiduciaries, registered investment advisors (RIAs) have a legal obligation to put client interests ahead of their own. They must provide advice that is in the best interest of the client.

While stockbrokers are expected to recommend suitable investments, they aren’t necessarily held to the same fiduciary standard as RIAs. Recent legal efforts encourage brokers to act as if they were fiduciaries, but the distinction remains.

Compensation Structure

RIAs often charge a flat fee, or a fee based on a percentage of assets under their management. This fee structure aligns their interests with those of their clients.

Stockbrokers, on the other hand, typically earn commissions based on transactions, or receive revenue sharing payments from financial product companies. This compensation structure creates conflicts of interest, as brokers are incentivized to generate higher trading activity, or sell particular financial products.

Services Provided

RIAs typically offer comprehensive financial planning and investment management services. They typically provide a holistic approach to financial advice.

Stockbrokers may focus more on buying and selling securities and executing trades. The range of their services vary and some offer financial planning services.

Transparency:

RIAs are generally transparent about their fees, and their compensation is usually more straightforward.

Transparency varies among stockbrokers. Clients should carefully review fee structures, commission rates, and potential conflicts of interest. Ask about revenue sharing arrangements with financial product companies.

Client Relationship:

The client-RIA relationship involves personalized and ongoing engagement, with a focus on understanding the client's financial goals.

Stockbroker: The relationship with a stockbroker may be more transactional, centered around executing trades.

Hiring a professional advisor can be a very smart move. However, do yourself a favor and do your research ahead of time. Make sure your advisor is worthy of your trust.


Please see important disclosure information here.

Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to smerrell@montereypw.com.