Other People’s Money: Beware of Financial Misconduct 

By Bob  || September 13, 2026

The Principal-Agent Problem

There is an old problem in finance that has a simple name: other people’s money. 

When you manage your own money, you receive the upside and suffer the downside. When you manage someone else’s money, the economics can be different. You may earn a fee if the account gets larger, a commission if a product is sold, or a percentage of the profits if an investment succeeds. If it fails, the customer generally bears most of the financial loss. 

Economists call this a principal-agent problem. I prefer a simpler question: 

Does the person giving me advice make more money if I say yes? 

A conflict of interest does not mean someone is dishonest. Most people working in financial services are probably trying to do a good job for their customers. But incentives matter. They can influence judgment consciously or unconsciously. 

It is also important to distinguish between a conflict of interest and financial misconduct. A conflict by itself is not misconduct. The problem arises when conflicts are hidden, poorly managed, allowed to influence judgment, or placed ahead of the customer’s interests. 

Fraud, theft and intentionally misleading a customer are clear red lines. The more interesting questions often live in the gray areas. 

When does a sales incentive begin to influence advice? When does an investment manager take more risk because the upside is disproportionately valuable to him? When does an advisor become more salesperson than advisor? 

Those are the questions I want you to think about. 

Follow the Money 

Start with one of the most common ways financial advisors are paid: a percentage of assets under management, usually called an AUM fee. 

Suppose you have $500,000 invested with an advisor who charges 1% per year. The advisor’s firm receives about $5,000 annually. If your account grows to $750,000, the annual fee grows to $7,500, albeit advisory firms often reduce the percentage charged as accounts grow. 

On the surface, that seems reasonably aligned. You want your wealth to grow and the advisor benefits when it does. 

But look a little deeper. 

What if you decide to use $125,000 to pay down your mortgage? The advisor’s annual revenue falls by about $1,250. The same issue can arise if you buy an immediate annuity, make a substantial charitable gift, move money into an employer retirement plan, or simply decide that part of your portfolio does not require ongoing management. 

None of those decisions is automatically right or wrong. The point is that the advisor has an economic interest in keeping your money under management. 

That becomes particularly important when expected investment returns are modest. 

Vanguard’s most recent capital-market forecast estimates that U.S. equities may return approximately 4.2% to 6.2% annually over the next ten years. Importantly, Vanguard says those forecasts are nominal and before inflation, taxes and investment expenses.  

Think about what that means. 

At the low end of Vanguard’s range, a 1% annual advisory fee consumes almost one-quarter of the 4.2% expected gross return before taxes. Even at the high end, 1% represents about one-sixth of the expected return. 

And the advisory fee may not be the only cost. There may also be the expense ratio of the mutual fund or ETF, transaction costs, insurance expenses, or other charges. 

Suppose, only for illustration, that you earn the midpoint of Vanguard’s forecast, about 5.2%, and have $50,000 invested. At 5.2% annually, $50,000 grows to roughly $83,000 after ten years before taxes. 

Reduce the return by 1.5 percentage points for advisory and investment expenses and the ending amount is roughly $72,000. 

That difference matters. 

Taxes will reduce what a taxable investor actually keeps, although the amount varies significantly depending upon dividends, realized gains, tax rates and the type of account. Because Vanguard’s forecast is before taxes, fees consume an even larger percentage of the after-tax return that eventually belongs to you. 

This is why I do not like hearing someone say, “It’s only 1%.” 

One percent of your assets is not necessarily 1% of your investment return. 

Good financial planning may absolutely be worth paying for. But understand what you are paying, in dollars, and compare the fee with the amount of return you might reasonably expect to keep. 

Best Interest Is Only the Starting Point

I have written before about the sometimes confusing standards governing financial advisors and the difference between suitability, best interest and a fiduciary obligation. Rather than repeat that discussion here, you can read my earlier post, Integrity, Trustworthiness and Your Best Interest Matters when considering a Financial Advisor.  

For purposes of this discussion, I think the more important question is simpler: 

If you are paying someone for financial advice, shouldn’t you expect that person to put your interests ahead of his or her own? 

Rules and disclosure requirements are important, but they cannot eliminate every conflict. 

An advisor, broker, insurance professional or investment manager may sincerely believe a recommendation is appropriate while also benefiting financially if you accept it. 

So don’t stop with the question, “Are you acting in my best interest?” 

Also ask: 

How are you paid, and do you make more money if I follow this particular recommendation? 

“Our Firm Is Focused on Selling Annuities” 

I recently spoke with a young employee of a financial services firm who told me that his firm was focused on selling annuities. 

