Today continues a series, appearing roughly once per month, on the main ways that the financial system rips off the average worker and investor. This is based upon my nearly decade-long tenure in the financial services industry.
The First Path of Corruption: Buying the Back Office
There are two ways that advisors are bought: an indirect way and a direct way. Indirectly advisors are purchased via their back offices.
To fully understand this, I must digress a moment and discuss how the industry is set up. Each advisor affiliates with a “broker/dealer”. This entity is how an advisor can get his/her clients’ money invested in stocks, bonds, mutual funds etc. It is the broker/dealers that give advisors access to the markets.
Advisors can be either employees of a broker/dealer (such as bank advisors) or simply contracted with them but employees of an independent firm or self-employed. What is important to understand is that in every transaction a broker/dealer must act as an intermediary.
Additionally, broker/dealers must perform certain regulatory functions as well as protect themselves from legal liability. Therefore, they provide suitability oversight to determine whether a particular trade is appropriate. This compliance function is important to both the broker/dealers as well as the advisors (which does not mean that clients don’t get screwed). Broker/dealers, of course, take a cut of an advisors’ commission for these services.
In the competition for advisors, broker/dealers will offer inducements and add on services. Perhaps they will offer a bonus for a top producer to move their clients from one broker/dealer to another. Also, they all provide value-added services such as business building tools, client management software and ongoing training and provide the required continuing education.
Even though broker/dealers compete for advisors’ business they have an enormous amount of control over them (especially for those broker/dealers that directly employ advisors). This control extends to choosing which products advisors have available. Every broker/dealer has funds and annuity products that are “preferred”. Ostensibly this means that the back office has carefully analyzed these products and determined that they are the best of the best. That is a quaint idea but hardly one that fits the reality of the situation. The way that funds and annuities become “preferred” is that the broker/dealers are paid to make them so.
Let’s take Edward Jones for example. I do not do this to pick upon them. Nothing they do in this regard is illegal. I choose them as an example for two reasons: one, they are large. They employee about 19,000 advisors nationwide and move a lot of money. Two they publish the amount of money they receive from fund and annuity companies as part of a settlement of a lawsuit, so the information is on their website and available (albeit not very prominently displayed). The tables below detail how much money they receive from various fund and annuity companies. Here is the source link.
| Mutual Fund Companies: Revenue Sharing Summary | ||
| Paid by | Revenue Sharing Payment – Maximum Annual Asset Fee (Based on $10,000 of eligible Product Partner assets held by clients at Edward Jones) | Total 2023 Revenue Sharing Payments Received1 |
| American Funds Distributors, Inc. | $3.50 | $109.3 million2 |
| BlackRock Investments, LLC | $13.00 | $9.3 million |
| Eaton Vance Distributors, Inc. | $10.00 | $1.4 million |
| Federated Securities Corp. | $10.00 | $0.3 million |
| Fidelity Distributors Company LLC | $13.00 | $1.8 million |
| Franklin Templeton Distributors, Inc. | $6.00 | $25.4 million |
| Goldman Sachs Asset Management, L.P. | $13.00 | $1.6 million |
| Hartford Investment Financial Services, LLC | $13.00 | $19.7 million |
| Invesco Distributors, Inc. | $13.00 | $25.7 million |
| John Hancock Funds, LLC | $13.00 | $12.2 million3 |
| J.P. Morgan Investment Management Inc. | $13.00 | $20.2 million |
| Lord Abbett & Co., LLC | $10.00 | $14.1 million |
| MFS Fund Distributors, Inc. | $11.00 | $35.1 million |
| Nuveen Securities, LLC | $13.00 | $2.0 million |
| PGIM Investments, LLC | $13.00 | $3.1 million |
| PIMCO Investments, LLC | $5.00 | $0.5 million |
| 529 Plan Program Managers: Revenue Sharing Summary | ||
| Paid by | Revenue Sharing Payment – Maximum Annual Asset Fee (Based on $10,000 of eligible Product Partner assets held by clients at Edward Jones) | Total 2023 Revenue Sharing Payments Received1 |
| American Funds Distributors, Inc. | $3.50 | $ 2 |
| Annuity Product Providers: Revenue Sharing Summary | ||
| Paid by | Revenue Sharing Payment – Maximum Annual Sales Fee (Based on $10,000 of eligible Product Partner assets purchased by clients at Edward Jones) | Total 2023 Revenue Sharing Payments Received1 |
