Here We Go Again

Here we go again. That's what I said when I heard about how Wells Fargo is being investigated again for overcharging and generally taking advantage of its customers. We've all heard in recent years how the bank opened tons of unnecessary deposit and credit accounts and overcharged customers for insurance on loans. But now it's not just the banking business that's in trouble, it's also their wealth management arm, Wells Fargo Advisors.

Last week Wells Fargo & Co disclosed that it's running an internal investigation of its wealth management business at the request of the Justice Department. This stems from recent whistleblower claims about the firm's sales practices. What's being reported is that the firm was asked to investigate inappropriate referrals to its wealth management business, overcharging customers, and steering them into expensive proprietary investment and loan products.

To some this is news but to me it's like a walk down memory lane. I have previously written about the fundamental flaws in the brokerage industry. In fact, these flaws are a large part of why I left to go into private practice as a fee-only advisor. So, while I've never worked for Wells Fargo Advisors, or any part of Wells Fargo, I have worked in the "banking channel" and wanted to discuss how and why these problems occur.

I just lapsed into some industry jargon and here's a quick explanation. The brokerage industry is broken into a few groups. There's the "wirehouse", which is how Morgan Stanley and UBS, for example, are referred to. There's the so-called "independent channel", which is made up of regional and local brokers who might have a local office with their name on the door, but directly or indirectly represent specific investment companies. Then there's the banking channel, which is what you might expect - brokerage and advisory services offered through a local bank branch.

The banking channel is interesting because it's full of potential conflicts of interest. Here's the typical structure.

Either a bank employee or, often, an independent contractor, has an office inside a bank branch. This person's job is to sell investment products and services to bank customers. Often the other branch employees, such as tellers and folks working on the floor, are incented to refer customers to this person. These incentives can be directly monetary, or more frequently are part of the bank employee's overall job description. Either way, this cross selling is typically expected, both by bank managers and by the advisor sitting across the room.

The teller, for example, isn't trained on investment products or required to hold a securities license. But they usually know their customer and are expected to strike up that first conversation, ideally leading to a referral. Maybe they see a customer depositing a larger check. Maybe they see a large savings account balance. Or, maybe the customer mentions they got laid off from work and aren't sure about their old 401(k) plan.

What's wrong with this so far? Nothing. And everything. I think it's absolutely fine for bank staff to ask cross-selling questions. Sometimes it's even done with the best intentions and the tellers are often only doing exactly what they're told anyway. But that's about where the appropriateness stops because from there the customer is being referred to a fundamentally flawed system, often without realizing it.

The brokerage industry perpetuates a game of double-speak about what they're doing in bank branches. To the public their advisors provide helpful advice, listen to their customers, and act in the customer's best interests. But in disclosure documents and before regulators their advisors are salespeople whose advice is "incidental to the sales process" and therefore subject to reduced disclosure, liability, and regulatory requirements.

Often titled as a Financial Advisor, the branch rep is, in truth and in practice, an investment salesperson who works for the bank or for a third-party "broker-dealer" contracted by the bank. Obviously, the rep's primary obligation is to their employer first, customer second, and they are paid to sell.

The rep may have a base salary, but the lion's share of their compensation comes from commissions. Compensation often changes monthly and months with lots of sales can turn into "big comp" months for the rep. The reason is the rep typically has a compensation grid that pays them a larger chunk of the commissions they generate as they sell more. This incentivizes generating commissions now versus spreading them out over time.

This virtuous (or vicious) cycle often leads the rep to sell products that pay higher upfront commissions (such as variable and index annuities, loaded mutual funds, etc), to juice up their compensation by hitting a higher target on the grid. This grid-gaming isn't often openly discussed in sales meetings, but managers darn well know it happens, in large part because their compensation is often tied to these same production numbers.

So, when the customer sits down the "advisor" are they receiving a product recommendation because it's the best thing for them or the advisor? Is the advisor just one sale away from the next level on the grid and would love to close a high-commission variable annuity sale, so that's what's being offered whether the customer needs it or not? Or, is the customer receiving a recommendation to buy the bank's proprietary products, which typically cost more and perform worse, because the advisor gets extra credit for selling them?

Potentially making this situation worse is that the rep could also have assumed expertise and competence by holding an industry certification, or maybe even be a Certified Financial Planner. Add that to the customer's comfort with other branch staff, the assumed safety and security of being in a bank branch, not to mention the FDIC (and NCUA for credit unions) placards scattered around, and it's no surprise that the customer could walk into the bank to deposit a check and walk out with a variable annuity.

You may have heard of recent court decisions that will likely send the so-called "fiduciary rule" to the US Supreme Court for final verdict. While the rule wasn't perfect, it was a start at clearing up some of the muck I mentioned above. Whatever happens with the rule, the Securities and Exchange Commission recently announced that it's trying to create its own fiduciary rule and one of the areas being looked at is job titles.

Maybe, just maybe, the key to helping the customer through the banking channel financial advice/sales gauntlet is simply changing job titles.

Think about it. Would your response be different when approached by a nice bank teller who asks if you'd like to talk with the branch's friendly Investment Salesperson? I think this simple change would make a huge difference and might make a meaningful start to fixing the flawed brokerage industry.

Have questions? Ask me. I can help.

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