From Fiduciary to Best Interest – September 2018

It’s that time of year again. My favorite season, Halloween. On August 31st Halloween stores started popping up in abandoned storefronts everywhere. Let’s see, if Halloween starts in August and runs to October 31st, I call that a season.

These two friends are debating knocking on the door of a big scary haunted house. Can they get through those gates to the front door? If they do live long enough to get to the front door will there be candy? Will it be worth the fear?

Have you ever felt like this walking into a brokerage firm? Talking to an advisor? Not sure what is going to happen with your money?

What scary things could happen?

One thing I find really scary is a new regulation proposed by the SEC. It is called “Regulation Best Interest.”

Regulation Best Interest is intended to enhance the quality of broker-dealer advice. It requires recommendations to be in the best interest of the retail customer, without placing the financial or other interest of the broker-dealer ahead of the retail customer.

Regulation Best Interest is the new version of the Fiduciary Rule. The Fiduciary Rule has been defeated.

This is the recovery attempt.

The total irony of the Fiduciary Rule and Regulation Best Interest is that in attempting to redefine what is in the best interest of the retail investor, it begs the obvious question:

“You mean the brokers and advisors I have been talking to were not required to act in my best interest?” (correct)

“And I’m finding this out now?” (correct)

Pretty scary stuff. What exactly is the message to retail investors?

I found out about Regulation Best Interest by reading the remarks of Brett Refearn Director, Division of Trading and Markets at the SEC, also known as the “Commission” at the Annual FINRA Conference.

I can’t decide if Regulation Best Interest is Orwellian or taken directly from Atlas Shrugged. I may have to read both books, again.

Regulators thought that by forcing a retail broker to act as a “fiduciary” it would redefine the moral compass, sorry, the quality of advice given to retail investors. Why do we need another rule?

I think it is pretty simple, don’t create another rule just do the right thing for the client.

A Wall Street Journal article entitled “The Fiduciary Rule is Dead. What’s an Investor To Do Now?” written by Lisa Beilfuss and published on Monday September 10th, 2018, begins with the following statement:

“It is a tricky time to be working with an investment professional. Regulation is in flux, and different types of professionals are held to different standards when it comes to giving advice and recommending products”

This isn’t a tricky time. The problems of conflict of interest, overcharging investors and providing bad advice have existed, let’s see, forever.

It is one of the reasons Main Street has a hard time trusting Wall Street. Regulations alone are not enough to keep every broker or advisor honest. Or to stop someone from being “tricky.”

The reality to me is that it doesn’t matter how many rules and regulations you put in place. Enforcement is the challenge.

The enforcement of rules and regulations is called compliance. As in the Compliance Department. Every firm in the securities industry has to have one.

When you work in the securities industry as a registered broker, compliance rules, as in rules your life. The costs of regulation, implementation and legal oversight have become so onerous for many firms, compliance is now the biggest cost center.

So much time is taken up complying with compliance, I wonder how the client actually benefits.

Compliance departments cannot catch every bad actor. Regulations cannot change human behavior.

In addition to the challenges of compliance, there is a structural relationship between a client and a broker that is adversarial, even if you think the world of your broker.

It is adversarial because incentives between you, the broker/advisor and the brokerage firm are never aligned.

You, the investor, have an expectation that the broker/advisor to whom you are paying fees, is going to provide investment advice that in turn provides a return on your money.

The employer of the broker has an expectation that the broker will continue to increase revenue to the firm, through fees. The way to increase fees is to bring in new client money.

Ironically, another way to increase revenue is though market performance, but no one today appears to be held accountable for the gains or losses in your portfolio.

Brokers and Advisors are inherently under pressure to produce higher and higher revenues for their company. They are all hunting the “high net-worth” investor.

The high net-worth investor is the person who has a minimum of one million dollars to invest. Find the elusive HNW client and you increase your fee revenue. It makes sense. One investor with a million dollars is an easier way to leverage the business than 10 investors with $100,000.00.

I’m going to go out on a limb here, but I am guessing most of us do not have one million dollars to invest. Even if you have $100,000, you will be a small fish in a big pond.

We would like to believe that when we hire someone to manage our money they will have our best interests in mind, and I am sure many brokers and advisors do.

But today it is more likely that if you ask an advisor to choose investments for you, it is an algorithm that will allocate your money between 10 or 20 funds.

This is not advice.

Click here to see the Wall Street Journal article.

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