Brokers consult -- but sell, too

A broker is a broker is a salesman. Sure, your broker calls himself a financial consultant or an account executive. He or she may very well deserve such a title if the advice is sound and earning you money.

But despite the authoritative title, he's not an independent expert. He and his firm profit from that advice. And investors should understand that the way a broker makes his money may color his advice.

``Wall Street is a selling machine,'' says Michael Billy, a veteran broker who now edits The Financial Investigative Reporter, a monthly newsletter based in Naples, Fla. ``You've got to keep asking yourself: What do I get out of this and what does he get out of this?''

In most transactions, a broker pockets from 25 to 50 percent of the commission fees you pay. Of the $100 (1 to 3 percent of purchase price) you may pay to buy $6,000 worth of stock, your broker will probably get about $40.

It doesn't sound like much, but the average broker has more than 300 clients. And most trades are larger. Last year, the average Merrill Lynch broker with more than two years' experience took home about $110,000.

The brokerage firm uses that payout spread (25 to 50 precent) to encourage its salespeople to sell certain products.

In February, for instance, Merrill Lynch made several changes in the payout rates to get brokers to shift their emphasis slightly away from selling stocks and bonds. The company now has financial incentives to get brokers to bring more of the customer's assets -- tax shelters, insurance, cash management accounts, second mortages -- to Merrill Lynch.

And for the first time, Merrill Lynch will be giving brokers a cut of the interest earned on margin accounts. A margin account is one for which you take a loan from your broker to buy more securities. The collateral is the stock you already own. It's a speculative investment strategy, and some experts are concerned that investors will be encouraged by their brokers to take unnecessary risks.

``I can see some real horror stories coming down the road,'' Mr. Billy says.

To get brokers to spend more time with clients of larger accounts (and less with smaller ones), Merrill Lynch recently cut the commission paid to brokers who make small trades. A number of large retail brokerage firms have taken or may soon take similar steps.

Pay incentives that could put brokers in conflict with client interests are not new, but the novice investor may not always be aware of them.

For instance, if you buy shares in a mutual fund or unit trusts bearing the brand name of your brokerage firm, your broker almost always gets a higher commission on such sales. Yes, his firm's fund may have a better record than the other independent funds he sells, but don't assume that is the only reason he's suggesting you buy it. Ask him about the performance record of other, similar funds he sells.

Most brokerage firms are also underwriters; that is, they are paid to introduce and create a market for new stock. So you are more likely to get a call from your broker suggesting the purchase of, say, Great Gains Inc. if his firm is underwriting it. It may be a wonderful investment. But keep in mind your broker may have additional reasons for recommending it.

Your broker may also be thinking about a weekend at a nearby resort when he calls. Sales work can be discouraging. The average broker makes 17 cold calls a day, according to a recent study by Registered Representative, an industry trade magazine. To spur his salemen on -- especially at the end of a slow month -- office managers will award cash bonuses or trips.

And like everyone else, brokers must make monthly mortgage or car payments. These concerns, Billy warns, may prompt a sudden interest in your account. The pitch tends to come a week or so before the end of the month.

Why? Because securities laws require a settlement period of five business days. If you buy Great Gains Inc. on April 25, for instance, the settlement date will be May 2. Your broker doesn't get his commission check until the end of May. But if you buy stock on or before April 23, your broker and his firm get credit for the sale in April.

Pull out some old confirmation slips and see if you bought an End-of-the-Month Special, Billy suggests.

In fairness to brokers it should be noted that they can be extremely valuable partners. They're often the first to know about events affecting your stock's price. Most are backed by well-financed and knowledgeable research departments.

But it behooves the novice investor to be aware of potential pitfalls. Mr. Billy cites four financially fatal factors that a broker can eliminate or exacerbate:

Not understanding what you're buying.

Paying too much for it.

Holding it for too short a period.

Not knowing who's giving the advice and why.

For more information on broker-client relations, check: ``How to Talk to a Broker,'' by Jay J. Pack (Barnes & Noble Books/Harper & Row, $5.95) or The Financial Investigative Reporter, Gulfwest Financial Group Inc. (PO Box 9586, Naples, Fla. 33940; 12 monthly issues, $158.).