Some Brokers Openly Acting Against Customers’ Best Interests

As is well known, a financial advisor paid by a client has a fiduciary duty to act in that client’s best interests, but a broker has no such responsibilities and deals with its customers as arms-length counterparties under the law.  It is for this reason ASIC legislation requires those taking fees for product distribution like brokers and trading platform providers to disclose their conflicts of interest so their customers are aware they have no obligation to act in the customers’ best interest and are in many cases product distributors are incentivised not to do so as they are remunerated by getting customers to trade rather than the eventual outcomes of those trades.

In practice most good brokers will try to strike a balance between the inherent conflicts of interest of trying to earn a fee from facilitating a transaction and ensuring the transaction facilitated is in the customer’s best interest.  A broker whose customer discovers the broker is “ripping him or her off” generally does not retain customers for very long. In the best examples of “honest broking”, a broker either brings a customer an attractive transaction the customer could not access otherwise in return for a disclosed fee or the broker takes a small fee in return for providing a service such as smoother execution or simply alerting a customer to an opportunity they may otherwise have missed.  A good example of the former is a bank distributing a new issue transaction to its clients and of the latter is the on-line trading platforms many brokers or market makers operate for term deposits where fees can be as low as 1bp to connect buyer with seller. However, there have also been occurrences of less scrupulous brokers inducing clients into trades that are clearly not in their best interests and putting their own interests ahead of those of their customers (which all brokers are permitted to do as they owe no fiduciary duty to act in their customer’s best interests).

One recent example is of some brokers promoting Northern Territory Treasury Corp (NTTC) bonds based on a new pricing structure from NTTC.  As interest rates have fallen, rates offered by NTTC have become attractive in the wholesale market.  NTTC initially offered brokers, agents or advisors a disclosed fee paid in addition to the rates they were willing to offer to investors with these rates for investors being identical whether the investor approached NTTC directly or via an agent. Brokers who promoted NTTC bonds under this scheme could be seen as acting in their customer’s best interests if the rates offered by NTTC were deemed to be attractive.

However as NTTC was inundated with large amounts of monies due to the investor rates they were offering, NTTC started varying terms and conditions. In November, NTTC initiated a new arrangement where it began to offer investors interest rates that were 20bps (running) better if investors contacted it directly rather than through an intermediary to whom they paid a flat fee of 25bps. This pricing arrangement disadvantaged investors who had previously used brokers to access investments from NTTC as they now received a lower rate if they went via the broker whereas previously the rate they received whether they had gone directly of via the broker was identical.

NTTC possibly thought the differential in rates would encourage investors to come to it directly, but this thinking relied on brokers who had previously helped customers to invest in NTTC to alert the customers to the new differential in rates, but there was also a strong incentive for brokers not to tell their clients as this could potentially involve them losing their commission. There was also no reason for any customer, who had previously trusted their broker, to question whether they could now get a better rate by going to NTTC directly as this had not been the case previously.

The worst part of this new pricing structure from NTTC was the investor could forgo up to four times as much in interest as the broker received in brokerage. For example,  NTTC offered a fixed rate of 1.00% for a 5 year investment for those investors who applied to them directly, but only a rate of 0.80% if the application was stamped by a broker who they would then pay a commission to of 0.25%.  Hence if an investor purchased $1 million of 5 year NTTC bonds, the investor would receive a cumulative amount of $50,000 in interest over 5 years if they went directly to NTTC, but only $40,000 if they went via a broker with the broker receiving a commission of $2,500.

If any broker put its clients into NTTC bonds under this scheme, it is very hard to argue it was acting in the best interests of its customer. Using the example above to make a $2,500 commission for itself, the broker is knowingly making the client $10,000 poorer and the only “winner” here is NTTC who saves itself $7,500 on a net basis from the reduced interest rate they pay less the broker’s fee.  A smart broker with integrity could take an alternative approach of disclosing this difference in interest rates to the customer and helping them apply directly to NTTC to achieve the higher rate and then charging the customer a $2,500 fee for bringing them the trade.  This would leave the customer $7,500 better off and the broker in an equal position financially as opposed to non-disclosure of the broker fee and the reduced rate for the customer.

Amicus is not a broker and at Amicus we do not take commissions because of the conflict of interests between taking fees and providing truly independent advice so Amicus always recommends the best method of execution for its clients and if it receives any commissions we disclose them and rebate them to the client. Advice for our clients is inexpensive as compared with the alternative as detailed above. For any investor who purchased NTTC bonds and received the lower rate our advice to go directly to NTTC with Amicus filling out the application form but not “stamping it” would most likely have saved them far more in one transaction than the sum of any advisory fees across many years.

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