This article originally appeared on Advisor Perspectives by Bob Veres.
Instead of focusing on the advantages fiduciary standards would provide to the profession, lobbyists who represent advisors should point to the catastrophic failures of the perverse incentives embedded in the brokerage business model.
In mid-September, I participated in a panel discussion for the Fiduciary September virtual conference, sponsored by the Institute for the Fiduciary Standard, moderated its CEO Knut Rostad. It was a distinguished panel; I was on-screen with securities/compliance attorney Brian Hamburger, longtime fiduciary RIA spokesperson Skip Schweiss, Tom Trainer of Hanover Private Client Corp. in Canada, and Steven Lee, Ph.D., of George James & Associates. The topic was the state of advice and fiduciary.
About halfway through the presentation, I made a bold prediction.
Normally I avoid making more than one or two predictions in a decade, and especially bold ones, because making these forecasts implies that you can somehow see into the future. But the more I think about this one, the better I feel about it.
Let me explain.
Our conversation went in all the usual directions: Regulators (most notably the SEC) have totally failed to support the idea that anybody providing financial advice in a professional setting should be required to give the same kind of advice to their clients as they would to their own mother. Rostad noted with some exasperation that in the most recent staff letter regarding Form CRS, the SEC went so far as to tell advisors that they cannot use the word ”fiduciary” in their most important disclosure form, because that would be a form of marketing, and is likely to ”distract” potential clients from the real issues.
What, Rostad asked, could be more important than whether an advisor is committed to embracing a fiduciary standard when giving advice?
Others, including me, noted that the brokerage firms are the primary architects of confusion about who is sitting on the same side of the table as their customers/clients. My best line was that the fiduciary standard, if implemented and enforced, represents an arrow aimed directly at the heart of the brokerage/wirehouse business model. My surmise was that brokerage executives are probably confused and exasperated by the whole idea; what’s in it for us with this fiduciary thing? How are we supposed to make money if they expect us to put the interests of our customers first?
In this vein, it’s notable that the FINRA and SIFMA lobbyists acting on behalf of the brokerage firms dismiss any suggestion that their brokers would have to act as fiduciaries as “unrealistic.” Roughly translated, that means that nobody in their right mind would imagine that those people with ”vice president of investments” on their business card would give advice that benefits their customers more than it benefits themselves or the company.
Schweiss made the obvious next point: Nobody is asking the brokerage firms to give up their sales agenda. There’s a role for salespeople in the financial ecosystem, and there is no shame in engaging in sales activities. The problem comes in when salespeople are allowed to pretend, for marketing purposes, that they’re providing objective, fiduciary advice.
My other comment is that RIA firms who are lobbying for a fiduciary standard, who want the SEC to make a clear distinction between those who adhere to one and those who do not, is a rare example of businesses lobbying for provisions that would benefit consumers at least as much as they would benefit themselves. (Can you think of another example? Anywhere in our business ecosystem?)
But here’s the rub: Rostad noted that whenever his organization or other fiduciary advisors meet with SEC officials to ask them to be more definitive about who is and is not a fiduciary, the SEC officials trot out a familiar line. They say that the fiduciary advisors should stop ”polishing their halos” when they advocate for these consumer-friendly standards and distinctions. To the SEC, fiduciary advisors are self-serving when they advocate for putting their clients’ interests first.
Viewers of the webinar might have noted, somewhere around this point, that my face was betraying a bit of impatience and even exasperation. This was when I made my prediction.
I predicted that, sometime in the fairly near future, the brokerage firms are going to be mired in yet another awful scandal which will involve serious harm to many of their customers. (Think: the misleading sales of packaged mortgages that nearly broke the global financial system and triggered the great recession. Or, before that, the scandals around securities analysis, where the analysts were issuing strong ”buy” recommendations to the general public while privately, and to their institutional customers, contemptuously deriding the things they were so enthusiastically recommending as ”garbage.” There are other examples, of course, but I’ll stop there.)
I made the prediction to make an important point about our fiduciary lobbying efforts. The people we send to the SEC and Capitol Hill sound self-serving and “holier than thou” because their arguments talk about the differences between them (fiduciary advisors) and the brokerage firms.
It would be much more effective if we argued, instead, purely on the side of the brokerage model. If the brokerage firms are fighting a fierce battle against having to be required to give the same advice to their customers as they would to their mother, isn’t it fair to ask what kind of advice they’re giving?
And, of course, you, me and the SEC staffers all know the answer. The brokerage model is founded on a fundamentally greedy incentive structure, where brokers are measured according to the assets they gather, and the (more profitable to the firm) types of products they recommend.
The people who create investment ”solutions” are incentivized based on how profitable and popular those solutions will be in the marketplace, not on whether they’re likely to be beneficial to the end customer. It was this kind of incentive structure that led a certain prominent brokerage firm to create an ”investment” that was profitably sold to unwary consumers, while the company allowed bearish hedge fund managers the opportunity to make financial bets based on their knowledge that this investment would inevitably fail. (Google ”Abacus.” The same company has also been accused of betting against its own investors for fun and profit.)
History has decisively shown that whenever there are greedy incentive structures, people are going to act on them. They will create toxic-but-profitable products and push self-serving investment solutions and advice. “Feed the hungry pig” is a term that originated on Wall Street. It has nothing to do with benefiting the consumer.
Self-serving investment solutions, sold under a structure that incentivizes greed, will inevitably produce scandal, and those scandals inevitably inflict real (sometimes crippling) financial damage on thousands of brokerage customers. Does the SEC want to enable that?
That is the argument that our fiduciary lobbyists should be making. We should be saying, as clearly as possible, that the current policies allowing brokers to market themselves as if they’re providing objective advice, while they’re operating under a greedy incentive structure that encourages advice not in the best interest of their customers, will predictably result in yet another major scandal.
We’ve seen it before, and we will see it again. If we lay that prediction in the lap of the SEC and make it public, then, when my bold prediction comes true, we should publicly make the point that all the harm that was inflicted on unwary consumers could have been prevented if the SEC had taken our simple advice. And we might note in passing that we offered that same advice, and a similar warning, before the previous scandal as well.
And we can note that, yet again, none of the collateral damage to consumers was caused by advisors who embraced a fiduciary standard. The solution to these never-ending cycles of scandal is really that simple.
How long will it take before the SEC learns this uncomplicated lesson and acts to protect the consuming public from the next scandal? And the one after that?
Unfortunately, that’s a question where I am unable to make a confident prediction.
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