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Should You Trust Your Broker? No, and Here's Why

I recently had an affectionate email from Steve, one of the devoted readers of this blog. I had written about the brokerage industry's habit of giving investment advice while dodging the fiduciary rule - that is, the rule that advisers have to disclose all fees upfront and put their client's interests ahead of their own. Because stockbrokers don't want to take that step, I reminded readers not to trust them. Here's Steve's love note, in full but corrected for family reading:

Jane you say we (I am a RR) can't be trusted. I am collecting statements like yours...expect to have you a** sued. I can't believe you are saying s*** like this. You need to be very careful what you say. I am Series 7 et al and it is legal for me to sell securities. By the way I charge FULL commission, always, you GD idiot!
Hmmm. I'm glad I'm not a customer of his, especially because of that "full commission" bit. He doesn't sound like someone who would cut a client a break.

Steve's behavior and language is certainly not typical of people in his industry, who usually disagree politely and with reasoned argument. What is representative, however, is his angry demand to be trusted - full commission and all. It made me think that I should explain myself further.

To get customers, brokers have to sell the belief that you can trust them with your money. That belief is their primary product. If you have faith, you will buy the financial products they recommend. The same is true of financial advisers and financial consultants, if those are the titles that your broker uses, as well as financial planners and insurance agents who sell products on commission.

As a customer, however, you should never trust your broker, and I don't mean that personally. You can like your broker, think him smart, or find him helpful. You can ask her for stock research or ideas. But trust should have nothing to do with your relationship. If it does, you'll be on the losing side.

You and your broker (or financial consultant or insurance agent) have different interests. They have to sell things to make a living. The more they sell, and the more expensive the products, the better off they'll be. Like any other salesperson - for shoes, cameras, advertising or high-tech medical devices - moving products is their job. Your job, as a customer, is to look skeptically at those products, ask yourself if you need them, compare them with other options and consider the cost. The more you pay, the worse your investments will perform.

All too often, investors get trapped by their brokers, emotionally. Because you've trusted and admired them, because you're friends, you're reluctant to think that something might be wrong. You don't want to hurt their feelings by challenging their performance or making complaints. It becomes hard to move your account, especially if you'll still see the broker in your social group.

Rule One for investors, then, is to keep their distance from their brokers. Don't play golf with them or invite them to parties. This should be purely a business relationship. If you're not satisfied, move on. Don't open an account with a relative or the spouse of your best friend, who would be especially hard to shed.

Rule Two is to remember how little "trust" really means when the chips are down. Your broker wants you to treat his or her ideas as gospel. If it turns out that you were sold a pig in a poke, however, the broker will argue that the decision to buy was entirely up to you. If you trusted him, that's your problem. So sorry. Bye bye.

Rule three is to understand the real nature of brokers' jobs. They're expected to bring in tens of thousands of revenue dollars each day. The firm "chains you to your desk in the morning and they're not going to release you until a certain quota has been reached," one broker said in a focus group for the National Endowment for Financial Education in Denver. When a broker asks a colleague, "How are you doing?" he's not asking, "have your recommendations made money for your clients?" All he wants to know is, "How much have you sold and what commissions or other revenues have you racked up?"

Brokers take the heat when they push investors into expensive or mediocre products, but remember that management lights the fire. Even a well-meaning broker can be driven to rogue practices by a firm that demands high sales at any cost. New brokers and less successful brokers are especially vulnerable to this kind of pressure. If they don't meet their quotas, they'll lose their jobs.

It's common for management to:

1. Offer incentives, such as higher pay or status vacations, for selling mediocre products that the firm makes extra money on. Some brokers love the game, others hate what this does to their clients but sell the stuff anyway.

2. Raise quotas to the point where brokers are tempted to churn accounts -- that is increase buying and selling simply to generate commissions.

3. Order brokers to sell a crummy block of shares that savvier institutional customers have rejected.

4. Create a climate of callousness, by passing out perks and vice presidencies to big producers no matter how unsavory their techniques.

5. Mislead brokers about the riskiness of a financial product. For example, remember auction rate securities? They were supposed to be as safe as money market mutual funds while paying higher rates. When the market started to fail in 2008, some big firms hid the truth from their brokers and, in fact, pushed them to sell more.

6. Demand that brokers sell fee-based advisory accounts, even to clients who might not benefit. I recently asked a broker what her most lucrative product was. She responded, enthusiastically, "The big $ comes from fee-based accounts. We get that annually! Got to build the fee-based book of business to reap the real rewards!!!"

So as I was saying, don't trust your brokers. Talk to them, learn from them, but suspect and investigate everything (for information, the Web is a big help). When it comes to expensive financial products, "no" is a mind-clearing, money-saving word.

More on MoneyWatch:
Financial Reform Bill: Investor Protection Gets Knocked out
Investor Protection: Brokers and Insurance Companies Hope to Weaken Gains
Congress Sells Out Seniors: No SEC REgulation for Indexed Annuities

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