Are References and Referrals a Conflict of Interest?

In 1988, I was named business editor at The Morning Call in Allentown, Pennsylvania, and I needed to make as many contacts as possible quickly in the business community. So I started networking, meeting with the top executives in the Lehigh Valley area and, at those meetings, asking for introductions and ideas on who else to meet.

Because of my strong interest in investing and personal finance, I asked everyone to recommend a stockbroker or financial planner. Quickly, a few names stood out, because they seemed to be the advisors of choice for the community's elite business leaders.

There was Al, from the big-name firm, who was recommended for reasons ranging from "he's so nice" to "everyone who is anyone uses him" to "he has the biggest minimum investment requirements in town" to "he's well connected."

There was Sean, who was "the funniest guy in town," "really sharp on picking stocks," and "who seemed to have the right attitudes about money." Stan "ran the show" at the second-largest brokerage house in town, and was "a whiz with the market." Ed was the head of the local stockbrokers club, had written articles for the newspaper, was "reasonably priced" and "just a guy who you meet and are sure you can trust."

And there was Matt, who apparently was nice, conservative, and "the right religion for some people in town."

I'm not kidding.
I kept notes and built files. (Eventually, I invited these men to participate in a stock-picking competition run by the newspaper. It turned out particularly badly for Al, because his performance was not only worse than the others but so much less than cracked up to be.)

Each person had something different to say about the advisors; if you had just moved to town and were looking for an advisor, one or more of those attributes -- bestowed on the brokers and planners by leading business minds in the area -- would stand out. Someone would jump to the top of your prospect list because of who he works with -- "If he's good enough for the chairman of a Fortune 500 company (or the rising executive star from another big multinational firm), he's good enough for me" -- or because he prices his services reasonably or because he's the same religion as you.

What's interesting about the list of advisors and their personal attributes is that it came from a group of executives who had a lot in common with each other. Money and work was a focal point of their lives, they were all successful, they had big aspirations and dreams, and they wanted to believe they could trust whomever they hired to oversee their financial life. Moreover, they were happy with their advisor and glad to discuss what made their guy so great; none of these people had any sort of horror story in finding or working with a broker or planner.

If you had been there, looking for a financial advisor and didn't know any better, you would have felt reasonably comfortable that any and all of these counselors could meet your needs. You also might have felt that the general impressions of the people providing you with a reference -- saying they would hire this guy or that -- was enough to tell you that an advisor was good.

That's where you'd be sadly mistaken. Each of the people I talked to made his or her referral by citing the one thing that stuck out about his or her particular advisor. In many ways, that referral was an attempt to justify each person's own decision, to say he had picked the right man because he was hard working, successful, diligent, well-connected, or reasonable. If I decided I liked a particular advisor -- and each person knew I was looking for sources, and not for a financial planner myself -- it would validate his or her opinion.

Therein lies one of the inherent problems with referrals, the potential for conflict of interest. With referrals, you always have to wonder whether the advice -- even when you go out of your way to seek it -- truly is in your best interest.

In this situation, the referrals were personal, rather than professional. When a financial planner recommends an accountant, however, there is reason to question the motives of the advisors involved. There can be referral fees or other incentives involved, either monetary or in the form of returned favors. (This almost always is the case in full-service firms, in which a financial planner wants to keep you in the house when you need, say, an insurance agent.)

Many trade groups are happy to provide you with the names and numbers of counselors in your area. Obviously, the groups have a bias toward their own membership, meaning anyone who is not a member or who has not achieved a certain credential won't be included. Your state society of certified public accountants, for instance, will not give you referrals to enrolled agents, a different status of tax preparer that may be better suited and less expensive to the tax preparation needs of many individuals.

Many advisors actually pay for a spot in a referral service, meaning their names go out only if they pony up some dough; there is no qualitative standard applied to these referrals, only a monetary one. What's more, the fact that an advisor needs to pay the freight to advertise on a service for more clients is not necessarily an endorsement for the advisor's business.
By Chuck Jaffe
Chuck Jaffe is a senior columnist and host of two weekly podcasts at MarkWatch. He has also been a guest speaker on several television and radio shows.

Copyrighted 2020. Content published with author's permission.

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