We are a “fee-only” investment advisory firm which eliminates many of the traditional conflicts of interest inherent to the financial services industry. We believe that if our sole source of compensation is our clients then our loyalty will lie solely with them. There are three primary means for “financial professionals” to be compensated for investment advice, which are commission based, fee-based (or hybrid) and fee-only. The following table will outline the differences in each
|Issue||Fee-only Adviser||Fee-based Advisor||Broker|
|Legal Fiduciary Duty||Yes||Maybe, check contract||No|
|Conflict of Interest||Limited (1)||Can be considerable (2)||Definitely|
|Tax deductible fees||Yes||Depends (2)||No|
|Discretionary Authority||Yes||Depends (2)||Typically not|
1) It cannot be overstated the critical importance of conflicts of interest in the world of finance. We sought to minimize the number of conflicts we have with our clients by establishing a "fee-only firm" but its impossible to obsolve every one. Even for fee-only advisers, there are a few that stand out. First, if an adviser chargers a performance fee, then the firm may have an incentive to take unnecessary risks. Another key area where conflicts arise is how firms may "gain advantage" for their own trading accounts by the way they manage their clients. Two major issues are front-running and free-riding. Front-running is fairly well known and we have implemented specific firm guidelines to prevent it.
The bigger issue in our opinion is free-riding. Free-riding is where a firm will buy or sell shares at one point in the trading day and then allocate them later in the day according to interday performance of the position. The way it works is a manager will buy some security in their master account that may or may not be intended for client accounts. If something happens throughout the day to positively impact the price, the manager will allocate a disproportionate share of the position to an adviser-owned account. If the position is flat or responds negatively, then the allocation is made to the clients' accounts. In order to remedy this at our firm, we have opted for a custodial relationship that allocates shares in real time as the transaction takes place. So free-riding is not an option for us.
2) A hybrid or fee-based advisor is a person who may act as both an advisor and broker on a client account. There are many ways in which this relationship maybe established. The nature of all these issues varies considerably depending on how the relationship is constucted. In our opinion, if the fee-based advisor maintains his or her commission (brokerage) business at the same custodian as their fee business, this raises a red flag. This type of arrangment could not be more conflicted and should be scrutinized by the client before signing an agreement or contract. If you ask the advisor directly, "do you have seperate custodians for your brokerage and fee business or are they maintained at the same firm?" and he or she should tell you. In order to better obsolve conflicts, they should be maintained at seperate firms.