That sentence bothered me. 

Why would a financial planning organization begin with the product it wants to sell rather than with the customer’s problem? 

Annuities are not inherently good or bad. 

A single premium immediate annuity can be a useful tool for someone who wants to exchange a lump sum for a predictable stream of lifetime income. A variable annuity is a different and generally more complicated product. It can include a base contract charge, underlying investment expenses, surrender charges, administrative expenses and charges for optional features. 

The Secutities and Exchange Commission notes that the base mortality and expense charge on variable annuities is typically around 1.25% annually and that part of the charge may be used to compensate the financial professional who sold the contract.  

A variable annuity might be exactly right for a particular customer. 

That is not my point. 

My question is this: 

Is the customer being offered an annuity because it is the best solution to the customer’s problem, or is the firm looking for customers because it wants to sell annuities? 

The order matters. 

Problem first. Product second. 

Life Insurance: Follow the Compensation 

I have also written previously about life insurance and when I believe term versus permanent coverage might make sense, so I won’t repeat the entire discussion here. Insurance: Why It’s Important and Some Considerations 

One correction to something I initially wrote while working on this article is worth mentioning. 

It is too simplistic to say permanent insurance is always more expensive than term insurance. The National Association of Insurance Commissioners explains that term insurance is intended to provide lower-cost coverage for a defined period, but cash-value insurance may be more cost effective when someone genuinely needs lifetime coverage. That said, I think the vast majority of folks would be served perfectly fine by term insurance. 

The conflict-of-interest lesson is more important than arguing that one type is universally better. 

Life insurance agents may receive commissions for selling policies. Different products can generate different amounts of compensation. Riders and additional features can also increase costs. 

So begin with the need. 

Do I need life insurance? 

How much? 

For how long? 

What risk am I trying to protect against? 

Only after answering those questions should the discussion turn to which insurance product solves the problem. 

Once again: problem first, product second. 

Paying More for Active Management 

I have already spent a fair amount of time on this blog discussing active versus passive investing, most recently in Who is the Customer? Why Passive Wins. In that post, I discussed both the evidence favoring low-cost diversification and the conflicts that can arise when investment companies pay to have their products distributed through financial advisors.  

There is no reason to make that entire argument again. 

But we now have another year of evidence. 

The S&P Dow Jones Indices SPIVA U.S. Scorecard compares active funds against appropriate benchmarks and includes funds that closed or merged rather than pretending unsuccessful funds never existed. That makes the comparison more useful.  

For the year ending December 31, 2025, about 79% of actively managed large-cap U.S. equity funds underperformed the S&P 500. Over ten years, about 86% underperformed, and over twenty years approximately 93% underperformed.  

There will always be active managers who outperform. 

The difficult part is identifying them before they outperform, determining whether the performance came from skill or luck, and knowing whether the advantage will persist after fees and taxes. 

The conflict arises when the more expensive product also generates more income for the people recommending or managing it. 

If a higher-cost investment is recommended, ask a very simple question: 

What evidence suggests that the additional cost is likely to improve my outcome after fees and taxes over a long-term investment horizon? 

Private Investments and the Pressure to Put Money to Work 

The same problem appears in private investment management. 

Suppose an investment manager raises a large pool of money from investors. The manager has employees, offices and an organization built around finding investments and putting that capital to work. 

What happens when attractive opportunities become scarce? 

The best investment decision for the customer might be to wait. 

The manager’s business incentives may point in another direction. 

Depending on the fund structure, fees may be based on committed capital, invested capital or assets under management. The manager may also need successful investments to raise the next fund. 

None of this means that private investment managers knowingly make bad investments simply to collect fees. 

It means there can be pressure at the margin. 

A deal that would have been rejected when opportunities were plentiful might begin to look acceptable when billions of dollars are waiting to be invested. 

Sometimes the best investment is the one you do not make. 

Carried Interest and the Incentive to Take Risk 

Private equity and hedge funds create another interesting incentive. 

Managers can receive performance compensation. In private equity this is commonly called carried interest, or “carry.” Many funds establish some threshold or hurdle before the manager begins participating materially in the profits. 

That can create good alignment. Investors make money and the manager makes money. 

But the alignment is not perfect. 

Imagine a manager approaching the level where substantial performance compensation begins. 

A conservative investment might produce an acceptable outcome but not enough return to generate much performance compensation. 

A much riskier investment could produce an enormous payoff if successful. 

If the risky investment fails, investors lose their capital. The manager certainly suffers too. Reputation can be damaged, future fundraising can become difficult, personal capital may be lost and clawback provisions may apply. 

