Beware of Broker Conflict of Interests

August 8, 2006 at 10:54 pm  ·  Category: The Investment Advice Business

Forbes recently ran an article worth reading: “Ten Ways Brokers Pick Pockets”:

Arbitration is how disgruntled investors usually have to bring their complaints against brokers.  In 2005, 6,074 cases were filed, the majority of which dealt with breach of fiduciary duty and negligence…. 43% of claimants were awarded damages.

One thing brokers will do, as I learned from my time at Morgan Stanley, is try and steer you into their own company’s funds.  They do this, of course, because their company gets more money this way and they get higher commissions. 

When they steer you to their own company’s funds they may also try and get you to invest in Class B rather than Class A shares.  Class B shares don’t have a front load as Class A shares do so they might seem like a bargain.  But these shares have higher annual expenses and impose a back load if you sell before a certain time period, generally 5 to 10 years.  The company makes more money over the long term with these shares because of the higher annual expenses and the back load if you don’t hold them for a long time:

After Marcia Lockwood’s husband died, a Morgan broker managing the family trust convinced her to stash it in – no surprise here – Morgan mutual funds.  The broker chose Class B shares, which carry higher expenses (an additional .86% each year) than the Class A shares, but don’t have the upfront sales charge of the A shares.

Lockwood had her pocket picked.  What the broker didn’t tell her was that it would have been better for her to buy the A shares.  That’s because she was investing $570,000, enough to take advantage of the sliding scale offered on Morgan load funds: Her upfront commission would have only been 2%.

Because brokers get paid from comissions when you trade securities they often encourage you to trade more than is optimal.  The more you trade the more commissions you pay and the more they get paid.  But these commissions eat away at your portfolio. 

Takes Forbes advice:

…. it pays to know how your broker is compensated before you walk into his office.  It may help you avoid getting your pocket picked.

Posted by Greg Feirman  ·  Trackback URL  ·  Link
 

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