Financial Advisors and Proprietary Investment Products
When you reach out to a financial advisor, you are typically in the market for either financial planning advice, help with investments, or some combination of the two.
During these conversations, it’s not uncommon for your advisor to discuss various investment vehicles such as life insurance, mutual funds, and/or annuities.
With this in mind, this article explores potential conflicts of interest and any terms surrounding your investment vehicle.
Definition of proprietary products
“Proprietary products” are investment vehicles issued by the same financial institution that is advising the client. In other words, your advisor acts as both the seller and manufacturer. This is just like, let’s say, going to doctors who not only prescribe and sell you medication but also make and package it themselves.
Why firms sell proprietary investment products
A financial advisory firm that sells proprietary investment products often has legitimate reasons—other than additional revenue—for advisors to offer their own creations.
Rather than limit themselves to ready-made products from other institutions, firms with proprietary offerings enjoy more control over what they suggest to clients. They may also design and sell products to best fit the needs of their customers while attempting to distinguish themselves from other advisory firms that do not offer custom solutions.
Reasons for conflicts of interest re: proprietary investment products
In theory, it’s great when a person you approach for advice says, “I have the perfect solution for your problem.” However, “real-life” advisors who sell proprietary products are sometimes affected by conflicts of interest.
In addition to your asset management business, financial advisory firms stand to collect management fees and other costs associated with proprietary products. The company may even be motivated to steer more assets into those products and funds so they can collect twice—often unbeknownst to the client.
As if implicit biases were not enough, some advisory firms reward employees for pushing company products. Although the Financial Industry Regulatory Authority forbids incentivizing proprietary product sales, the practice unfortunately still exists—and it isn’t just large banks with hefty product portfolios and the capital to absorb outsized penalties who take advantage. Many advisory firms are in fact fined millions for insufficiently guarding against conflicts of interest.
Regulation Best Interest (BI) and its impact on proprietary products
Starting this month (June 2020), the SEC will require brokers to comply to act in the best interest of their customers through Regulation Best Interest (BI) when recommending any strategies or transactions involving securities.
This rule is an improvement in the standard of care because it now requires broker-dealers to disclose any potential conflicts of interest. However, it’s only a marginal improvement over current “suitability standards” because Regulation BI does not clearly define “best interest” and still allows for commission-based compensation; and while Regulation BI helps mitigate other forms of compensation (such as award trips and bonuses), the rule doesn’t prohibit them outright.
What’s more, the “best interest” standard does not require advisors to maintain a continuing duty of care or loyalty to clients after providing recommendations.
There’s also still debate surrounding how enforceable these new regulations are—with fiduciary elements included in Regulation BI still falling very short of the full fiduciary standard RIAs are held to.
Your options with firms that sell proprietary products
If you work with a financial advisor who promotes proprietary products, ask if the institution also sells third-party funds. He or she may be required to push company products first, even if there are better options available. If your advisor only offers proprietary products, you’re perhaps limiting your options by building out your assets with him or her. By restricting diversification, your portfolio is thus less equipped to mitigate risk.
Before purchasing proprietary products, learn what would happen to your asset if you move your account away from the institution that issued it. Some proprietary investments are not transferrable, meaning you may be required to sell them before swapping firms—potentially resulting in a capital gain/loss as well as transaction fees or other expenses. Associated costs and tax implications could make it cost-prohibitive for you to switch advisors, once again limiting your options.
Proprietary financial products: the bottom line
While proprietary products are not necessarily a red flag for an advisory firm, it’s important to educate yourself on potential conflicts of interest and any terms surrounding your asset. At the end of the day, it’s not about who issued or manages the product but whether it is the best fit for your investment strategy.
Still have questions? Schedule a FREE Discovery call with one of our CFP® professionals today!
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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.
Disclosures:
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
