Can You Find An Honest Broker on Wall Street?

The answer to this question is yes, maybe, and no, depending upon what services you are seeking and the degree of your expertise in the market.

Diogenes the Cynic
Diogenes the Cynic

Seeking a proper broker on Wall Street reminds us of Diogenes the Cynic who, as the story goes, went out in broad daylight with a lantern, looking for an honest man.

If you are only looking for custody service, the answer to the headline question is a resounding Yes! There are many honest brokers providing high quality custody service at an extremely reasonable price.

For most investors, custody services are one of the great value bargains in U.S. financial markets.

Most brokers will provide custody services free of charge to their clients, including safe custody, collection of dividends and corporate entitlements, accounting, valuation, and reporting of positions, custody insurance, reinvestment of dividends (without a commission), provision of tax documents, and forwarding of reports and communications from issuers.

One caveat with respect to custody services is that brokers try to promote ‘paperless accounts’, which means that the only proof you have that your assets exist will be on the broker’s own computers, which may be destroyed in a terrorist attack. Prudence calls for paper-based documentation.

Trade Execution is Also a Bargain

The next great bargain for quality service on Wall Street is trade execution: the service of buying or selling securities for your account.

Top flight discount brokers provide this service for between $10 to $13 per thousand shares — which is usually less than 1/5 of one percent of the value of a transaction. This service includes the execution of the trade, clearing, settlement, and receiving or delivery out of custody.

Another bargain available in the market is investment information, which because of the Internet and SEC disclosure rules, can be obtained at low cost, or free, for many publicly-held securities.

Brokerage houses sometimes provide free research reports on a selected basis to certain clients. Investors can get further information without charge from online statistical services at public and university libraries.

Where Brokers’ and Clients’ Interests Collide

Provision of investment information is where the quality of broker service begins to break down.

Information from broker-dealers is often spotty, weak, or non-existent for lesser-traded securities, issues of small companies, bonds, closed-end funds, and foreign securities. For other securities, the information and recommendations may be tainted by conflicts of interest.

Information provided by broker-dealers is available mostly for those market segments and operations in which brokers earn the greatest commissions, rather than areas that might be to the best advantage of their clients.

For example, the goals of most investors are long-term, for retirement and education of children. However, software tools offered by brokers are aimed at speculators and day-traders, the segment of the investor population that generates the highest commissions.

The Schwab StreetSmart Pro software will show the Delta, Gamma, Theta, Vega, Rho, and implied volatility for your portfolio of actively traded common stocks, but omits dividend yield, dividend coverage, earnings-growth, or other fundamental data that might be useful to long-term investors. For closed-end funds or REITs, there is no information on discounts from net asset value, and the software fails entirely when it comes to bond portfolios.

Advice and Portfolio Management

It is in the area of advice and portfolio management, however, that the interests of brokers and their clients are most at odds.

The probity of Wall Street is sorely tested in these areas:

  1. Fees for Portfolio Management: With modern computer technology, it should be possible for a brokerage house to manage a standard portfolio designed for specific investment horizons and goals for fees as low as 1/10 of one percent per year, provided that the client agrees to accept a pre-determined investment plan and that purchases and sales are executed automatically across several thousand portfolios by a small team of central managers, backed up by a focused research staff, and that normal discount level commissions are charged on each trade, subject to an annual ceiling. However, most brokers will charge fees of 1% per year, or higher, for “asset management” services, even when the portfolios are rarely modified and consist mainly of long-term Treasury bonds.

  2. Conflicts of Interest: Many broker-dealers run trading desks, investment banking operations, and sell proprietary products such as mutual funds, exchange-traded-funds, insurance, annuities, or commission arrangements on proprietary products of others. This means that your ‘advisor’, ‘portfolio manager’, or ‘private banker’ is under pressure from higher management to sell products to you, even when this is not in your best interest. The account executive that acts strictly in your interest usually receives lower remuneration and lack of advancement, and may even be fired.

It is possible to avoid such problems, side-stepping the fragile honesty of Wall Street regarding advice and portfolio management, while taking advantage of the bargain services of custody and trade execution. But to do this, you must have the time and know-how to do your own research and manage your own portfolio.

You may, of course, try to find an independent advisor to handle your portfolio for you, but this is easier said than done. The SEC requirements for licensing as an investment advisor are skimpy at best (See: “How Well Does the SEC Protect Investors?“), and there is no simple way to find an honest, competent advisor that lives in your area and that will charge a fee that doesn’t consume most of your investment income.

Waiting For Mr. Honest Advisor

The chances seem reasonable that some smart entrepreneur will come along sooner or later and apply computer technology and enterprise reorganization to the problems of portfolio management fees and conflicts of interest, just as over the last decades innovators have dramatically reduced brokerage commissions while improving custody and execution services.

In the meantime, each investor will have to grab a lantern, like Diogenes, and be on the lookout for his or her own honest broker.

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