When searching for and choosing a stockbroker, many of us tend to become passive and even a bit deferential. After all, the broker is supposed to be an expert. But passivity is dangerous when you’re choosing someone who can potentially destroy your financial security. Here are five things people should ask brokers, but almost never do.
1. Do you have errors and omissions insurance?
A posh address and plush offices tell you nothing about whether the broker would be capable of paying your claim in the event things go wrong. Many independent broker-dealers have gone out of business when faced with substantial liabilities. Unless you’re portfolio is with a giant financial firm like Merrill Lynch or Morgan Stanley, you need to know whether the broker and firm are insured, what the insurance covers, and how much insurance exists.
2. Has any firm with whom you’ve been employed ever placed you on “heightened supervision?”
When a brokerage firm wishes to hire or retain a stockbroker who has been the subject of numerous customer complaints, disciplinary actions, or arbitration claims, the firm is supposed to institute more stringent procedures to ensure supervisory control over that employee. This heightened supervision may involve a variety of measures ranging from increased supervisory scrutiny of the advisor’s sales orders to assigning a “minder” to work with the advisor. If a broker has ever been the subject of heightened supervision, you know you’re probably dealing with a serial offender.
3. Where did you go to school and what degrees or special training have you received?
This one isn’t about snobbery. Sure, it’s possible for a person with little formal education to become a financial expert. But your goal is to choose a broker who can protect and grow your savings. Information about education and specialized training are relevant to that goal.
4. How will you and your firm be compensated for services you provide to me?
You would think brokers would always willingly discuss compensation, but you would be wrong. Many brokers are less than candid about how they earn money. For instance, a broker who charges an annual fee equal to some percentage of your assets under management may not mention that he also plans to recommend lots of investments that will be excluded from the management fee and will generate big commissions for the broker. Thus, you should ask the broker to review all of the ways he or she might earn compensation from working with you.
5. Will you always tell me when an investment you’re recommending is the subject of a sales contest or will result in your receipt of an above-average commission or bonus or other incentive?
If a broker has two similar products to sell and chooses to recommend the one that would pay him a much greater commission or advance him in the standings of a sales contest, the broker has a conflict of interest and should disclose it to you before you invest. Brokers often allow self-interest to dictate what they sell, but they keep their motivation hidden from the customer. Ask the broker at the very beginning of your relationship whether he’ll promise to always disclose such conflicts. Disclosure doesn’t eliminate the conflict but it ensures that you can more thoroughly evaluate the broker’s recommendation.
More information on questions you should be asking:
5 Questions to Ask Your Stockbroker
Hugh Berkson is a Securities Attorney with McCarthy, Lebit, Crystal & Liffman, Co. LPA. Hugh is rated AV® Preeminent™ by Martindale-Hubbell®.
He obtained a business degree in Finance from the University of Texas at Austin in 1989, and is a 1994 graduate of Case Western Reserve University School of Law, where he was a member of the Order of the Barristers and received both the American Jurisprudence Award, (National Mock Trial) in 1993 and the Jonathan M. Ault Mock Trial Prize for 1993-1994.