The Securities and Exchange Commission (SEC) continues to crack down on broker-dealers for disclosure violations, misrepresentations, and breaching their fiduciary obligations to clients. In the month of July alone, it has brought charges in more than a half-dozen cases. This is a strong reminder to investors to choose their financial advisors carefully; advisors should always put their clients’ best interests ahead of their own. Always.

Sadly, “revenue sharing” continues to be an all-too-common practice between some mutual fund companies and brokerage firms. Simply put, it’s an arrangement whereby the fund company pays a broker for selling fund shares to his or her clients. Brokerages often refer to mutual fund companies with which they have revenue-sharing agreements as their “preferred” funds or products.

This type of incentive (a.k.a. kickback) creates a serious conflict of interest. That conflict must, by law, be disclosed to the client. Unfortunately, some brokerage firms intentionally break this law or simply ignore it. Others provide disclosure that is convoluted and ambiguous.

Here are just two recent examples. (Click on the headlines below to read the full news release on the SEC Web site.)

SEC Charges Ameriprise in Fraudulent Scheme to Obtain Undisclosed Compensation

July 10, 2009 – The SEC announced an enforcement action against Minneapolis-based broker-dealer Ameriprise Financial Services, Inc., for receiving millions of dollars in undisclosed compensation as a condition for offering and selling certain real estate investment trusts (REITs) to its brokerage customers. Ameriprise agreed to pay $17.3 million to settle the SEC’s charges.

SEC Charges Morgan Stanley and Former Adviser with Misleading Clients

July 20, 2009 – The SEC charged Morgan Stanley and one of the firm’s former investment adviser representatives with securities law violations for misleading clients about the money managers being recommended to them and failing to disclose conflicts of interest.

Fortunately, investors who are armed with information can protect themselves and their money from such schemes. Consider the following suggestions.

Advisor vs. Broker

As more people call themselves “advisors,” the task of finding the right professional to address your needs can be daunting. The biggest difference between advisors and brokers is who regulates them and, as a result, how those regulations impact the service they provide investors.

Registered Investment Advisors (RIAs) are regulated by the SEC or the state. As such, they are required to disclose their sources of compensation and any potential conflicts of interests, as well as to put their clients’ best interests first when selecting investments.

Brokers, however, are regulated by FINRA (the Financial Industry Regulatory Authority) and exempt from advisor standards and regulations, as long as they classify the advice they offer clients as “incidental.” Thus, they are not required to demonstrate that all advice, purchases, fees and sales were appropriate, fair and clearly in the best interest of their clients.

The easiest way to know for sure if your advisor is, in fact, an RIA is to ask for a copy of his or her ADV form or to visit the SEC Web site at

Choosing an Advisor

By working with someone who is a Registered Investment Advisor, you help ensure a certain degree of accountability in the services he or she will be providing.

Your advisor also should have experience working with individuals on their financial needs, and his approach to financial planning should be similar to yours – not more cautious or more aggressive than suits you. Although no designation guarantees a financial advisor is qualified or competent, it can imply a certain degree of commitment, training and code of ethics. Is the advisor recognized as a Certified Financial Planner™ practitioner (CFP), a Certified Public Accountant-Personal Financial Specialist (CPA-PFS) or an Accredited Investment Fiduciary (AIF)?

Understanding Compensation

The way an advisor is compensated for services also can speak volumes about where his true interests lie. While there is always the possibility of a hidden conflict of interest, some forms of payment create more question than others. Be sure to ask how your advisor is compensated, and then ask yourself, does he represent you, or does he represent an investment company?

Planners can be paid in several ways:

  • Salary –- Some planners receive a salary from the companies for which they work and represent. The company generates revenue from you, either in fees or commissions or a combination of both.
  • Fees –- Fees can be based on an hourly rate, a flat rate or on a percentage of your assets and/or income. A “fee-only” advisor receives compensation directly from his or her clients, which helps remove third-party conflict-of-interest from the planner-client relationship.
  • Commissions -– Commissions can be earned from a third party on the products sold to you to carry out the financial planning recommendations. Commissions are usually a percentage of the amount you invest and vary significantly from product to product.
  • Combination -– A combination of fees and commissions can also be arranged, whereby fees are charged for the amount of work done to develop financial planning recommendations and commissions are received from any products sold. This is often referred to as “fee based.”

Ultimately, your financial advisor should be clear about how he gets paid, should disclose any potential conflicts of interest in a straightforward way, and should put all of that in writing.