| American General Life Insurance Company and The United States Life Insurance Company in the City of New York | $25.00 | $0.5 million |
| Brighthouse Securities, LLC (formerly MetLife Investors Insurance Company Inc. and First MetLife Investors Insurance Company) | $25.004 | $0.0 |
| Lincoln National Life Insurance Company and Lincoln Life and Annuity Co. of NY | $25.00 | $0.8 million |
| Nationwide Life Insurance Company | $25.00 | $0.9 million |
| Pacific Life & Annuity Company, Pacific Life Insurance Company and Pacific Select Distributors, Inc. | $25.00 | $0.3 million |
| Protective Life Insurance Company and Investment Distributors, Inc. | $25.00 | $1.4 million |
| Prudential Annuities Distributors, Inc., Pruco Life Insurance Company of New Jersey and Pruco Life Insurance Company | $25.004 | $0.0 |
| Transamerica Capital, Inc. | $25.004 | $0.1 million |
They euphemistically call this arrangement “revenue sharing”. This in laymen’s terms is a kickback or a rebate. For every dollar invested with the above listed fund and annuity companies, those companies’ kickback a certain percentage. As you can see the numbers are substantial. Along the lines of 17% of Edward Jones’ net income. Leading the pack is American Funds at $109 million in 2023. What fund do you think Edward Jones’ back office has encouraged their advisors to sell a lot of?
Two observations are needed here. First, every broker/dealer in America engages in this pattern of behavior. There is nothing at all unusual about Edward Jones vs. any other broker /dealer. Secondly this arrangement does not mean that the recommended fund is inherently a bad recommendation. It does mean that it is likely an overpriced suggestion as high fees are necessary to pay for this revenue sharing.
The point here is that clients think that they are buying objective advice but what they are really being sold is deeply compromised advice which is ill disclosed.
The Second Path of Corruption: Buying the Advisor
Equally ill disclosed are the other ways that fund and annuity companies buy access to advisors through broker/dealer back offices. Chief among these dealings is support for advisor trips and meetings. Advisors, while doing their business, can qualify for award trips and so-called “due diligence” trips (ostensibly working retreats in a swanky locale). These trips are routinely underwritten to a large degree by one or many fund and annuity companies.
In exchange for these monies to underwrite the trip, the fund and annuity companies get the right to have one of their representatives present to those advisors’ present. This gives the fund/annuity representatives access to a captive audience of above average producers to pitch their wares. The quid pro quo occurs when the advisors return to the office and are expected to offer their clients the products they heard presented while on the trip.
You might think, “It can’t be that brazenly obvious?” You would be wrong to think that. Let’s use again the example of Edward Jones (because while not unique they were very organized about the practice). My former employer underwrote many award trips for Edward Jones’ top advisors. These were called “diversity” trips because they were held in exotic locations such as Italy, Hawaii, etc. At these trips, there was a mix of pleasure and business. As an underwriter of the excursion, we sent a representative to pitch our products. As Internal Wholesalers, we were given a list of those who would be attending prior to the trip. We were instructed to call those advisors and let them know that our representative would be speaking and to suggest a meeting with the local representative after the advisor returned home. After the event, we called all those advisors back who were in attendance and tried to set up a meeting with the local representative and to specifically ask for business from that advisor. It was so expected that we would receive business from the advisors who attended trips we underwrote that their activity was tracked on spreadsheets. These spreadsheets would contain the advisor’s name, location etc. Also tracked was how often someone from our company (both internally and externally) had contacted them. Also tracked was their sales production after the event broken down into 30-60-90-day time periods. If an advisor would not at least meet with the local representative that name was to be passed up the management chain and word would be gotten to Edward Jones HQ in St, Louis so that the advisor in question could be lined out and made to play ball. Yes, it was that explicit a pay to play arrangement.
