Wall Street engages in many conflicts of interest and bad behavior that many people do not know about. There are enough anecdotes and stories to fill several books, but below are a few examples.
Preferred Funds Are Preferred for the Seller not the Client
Ever wonder how some advisors decide which funds to recommend? Or why certain brokerages have preferred families of mutual funds? Many mutual fund companies pay to have their fund families recommended. Brokerages’ recommendations aren’t always in the clients’ best interests.
Brokers’ Behavior Harms You and Helps Them
Brokers only get paid when they can sell you something, although some major brokerages have been instituting fee-based programs. There are several major conflicts of interest at work in a commission-based pay structure.
First, there is pressure to continually sell products to the client. Often this means buying and selling stocks frequently to generate commissions. In a recent twist to discourage this behavior, some brokerages now do not let a broker collect a commission unless the stock is held for more than a year. This now gives the broker a perverse incentive to hold the stock when it might be best to sell. If a bankruptcy filing by the company is imminent,the broker may not call you to sell because he or she would lose commission.
Second, the commission payout grids encourage excessive trades. Payout grids have different levels based on how much in commissions a broker generates. For example, say a broker is at the 35% payout level (meaning they get 35% of the commissions they generate) and is close to reaching the 40% payout level. If he or she can reach the 40% level before the end of the year, he or she will get the 5% increase retroactively for the whole year. This often gives brokers an incentive to sell as many products as possible, regardless of the needs of their clients, when they are close to reaching the next step in the payout grid.
In-Stock Products Are Recommended Over Other Options
Broker/Dealers frequently buy securities for themselves on their own account with a goal of selling them to clients. The firm’s brokers or “financial advisors” are encouraged to push these securities. The firm stands to make much more money on these transactions than on other securities the broker/dealer does not have in stock. Brokers are incentivized to sell these products because they receive substantially higher commissions when they do.
Wall Street’s “Research” Is Anything but Research
One of the things Wall Street likes to remind everyone about is just how much data and research they have access to and how you cannot possibly know how to invest for yourself without their guidance. What many people don’t know is just how worthless most Wall Street research is. Many of the firms that employ research analysts also have large investment banking operations. Many firms will cover only companies that are investment banking clients of the firm and will also discourage or outright prevent analysts from making negative comments about these companies.
In addition, analysts are often judged by their ability to correctly forecast a company’s yearly and quarterly earnings. To do this they are in frequent contact with company management and rely on management to give them hints or guidance about what the earnings are likely to be. If the analysts make too many negative comments in their research reports, then company officials will simply cease to give them hints about the company’s earnings. For Wall Street research analysts, the only thing keeping them in business is constant praise from the companies they cover.
At Strubel Investment Management we do our own independent research. We have a thorough knowledge of all the investments we recommend to clients and never merely trust the words of a third party.