But the economics are still not necessarily symmetrical. 

When upside compensation is enormous and downside exposure is more limited, there can be an incentive to take more risk. 

That does not prove misconduct. 

It does mean investors should understand the incentive. 

Leopold Aschenbrenner and Situational Awareness 

A remarkable recent story demonstrates why this matters. 

Leopold Aschenbrenner graduated from Columbia University at age 19 as valedictorian of his class, later worked at OpenAI and founded the investment firm Situational Awareness. He is now 24.  

His conviction about artificial intelligence attracted enormous amounts of capital and initially produced extraordinary investment results. 

Then things changed. 

Reuters reported that Situational Awareness suffered a 67% portfolio decline in July 2026 following losses in leveraged AI-related investments and a margin call. Much of its public-equity portfolio was subsequently liquidated. JPMorgan recently stopped lending to the fund, and the SEC has reportedly subpoenaed several banks seeking information about the fund’s trading and use of leverage. An SEC inquiry does not establish that anyone committed wrongdoing.  

I want to be careful about that distinction. 

I am not suggesting that Aschenbrenner committed financial misconduct. 

What interests me is the economic structure surrounding the decisions. 

An SEC filing states that the fund’s investment adviser receives investment-management fees and that its general partner receives a performance allocation. Another SEC filing identifies Aschenbrenner as the managing partner and control person of both the investment adviser and general partner. The public filing does not disclose the percentage of that performance allocation.  

So we should not pretend to know exactly how much Aschenbrenner personally stood to make. 

But think about the incentives. 

If a manager receives a substantial percentage of profits, extraordinary investment performance can generate extraordinary personal compensation. Leverage can magnify those profits. 

Leverage also magnifies losses. 

Did performance compensation cause excessive risk taking at Situational Awareness? We don’t know. 

Did youth or inexperience cause it? We don’t know that either. 

But when concentrated investments, substantial leverage, enormous conviction and performance-based compensation come together, an investor should ask difficult questions about risk controls. 

Intelligence is valuable. So is conviction. 

Neither replaces risk management. 

When Should an Advisor Say No? 

I recently asked an experienced wealth-management executive at a Registered Investment Advisory firm a question. 

Suppose a customer wants to make an investment that the advisor believes is not in the customer’s best interest. The advisor explains the risks, recommends against it and the customer proceeds anyway. 

Would the advisor resign? 

His answer was no. 

I have thought about that answer. 

The customer’s money belongs to the customer. An advisor should not resign every time someone disagrees with advice. Adults are entitled to make decisions that other people might consider foolish. 

But there must be a point where the question becomes different. 

If an advisor genuinely believes a customer’s actions are seriously inconsistent with the financial plan, risk tolerance or long-term welfare, is simply saying “I advised against it” enough? 

At what point does continuing to collect the fee become inconsistent with the responsibility the customer thought he or she was paying for? 

I don’t think there is an easy answer. 

That is precisely why the gray areas matter. 

Protect Yourself by Asking Better Questions 

You do not need to become an expert in every financial product. 

You do need to understand enough to ask good questions. 

When someone recommends a financial product or service, ask how that person and the firm are paid. Ask whether the compensation changes depending on which product you choose. Ask for the total cost in dollars, not only percentages. 

Ask what the simplest alternative would be. 

Ask whether there are commissions, referral fees, performance fees, revenue sharing, surrender charges or other compensation you should understand. 

If the investment is complicated, ask the person selling it to explain it in language you understand. 

If you still don’t understand it, don’t buy it. 

And I particularly like this question: 

Would you recommend the same thing to me if your compensation were exactly the same regardless of which option I selected? 

You may learn something from the answer. 

Final Thoughts 

Money creates incentives. Other people’s money creates even more complicated incentives. 

An advisor paid on assets under management has an incentive to keep assets under management. 

An insurance producer paid a commission has an incentive to sell insurance. 

An investment manager charging a higher fee benefits when investors select the higher-fee product. 

A private investment manager may have incentives to put money to work. 

A manager receiving performance compensation has an incentive to generate returns above the level where that compensation becomes valuable. 

None of those statements proves dishonesty or misconduct. 

They simply identify conflicts. 

Good financial professionals can provide tremendous value. The answer is not to distrust everyone working in financial services. 

The answer is to understand the business model before accepting the advice. 

When someone recommends a financial product or investment, ask two questions: 

Why is this good for me? 

And what happens financially to you if I say yes? 

If the answers are clear, reasonable and aligned, proceed with greater confidence. 

If the answers are vague, complicated or defensive, keep asking questions. 

It is your money.