Put Your Clients' Interests First

Q: Where do you draw the line between what is best for your clients' money, and what is best for your clients in the long run? My manager gets upset with me sometimes when I steer a client away from a 529 that I can manage, to the state 529 plan that no broker can manage. The state plan will give the client a state tax credit. I also have steered clients from an annuity to mutual funds because of

Q: Where do you draw the line between what is best for your clients' money, and what is best for your clients in the long run? My manager gets upset with me sometimes when I steer a client away from a 529 that I can manage, to the state 529 plan that no broker can manage. The state plan will give the client a state tax credit. I also have steered clients from an annuity to mutual funds because of the associated fees.

Both of these decisions have reduced my commissions, but it's what makes me feel the best. My manager tries to convince me that it's in my clients' best interests that I stay in the game and manage their money. In order to do that, he says, I need to place my clients' money in products that drum up more commissions. I have a hard time dealing with this thought.

A: There is nothing more important than putting the interests of your clients first — nothing.

The NASD (now FINRA) Rule 2310 states, unequivocally, that “in recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer.” This rule also requires you to learn enough about the customer's investment objectives and financial status to be able to make such a determination. When you steer clients away from investments or strategies that are not in his/her best interests, you are fulfilling your responsibilities as a registered representative.

The pressure you have described from your manager is nothing new. Managers who are responsible for the profitability of the branch, or who are being asked to influence the sales staff to push certain securities or products, often put those considerations ahead of your primary mission not to abuse the trust of your clients. Being told by anyone in management that you have to put people into products that drum up more commissions in order to “stay in the career” is an absurdity. I would suggest that the reps who have the most successful careers in the long term are those who view their client relationships as more important than hitting monthly or quarterly numbers.

Your manager's statements also indicate a basic flaw in his reasoning, because implicit in them is a belief that your clients will never understand that they are being taken advantage of, and that full and complete disclosure is about as inconsequential as cocktail party conversation. Don't buy it. What's best for your clients in the long run is that they are able to trust you to do what's right for them.

Philip M. Aidikoff
Aidikoff, Uhl & Bakhtiari
Beverly Hills, Calif.
(310) 274-0666

[email protected]

A: The tension between what is best for your customer, and what generates the most in commissions, has been a core problem in the securities industry. In accounts that hold individual securities, this tension manifests itself in concerns about trading activity. Measures such as turnover ratio (the number of times per year a dollar is used to purchase securities), and cost-to-equity ratio (the cost of the account relative to the equity in the account, also known as the “break-even” ratio), are measures used by regulators to assess whether the trading was suitable for the customer in light of the customer's investment objectives, financial resources and risk tolerance.

In the past two decades (particularly in the past decade), the securities industry has moved away from the trading model as the basis for generating commissions, and now focuses on a variety of fee-based products that generate quarterly or annual fees for the firm based on the assets held in the account (or in the product). In theory, the fee-based model should align the customer's interest with the firm's interest, since there is no incentive to generate commissions through trading.

Your situation, however, highlights the downside of the fee-based model. Not all products are created equal. Some products carry higher fees (and therefore income to you and the firm) than others. The sordid history of some firms pushing their own in-house mutual funds over non-proprietary funds is one example of the downside of the fee-based model.

In your situation, the legal answer is quite clear: You must do what is best for the customer. This principle is found in numerous NASD Rules. For example, Rule 2110 requires that “[a] member, in the conduct of its business, shall observe high standards of commercial honor, and just and equitable principles of trade.” It certainly would not be consistent with high standards of commercial practice for you to recommend a product based not on the customer's needs, but your (or your branch manager's) desire for higher commissions.

Similarly, NASD Rule 2120 provides that “[n]o member shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance.” Wouldn't you consider it deceptive to explain to the client that you were recommending a product because of the product's attributes, when in fact you were recommending the product because it generated higher commissions? In interpreting Rule 2120, the NASD has made clear that deceptive conduct is not excused just because the customer doesn't lose money: “[S]ales efforts must be judged on the basis of whether they can be reasonably said to represent fair treatment for the persons to whom the sales efforts are directed, rather than on the argument that they result in profits to customers.”

Last, but certainly not least, NASD Rule 2310 (the “suitability rule”) provides that “[i]n recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings, and as to his financial situation and needs.” How could it serve the customer's needs to recommend a higher cost product based not on the product's features, but on the commission generated?

So, from a legal perspective it is clear that you must resist the manager's pressure to push the higher-fee product. From an employment perspective, you should clearly document why you are recommending the product, and why you are not recommending the higher-fee product. You also should keep track of the manager's pressure by making notes of conversations, copies of e-mails, etc., so that in the event the manager takes any punitive actions against you, you have a record to support your recommendations to the customer.

William A. Jacobson, Esq.
Law Offices of William A. Jacobson, Inc.
Barrington, R.I.
(401) 490-7500

[email protected]

Encounter a situation at work that makes you uncomfortable? Hesitant to change firms because you're unclear how your clients could be affected?

Don't fret. Send your questions to Registered Rep. Contributing Editor Ann Therese Palmer at [email protected]. Then look for an answer in a future Ethical Rep column. Anonymity guaranteed.

The Ethical Rep.
Registered Rep.
249 West 17th Street, Third Floor
New York, N.Y. 10011-5300
[email protected]

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