Service Snitch: Brokers and Dealers in Financial Products (Stock Brokers, Investment Advisors, Financial Planners): Tricks of the Trade

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Stock Brokers and Dealers in Financial Products: Tricks of the Trade

Save a few stragglers holed up in the mountains somewhere, few people nowadays go through life without investing money one way or another. Most of us have long-term financial goals in mind when we invest, such as retirement or our children's college education, and we pin our dreams for the future on stocks, bonds, mutual funds, and other investments. For most individuals, even professional financiers, trading is done exclusively through a broker.

A stock broker (Series 7) license allows a person to sell stock . Most stock brokers sit for additional exams and earn additional certifications which allow them to call themselves financial planners, financial analysts, financial advisors, and a whole host of other things that sound better than "stock broker." As far as this article is concerned, anybody who makes their living by buying and selling stock, bonds and other related securities directly to and from the general public is a stock broker, regardless of what additional licenses he might hold.

Each broker is affiliated with a firm, whether an industry powerhouse like Merrill Lynch or Smith Barney or a less renowned local outfit. In-house regulation of brokers, however, never goes far beyond the bottom line. In most arrangements, the broker makes a commission on every trade his clients make, which he splits with the firm. So long as the broker is making the firm money, the firm won't care how he does it.

While brokers have to pass licensing exams and could face scrutiny by state and federal government auditors, most dishonest brokers, like dishonest attorneys, get away with a slap on the wrist, in the unlikely event that they get in trouble at all. Nowhere does the expression “caveat emptor” apply more strongly than in the finance industry.

What It Costs:

Brokers' fees will depend first and foremost on the extent of their service. So-called "discount" brokers will execute any stock trade their client wishes without blinking; the dozens of online trading services fall under this category. Some discount brokers offer commissions as low as $10 per trade with no ceiling on buying price or number of shares. Of course, these low fees cover nothing more than the transaction itself.

"Full-service" brokers are what most people think of when they think of stock brokers. They're the ones who give advice, who feed clients hot tips, warn clients not to give up on that declining stock too quickly and who state what their clients should buy and sell. Some people give their broker carte blanche access to their portfolio and allow him to execute whatever trades he sees fit without their prior approval. The commission rates for full-service brokers are significantly higher than discount brokers'. They're usually up to $50 – $150 a trade, and it can be even more depending on the price of the stock and how many shares are purchased.

Many firms now offer flat-fee accounts to their customers. Clients are billed a percentage of their assets on a monthly cycle. Under these plans, brokers get a monthly cut as opposed to a per-trade cut. While the lure of commission-free trading is tempting, it could take a lot of trades to justify the flat rate so caution is required. Brokers are sometimes even given incentives to sign clients to fee-based plans, since it usually makes the firm more money. What's more, a commission may still apply to certain trades, even as the money a client makes from those trades counts towards the calculation of the monthly fee, but all that will be buried deep in the fine print.

The Stock Broker Says:

“Because of my extensive training, my reputable certification, and my tenure at an established firm, you can be sure I am an honest, hard-working professional who looks out for the interests of my clients. Whenever I offer advice or make a trade, I will always keep your long-term investment goals in mind. If you ever need to get in touch with me, I will always be available for you, whether you have ten million or ten thousand invested with us. Every financial relationship is built on trust, so how could I be where I am today if you couldn't trust me?”

The Snitch Says:

“Nobody in the history of the world has ever become a stock broker because he loved the social aspect of calling people to find out if they felt like buying or selling stock and the challenge of filling out all the paperwork if someone said yes. To put it bluntly, most stock brokers would sell their own mother on the NASDAQ if they could. Theoretically, this can be a good thing because the more money you make, the more trading you can do, which means more commissions for him.

Unfortunately, so many opportunities exist for him to make a short-term profit at your expensive that doing so can be nearly irresistible. And needless to say he won’t get promoted any time soon for wasting opportunities to make the firm money. Industry reps will tell you these are just a few bad apples, but all you have to do is sit down at any bar near Wall Street around 5 PM and listen to people’s trusted financial advisors speaking amongst each other. Considering the culture of greed enveloping the finance industry and the tremendous losses you stand to suffer if you happen upon one of these “bad apples”, the entire orchard deserves suspicion.

