August 5, 2010
While I applaud the industry for making efforts to create better advisors, I do not believe that the current legislative proposal, making all advisors adhere to a fiduciary standard, will create a better client/advisor relationship without causing significant harm. I believe this for several reasons.
First, we currently have regulations that form the basis for brokers and an advisors that have not been managed in the publics best interest. These regulations have been on the books for over 70 years, yet the regulations have enabled 1933/34 Act Advisors to market and promote their services as if they were 1940 act advisors. As I understand it, a 1933 act advisor cannot give advice to their client unless, "it is incidental to a product sale." This seems to fly directly in the face of most of the marketing material I see today. Prior to making a wholesale change of the regulatory framework, shouldn't the regulatory agencies be properly enforcing the rules that are already on the books? Should not a broker, be a broker? And an advisor be an advisor? How did we get to the point that a wire house broker could put the title "investment advisor" on his business card? This goes directly against the regulations that were written in 1933. Is it really necessary to make a broker a fiduciary or let the market determine whom it wants to work with? Shouldn't we really be changing the deceptive marketing practices, not the law?
Second, the definition of Fiduciary is not now, but will forever become a useless word in the industry. What is a fiduciary? It is a "higher standard of care." If that is the case, how will it remain a higher standard of care if it is the only standard of care? This word will be relegated to how the courts and arbitration panels define it. Is it possible that one persons advice could be considered reckless, yet another advisor would make the same recommendation and deem it practical? Would an advisor now be giving advice based on what a courtroom would say, not based on the financial conditions a client faced? Could contrarian advice to a client eventually be deemed unlawful?
When working with clients, the correct answer to almost all questions a client asks begins with "it depends." How an advisor interprets the it depends will be the quality of advice that he gives. If a 1933 act broker is obtaining a commission on their advice, how will a court decide which component is advice and which is sales? Is it possible to break them out?
Third, what type of information and knowledge about a client is required to become a fiduciary? If a retail client wants to buy a fund that is very volatile, what due diligence does the advisor have to do to fulfill his fiduciary duty? What if the client doesnt want to get his advice, and merely needs the transaction executed? Is it possible to waive the fiduciary liability? If not, why would an advisor execute the transaction and take on legal liability? Where can the client then go to execute the transaction?
It is my belief that to be a fiduciary for a retail client, you must have a comprehensive view of their financial resources to make that decision. It is impractical for every financial salesman to complete this task, much less put a client through this task, prior to every transaction. By doing this, transaction costs, in terms of time, compliance and insurance, increase dramatically. This will eventually cause the barriers to entry in this business to rise, and lower the overall standards and quality of advice.
The current rules seem to have all the teeth they need to manage the differing worlds of investment brokers, insurance brokers, investment advisors and financial planners. The issues seem to revolve around the enforcement of those rules and the cost of enforcement. The most noted examples of financial shenanigans did not come about due to inadequate rules, but to the fraudulent activity of those perpetrating the acts. (Madoff, Stanford, etc.) Just because the law said they were supposed to be fiduciaries didnt prevent the fraud from occurring.
Regulatory Agencies have the difficult task of balancing the acts of promoting commerce, yet protect the integrity of the industry. They, for better or worse, have no ability to change behavior through a regulatory framework they can only change costs and consequences. It is clear to me that the cost and consequences to this change would harm the consumer through a false sense of security, in addition to needless extra costs that will be born on the whole industry, not just those who choose to be fiduciary advisors. In my professional opinion, advisors will not change their behavior, but will merely cover their liability. This will not have any positive effect on the industry or its clients.