FINRA Report Reveals Dangerous Gaps in Investor Knowledge

This week the FINRA Education Foundation released a report titled “Investors in the United States 2016.” The results, based on a sample of 2,000 investors, highlight dangerous gaps in investor knowledge that could well lead to financial disaster.

An infographic accompanying the report points up a couple of the most troubling findings. First, while 69% of survey respondents read a review before visiting a restaurant and 38% checked Carfax before purchasing a used car, only 23% consulted FINRA, the SEC or a state regulator about the background of a financial professional before hiring and investing with that person.

Think about that for a second—people are three times more likely to read Yelp, Zagat or a similar source before they pick a restaurant than they are to check whether a stock broker has been sued, declared bankruptcy, been disciplined by a regulator or been fired for investment-related misconduct before they entrust their life savings to that broker. It’s true there are gaps in FINRA’s BrokerCheck system, which we’ve written about before, but it’s certainly better than nothing, and can often act as an early-warning system for investors who are poised to make a big mistake with their money.

The second gap that caught our attention is the fact that just 56% of the investors surveyed agreed with the statement “I understand how my advisor gets compensated.” Broker compensation models differ from firm to firm and even from account to account. For example, a broker might get paid an annual fee of 1% of “assets under management” on one account, but charge a different customer 2.5%. Or the broker might get paid per trade. And even within this second, commission-based framework, certain preferred (often wealthier and more sophisticated) investors will get a far lower commission rate than others. These variations add up to real dollars, thousands of dollars a year and tens or even hundreds of thousands over the life of an account, depending on the account value and transaction frequency.

Another aspect of broker compensation that goes largely unnoticed is the different incentives brokerage firms set up for their employees to sell specific products. For example, on an investment product for which the firm’s investment-banking arm also acts as an underwriter, brokers will often earn more money for every sale than they would by selling a different product. That can be fine as long as the broker and firm disclose the incentives to the investor when recommending the investment, and as long as they carefully consider the alternatives when determining what is suitable and what is in the investor’s best interest. On the flipside, when a broker recommends the more expensive, riskier product in part because it pads his or her paycheck, instead of the safer, more transparent but less lucrative functional equivalent, that’s where we see the dark side of broker-compensation incentives.

If you have questions about a broker’s background or compensation, or suspect you have suffered losses as a result of broker fraud or other misconduct, please contact a securities attorney at The Galbraith Law Firm. Call 212.203.1249 or email kevin@galbraithlawfirm.com for a free confidential consultation regarding your legal rights.