Now before we discuss the conventional tricks of the trade, it should be noted that when a few “bad apples” caused Enron and MCI/Worldcom to tank a few years ago and thousands of people lost their life savings, Congress woke up and started holding a lot more people in the finance industry accountable for their actions. So while we are still seeing plenty of the tricks covered below, the trend is turning towards fee-based services and away from commission-based services.

Fee-based services sound great, but what this boils down to is so many fees for so many little things that you end up paying just as much or more than if you had paid commissions directly. Stock brokers don’t like it because it means more for the boss and less for them. So now we’re seeing a split in the finance community whereby the more legitimate brokers are getting licensed to offer fee-based advice and to sell alternative investment vehicles that still pay giant commissions like annuities and life insurance. The more “hardcore” brokers are going into the same line of work in as-yet unregulated professions with very big commissions, such as the mortgage brokerage industry (which resembles Wall Street in the 1980’s right now).

One staple tactic of the crooked broker is churning. Churning exploits the significant per-trade commission rates most firms charge, of which 30% – 50% will go straight into the broker's pocket. The broker will advise you into making hasty trades or, if you've given him the discretion, execute these trades himself. He'll buy and sell without any discernible pattern to any of it, except that he's doing it all as quickly as possible. By the time you catch on to him, he'll have pocketed thousands of dollars of your money in commissions, while you'll be lucky to have made a dime off of all those trades put together.

Incentives are another tactic unhelpful to the buyer of financial services. Because the broker is affiliated with a firm, and most firms do not limit their financial services to brokerage alone, the broker may be given "incentives" (read: kickbacks) to get you to invest in whatever other financial products are in the firm's best interest. Of course, he won't tell you it's in the firm's best interest, and he certainly won't tell you he's getting a kickback. For example, the firm may be affiliated with Metlife. When it sells a financial product offered by another Metlife-affiliated company, there would be an extra commission (this is just a made-up example. I have no idea what Metlife’s practices are.)

A little further down the ethics scale, your broker may be taking patently illegal bribes from an outside company without the firm's knowledge, and coaxing his clients into buying the stock even if it's sure to crash and burn. The most unethical of the bunch will just find a way to take your money and disguise it as an investment loss.”

Protecting Yourself:

Ironically, one of the world’s wealthiest financiers recently started a blog. One entry was on how to invest. He said to invest in yourself through education, training and experience and to make more money through your enhanced abilities. He said that if you still had excess capital after buying your house, car and whatever else you might need, you should just buy government bonds and not think about it. Who needs Service Snitch with guys like that around?

Anyway, when you're looking to invest your money with someone, always choose an individual broker, not the firm he works for. Too many people call up investment firms without any idea of what kind of broker they need and take anyone the firm gives them. Remember, the broker's going to be the one who handles your money, with little to no oversight from the firm. When it comes to brokers, the firm is nothing more than a glorified referral agency. You choose a doctor based on his qualifications and your personal needs, not the referral agency he's listed with. One way to get a lead on a good broker is to ask for recommendations from people you know.

Ask any broker you're considering how long he's been in the business and how long he's been with his firm. If he's just joined up, he may be inexperienced, or he may have been run out of his last firm for incompetence or worse. Ask the broker how many clients he has, and whether you'll be able to speak with him personally whenever you need to talk to him. Too many brokers won't deign to speak to you if you have less than $100,000 in assets, and will shunt any calls from their "less important" clients to an assistant, a secretary, or a call center.

Brokers are just like any other investors. Some of them are aggressive, all-or-nothing desperados, some are more cautious and conservative. You'll want to find a broker whose approach to investing is compatible with your own. Discuss with any candidates what you're looking for in a broker and how much control over your portfolio you want to retain, if any. Some of them love nothing more than having free rein over your assets, others are more comfortable acting as advisors. Don't settle on a broker until you're sure you've found one who suits your style.

Always check into the background of any broker you're considering. The National Association of Securities Dealers (NASD), a self-regulatory organization of investment firms, provides an online service called BrokerCheck that lets you peek into a broker's history, including any past indiscretions. You should also call up your state's securities commission to see if they have anything on file.

