Ethical Standards You Should Expect From Financial Advisors

A few years ago, the American Association of Individual Investors (AAII) conducted a study to see how trusted financial advisors were. When asked how much people trust the financial services industry to act in the best interest of its clients, over 1,900 respondents answered as follows (not adjusted for rounding errors):

  • 17% of respondents trust the financial services either "a lot" or "a little".
  • 19% of respondents neither trust or distrust their advisor.
  • 65% of respondents mistrust the financial services industry "a lot" or "a little".

Ethics are the moral principles defining someone's actions. It doesn't matter how technically sound a financial advisor's recommendations are: Without principles and standards behind them, there isn't any validity to their services. So how can investors find an ethical financial advisor?

In this article, we'll describe how you can choose wisely if you know which entity regulates your advisor, which professional designations to look for, and the warning signs of a bad advisor.

Key Takeaways

  • Most investors have historically not trusted the financial advisory industry.
  • Financial advisors are often regulated by FINRA, the SEC, or both.
  • Unethical financial advisors usually have warning signals including inconsistent reporting, product pushing, and guaranteeing future results.
  • Ethical financial advisors prioritize learning about your personal history, explaining unfamiliar financial matters, and planning for their succession.
  • There are multiple online resources to evaluate whether your financial advisor has a clean history or has received disciplinary feedback.

Know Which Entity Regulates Your Advisor

Let's start with the good news: there are rules in place to make sure advisors act ethically. The two regulatory organizations that oversee financial services are Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC). FINRA regulates the sale of financial products such as insurance policies, annuities, and mutual funds. The SEC regulates the giving of financial advice.

Advisors covered by either regulatory body are bound to sell the best product for you based on your answers to questions about your age, other investments, annual income, liquid net worth, investment objectives, investment experience, time horizon, risk tolerance, and other factors. Some advisors are only regulated by one of these entities.

Advisors are often restricted by suitability standards or fiduciary standards. Suitability standards stipulate that advisors must consider each individual investor's position independently and provide guidance specific to what is suitable for the investor's needs. Alternatively, fiduciary standards require advisors to consider their client's needs before their own.

Look for Advisors With Well-Known Professional Designations

If your advisor is purely SEC-regulated, your advisor is held to the highest standards. If your advisor is only regulated by FINRA, there are some gaps in their fiduciary duty. That's where professional designations come in handy. For example, Certified Financial Planner (CFP®) must uphold the fiduciary standard even if they are not FINRA regulated. As the CFP license is entirely optional, it is generally a demonstration of good faith that an advisor has self-initiated

Each professional designation has its own set of independently managed standards. Chartered Financial Analyst CFA charter holders are bound by a code of ethics and professional standards, and they are required to attest annually that their actions have been bound by those standards.

Other credentials to look for are Personal Financial Specialist (PFS) and Chartered Financial Consultant (ChFC), according to the National Association of Professional Financial Advisors (NAPFA). Again, each license will have its own ethical standards. Licenses requiring examination will be covered by varying degrees of ethics and may require continuing professional education.

Warning Signs of a Bad Advisor

There's generally some warning signs you can spot when working with an advisor. Though there may be circumstances that do warrant some of the events below from happening, here are some items to watch for:

Changes in Performance Reporting

Because there is no standard for performance reporting, there is a lot of room for manipulation, and many advisors switch between different formats of performance reporting so they can choose the format that makes them look best. If your portfolio performance isn't as strong, you deserve to know.

When you first begin working with a new advisor, ask to see example copies of reports from other clients, even if their names must be removed or identification information omitted. Unless there is explicit reason to expect your reports to look different, you should expect to see similarly-formatted reports.

Once you have an established relationship, ensure the information and format you receive are continually consistent. Your advisor should not omit information previously provided, and their data sources should remain consistent. Verify that prior quarter information properly rolled to next quarter (i.e. ending balances turn into starting balances), and always ask for originally-sourced information like statement exports directly from brokerage services.

Product Pushing

Advisors that sell a product rather than their fiduciary advice are at great risk for unethical behavior. This unethical behavior arises when your financial advisor receives commission for the sale of specific financial products. Those products may not fit with your long-term, but your advisor may still recommend them to you for their benefit.

There's several things to consider here. First, the more educated you are financially, the easier it will be to detect these products. Second, ask your advisor about their relationships. An adviser must look to both its general disclosure obligations as a fiduciary and to the specific disclosure requirements forms submit to the SEC as part of their registration.

Fortune Telling

Advisors can claim to know what will happen in the future, but this often isn't the case. Financial advisors do use historical precedence to make a roadmap of where they think current events may lead. However, past performance is not an indication of future results.

When discussing investment options, ask your advisor about the likelihood of specific outcomes from happening. For example, if your advisor is suggesting you change your portfolio allocation to generate higher returns, ask them how likely it is the outcome they project will occur. Unless you are discussing something that has already happened, approach with caution if they said it's guaranteed.

Flashy Behavior

Advisors may use flashy behavior to create an atmosphere of wealth and financial success. They may have done well for themselves in the past, but their prior success should not deter your relationship with them about your financial future. Be aware when your discussion with financial advisors feel less like advice and more like advertising.