This occurs constantly in this industry. All of this is paid for by the client fees that, as we have seen previously, act as such a drag upon their performance. More importantly the entire process is a sham. Clients have no idea that the advice they receive while sitting with an advisor has been placed into the advisor’s mouth by those who paid money to the advisor’s back office. It is nothing short of legalized fraud. That in a nutshell is how advisors are indirectly bought.
The “Counterargument”
There is a counter argument offered by industry supporters. They will claim that just because one fund is “preferred” there is nothing preventing an advisor from selling a client a non-preferred fund. In fact, defenders will point out that there is no greater commission paid to advisors who sell preferred funds over non-preferred funds.
This is true. Equally true is that advisors pay a penalty if they sell non-preferred funds. Here is how it works. If an advisor were to sell a non-preferred fund, they would have to incur a “ticket charge”. This is simply a trading fee, usually, at the time, about $20 per trade. Now this does not sound like much but let’s look deeper. If over the course of a year an advisor did this just 100 times, that is $2000 that the advisor must pay out of pocket. They simply won’t do that.
This comes into even sharper relief when you look at advisors who focus primarily on managed money. These advisors receive a fee, usually 1-1.5%, on the total amount of money in a client’s account. This money is spread among a variety of asset classes, so the client remains diversified. So, let’s say a wholesaler convinces an advisor that their intermediate term bond fund is terrific and worthy of her client’s money. This terrific fund, however, is not preferred. In any event, the advisor is sold and since she has a managed money practice she will move that asset class of every client’s accounts from the one intermediate term bond fund to the new intermediate term bond fund. A typical managed money advisor will have say, 300 clients. That’s 300 trades from one fund to another. That’s 300 X $20, which equals $6000. Guess what trade is not going to take place. That is how firms control what their advisors sell based on which fund companies pay them the most for access. So, their defense regarding the equal treatment of commissions is technically true, it technically does not matter because advisor costs are as equally an important concern of advisors as commissions.
Street Level Corruption
Advisors are also bought directly at the street level. Fund and annuity companies give each of their field representatives a budget to use for “marketing support” of advisors. This support can range from basic “tchotchkes” such as logoed pens, padfolios, stuffed animals to more expensive items such as polo and dress shirts, even watches and other forms of jewelry are available. This process of plying advisors with trinkets is so formalized that all the items available for representative’s use are on a web site that resembles a shopping site. The items are ordered, logged against the correct budget account, and sent directly to the advisor if so desired.
In addition to this there is money provided for support of local advisors’ events such as client seminars, client appreciation events and advisor/client meet and greet events. Rarely, if ever, are the fund and annuity company representatives identified as a partial or full funder of these activities. They are simply identified as experts in the field of investments and retirement planning and serve to add credibility to an advisor’s business.
There is even a monetary formula to determine how much money to use in support of an advisor. The rule of thumb in the business is 5 basis points of support for every dollar of production delivered by an advisor. That is .0005% of sales. If an advisor places a $1million trade with the company, the advisor can expect $500 of marketing support. I have sat in sales training sessions with these field representatives and seen them specifically trained to proposition an advisor with verbiage such as “I am willing to invest in your business Mr. Advisor, are you willing to invest in mine.” When a company spends dollars to have a sales training expert train their sales force on how to extract a quid pro quo from an advisor, something is seriously amiss. More details on this aspect of the business will follow later. Next month we will turn to the various types of advisors that are plying their trade. It is not a pretty picture.
Praise be to God