Ask the broker candidate how he gets paid. Does he tout investments to his clients at his firm's behest and make money off of the kickbacks? He'll be pretty shocked at such a blunt question, but this way you'll let him know from the get-go that you're no sucker. If you've signed on with a broker and he relentlessly pushes you into an investment even after you've made it clear you're not interested, it's a good sign he's trying to make a kickback, whether from his firm or from someone else.

Don't assume a broker is reputable just because he works for a reputable firm. The big-name multinationals want to make money just as much anyone, and if a broker gets the job done for them, they won't care how he does it. In fact, they can't afford to care how he does it, since he's just one of hundreds of brokers they house.

Not only is malfeasance less likely to escape the attention of smaller firms, but brokers at smaller firms typically service fewer clients, meaning you'll get personalized attention no matter what your assets are. Unfortunately, when big-firm brokers get caught with their hands in someone else's pockets, they sometimes seek refuge in the relative anonymity of a smaller outfit. In the end, no matter what size the firm is, you always have to do a background check on a broker.

Many people think commission rates are inflexible, but if you negotiate in earnest with your broker before you sign on with him, he may come down by as much as 20% – 30%. Remember, both the broker and the firm will rather have your business at a discount than not have your business at all. You also might be able to work out an arrangement where you pay full commission on trades done on your broker's advice and a discounted rate on trades done on your own accord.

Every industry has its share of unmitigated crooks, and the brokers of this breed will take whatever money you give them and never make one investment. Some of them will try to get away with this by withholding your monthly statements, so if you ever miss a statement, call the firm immediately. Most brokers now offer real-time online service where you can check up on your portfolio at any time; this makes it much easier for you to detect any suspicious activity. Compare your online statements with your paper statements every month, and call the firm immediately if you notice any discrepancy.

A less drastic but much sneakier way for the broker to rip you off is churning. It can be difficult to tell whether a broker is churning or simply being aggressive, but a telltale sign is inconsistency: if a broker sells anything as soon as it makes a dime but hangs on to duds long after they plummet to the ground, he's probably churning. A broker is not going to be at once a patient and an impatient trader unless his investments are not in good faith.

What's the best way to avoid getting scammed by a con broker? Taking charge of your own money and working with a discount firm or online service. Independent investing is not for everyone, but if you have the time, the patience, and the know-how, you have no reason to trust your financial future to a stranger, let alone pay his ridiculous commission rates. If you want to trade for yourself but lack confidence in your investment acumen, you can always pick up a few books at your local library or take a class in investing at a nearby college. And in the meanwhile, government securities pay nicely. Bottom line, the more direct control you exercise over your money, the less opportunity anyone has to take it away from you.

Just Because You Were Curious:

Here are some of the distinctions between the various fields stock brokers identify themselves with:

Broker: An individual--licensed to sell securities--who acts as an intermediary between you and the companies and agencies that sell securities on the open market.

Chartered Financial Analyst (CFA): An advisor who has passed a test--covering economics, accounting, security analysis, and money management--administered by the Institute of Chartered Financial Analysts.

Chartered Financial Consultant (ChFC): An advisor who has completed a program of economics, taxes, insurance, and investing.

Chartered Investment Council (CIC): An individual who has passed tests in economics, accounting, taxes, and money management and has at least five years of relevant work experience.

Chartered Life Underwriter (CLU): An advisor who has completed training in life insurance and personal insurance planning, is licensed by his or her state, and appointed to sell insurance products by one or more specific insurance companies.

Registered Investment Advisor: An investment advisor registered with the Securities and Exchange Commission. No standardized test for certification is required.

Registered Representative: An advisor who is licensed to sell securities and has the legal power of an agent, having passed the Series 7 and Series 63 exams; usually works for a brokerage licensed by the SEC, NYSE, and NASD.

Certified Financial Planner (CFP): An advisor who has passed a rigorous series of exams covering most or all of the above topics.

(Excerpted from MSmoney.com)

Posted by admin on 09/01 at 01:58 AM

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Friday, September 01, 2006

Stock Brokers and Dealers in Financial Products: Tricks of the Trade

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