Incomprehensible Jargon

If an advisor communicates in a way that is too complex for you to understand, they may simply be doing a poor job of relating to you and your lack of knowledge regarding financial markets. Don't be shy to approach your advisor and ask them to explain acronyms or phrases you're unfamiliar with. They may already have a diverse set of clients with varying degrees of knowledge, so you might not be alone.

This opaque jargon might not even relate to financial markets. If it's unclear what your financial advisor's fee structure, investment process, or overall investing philosophy is, it's up to the advisor to make it more transparent and for you to gauge this as a warning signal.

Inadequate Past Performance Compared to Benchmarks

Investors can compare the returns a financial advisor has achieved to those of benchmarks like the S&P 500, the Barclays Capital Aggregate Bond Index and others that resemble the advisor's investment holdings. The great thing about historical data is it does not play favorites - if one fund outperforms the other, it's as simple as that.

Your financial advisor should be willing to proactively demonstrate their success not only for their firm but how they performed compared to the market and other firms. Publicly-traded funds can act as the data point to compare again. Be advised that your advisor is using an appropriate benchmark, as they can decide to use different metrics to compare against to make their performance look better.

What to Expect from a Good Advisor

As discussed above, a good financial advisor will be held to a fiduciary duty that puts the client's interests first. They will also have well-known and highly respected professional designations such as CFP, CFA, PFS and/or ChFP and be compensated with fees, not commissions. Here are some additional characteristics to look for in a good advisor. 

A Comprehensive Understanding of Your Situation

The advisor should thoroughly discuss your needs and circumstances with you, then carefully match products and services with your situation. The CFA Institute's Statement of Investor Rights is a list of 10 principles intended to help those who buy financial service products demand the professional conduct they deserve.

When you first meet with a financial advisor, expect much of the conversation to not be about money at all. Good financial advisors will get to know their client, what is going on in their life, what their personality is, and what they dream to achieve. Once your advisor knows where you want to go, they can begin crafting the plan to get there.

A Manageable Client Base

Make sure the advisor does not have so many clients that they will not be able to devote sufficient attention to you. It's great if your advisor is in high-demand; however, high-quality advisors know when they are at capacity and turn away business to prioritize existing clients.

A Solid Business Continuity Plan

If your advisor retires, changes professions or passes away, he should have a plan for who will take over the management of your account. Prior to your old advisor's retirement, your advisor may ask to meet with both you and the incoming advisor to make sure all parties are on the same page about the transition.

A continuity plan may be different if your advisor is leaving the company. Often, firms will not allow financial advisors to engage clients once the advisor has put in their notice. The advisor's e-mail and telephone number may also be disconnected to prevent the advisor from taking clients with them to their new company. Do not be alarmed if this occurs, and your advisor may decide to still reach out to you using different means of communication.

Lack of Pressure

Your advisor should give you all the time you need to make decisions. Unless there are legal or imminent tax implications to immediately address, you shouldn't feel like you're on a deadline. Most of the guidance from a good financial advisor is geared towards long-term success, so any short-term deadline or goals are simply single hurdles along a long path.

Clear Communication

Your advisor should prepare an investment policy statement that explains the plan for your finances in language you can understand. All communications from your advisor, including the explanation of fees, should also be easy to understand.

A Clean Disciplinary History

Check the SEC's Investment Advisor Public Disclosure website, FINRA's BrokerCheck website, and the North American Securities Administrators Association's Check Out Your Broker website, which recommends the NAPFA.

While you want to hire someone who is SEC-regulated and therefore a fiduciary, they might have been registered with another regulatory authority in the past. You can check all three places to confirm that they have a clear disciplinary history.

Special Considerations

Once you've hired someone you think meets these standards, make sure to evaluate your financial advisor on an ongoing basis. Are they meeting your needs? Have they done what they said they would? Has the advisor charged you the fees they said they would and nothing more? Is your advisor available when you need them? Do they respond to your questions quickly and satisfactorily?

If you have experienced problems in any of these areas, discuss your concerns with your advisor. If their response is not satisfactory, it's time to look for a new advisor.

Are Financial Advisors Ethical?

Like any profession, there are ethical financial advisors and usually some unethical financial advisors. Though there are many professional certifications and memberships that enhance the validity and standards of the industry, anyone can encounter a bad apple at any time.

Fortunately, financial advisors are held to a very high standard across multiple regulatory boards. This may not guarantee ethical behavior, but it's a tremendous start to help clients feel more secure when working with an advisor.

Can I Sue My Financial Advisor?

Yes, you can sue your financial advisor. If you can prove they failed to abide by FINRA rules and regulations and you suffered an investment loss as a result, you can file an arbitration claim to try and be financially compensated for the loss.

How Do I Know My Financial Advisor Is Ethical?

In the same way you can't really know whether your doctor is ethical, a matter of morals is a judgement call you must make every time you interact with your financial advisor. Take note of how they act and what they say over time. As you build your relationship with them, you'll continually gather evidence on whether they have earned your trust or not.

The Bottom Line

It's an unfortunate circumstance in any profession that people with more knowledge than their clients may take advantage of those they do business with. With a little insight and common sense on top of the law, you may be able to avoid the unethical actions of some professionals that give the finance industry a bad reputation.

Article Sources
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  1. American Association of Individual Investors. "Uses and Misuses of Ben Graham-Style Investing."

  2. Securities and Exchange Commission. "Frequently Asked Questions Regarding Disclosure of Certain Financial Conflects Related to Investment Adviser Compensation."

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