Investors Receive Biased Advice From Stockbrokers New Study Confirms

In our May 18th post, we discussed stockbrokers (sales persons who purportedly dispense advice only in conjunction with selling investment products) and investment advisors (who give investment advice but don’t sell products.)

Although stockbrokers are fiduciaries under the law of some states — including our own state, Ohio — many courts have held otherwise, concluding that brokers are governed solely by the “suitability rule.” The suitability rule requires a broker to ensure that each purchase, sale, or strategy recommended to a customer is suitable in light of the circumstances and needs of that customer. But the rule does not deter the broker from favoring ostensibly suitable yet inferior products in order to maximize his or her fees and commissions. In contrast, investment advisors are required by law to follow the more stringent fiduciary duty standard, under which advice must always be based on the best interests of the client.

Stockbrokers Likely to Promote Bad Investments

Because we had just written about this subject, a new article pointing up the practical effect of applying these two differing standards happened to pique our interest today. Written by Professor Antoinette Schoar of the MIT Sloan School of Management, the article reports on a recent study Professor Schoar conducted with colleagues from Harvard University and Hamburg University. The co-authors of the study recruited “mystery shoppers” to impersonate customers seeking advice on how to invest their retirement savings. The shoppers, presenting varying levels of bias or misinformation about financial markets, were sent to financial advisers and stockbrokers in the greater Boston area.

Professor Schoar reports:

What we learned is highly troubling. By and large, the advice our shoppers received did not correct their misconceptions. Even more troubling, the advice seemed to exaggerate the existing misconceptions of clients if it made it easier to sell more expensive and higher fee products.

Advisers who have a fiduciary responsibility towards their clients provide better and less-biased advice.

Professor Schoar notes that only 7.5% of stockbrokers encouraged customers to invest in low-cost, passively managed index funds rather than high-cost actively managed funds, “exactly counter to insights from finance research, which suggests that the average investor should choose low-cost index funds over actively managed funds.” Moreover, she reported that when fees were discussed at all, they were downplayed in importance.

Professor Schoar and her co-authors found that investment advisers who have a fiduciary responsibility towards their clients “provide better and less-biased advice than those who are only registered as brokers” and “are less likely [than stockbrokers] to move people away from index funds and to reinforce erroneous beliefs about the market.”

Summing up the results of the study, Professor Schoar states:

Of course, no one expects financial advisers or brokers to work pro bono. But what is alarming is that incentives seem to be set in such a way as to move clients away from the existing strategy regardless of its merit, i.e., even when they looked at a low-fee-diversified portfolio. As a result, we found that clients end up with worse investment choices, since brokers and advisers are trying to secure financial gain for themselves. This is bad news for savers — including the many baby boomers — seeking to boost their retirement nest egg.

Stockbrokers Aren’t Complying with Suitability Rule

The findings of this new study are consistent with what we’ve known and been saying for years. Even stockbrokers who attempt to comply with the suitability rule have conflicts of interest that tend to push them toward selling what is best for the broker rather than for the customer. Imagine the devastation wreaked by the thousands of brokers nationwide who routinely violate the suitability rule.

If you’ve lost more money in your investments than you thought was possible or have suffered results you were led to believe could not occur, you may well have a valid claim to recover some or all of your money.  Contact our offices today. It will cost you nothing to have us review your situation and tell you whether you have a case. Use the email form to the right or call Hugh Berkson  at 216-781-5515 (from the Cleveland, OH area) or toll free at 866-932-1295.

 

Related Information