I know it’s February, but I’m just getting around to reflecting back over 2010. It’s been that kind of year. In my musings, the one thought that keeps coming back is how much I’ve learned—and more interestingly, how much my views have changed—during the financial reregulation that started some 19 months ago. When you’ve been around as long as I have, you really start to feel like you’ve figured it all out, that you’ve heard all the arguments, you know the histories and the agendas, you’ve uncovered the driving forces (economics often leading the pack), and you’ve seen ideas tried and how they turned out. Consequently, I thought I had a pretty good idea, not of what the future would be, but about what a better future would look like, at least in the financial advisory world and the financial services industry.
But this time, it truly was different. The possibility (or specter, depending on your point of view) of the first major overhaul of financial advisor regulation in some 70 years brought out many of the best minds and deepest thinkers in the industry. This wasn’t the usual mishmash of tired rationalizations for making large fortunes at the expense of the investing public or transparent turf grabs. Instead, for the first time in my career, we had an extended debate among people with long experience and deep knowledge exploring the best ways to change how financial advice is delivered to the public.
As for me, I’ve enjoyed every minute hobnobbing with some of the brightest minds in the industry about what advisor regulation should look like. What’s more, much to my amazement, I found my views changing on long-held positions that two years ago, I would have bet could never change. Equally surprising, at least to me, much of this re-education came from the most unlikely sources, such as the CFP Board, broker-dealer executives and compliance folks. Now, before you get started, I’m fully aware that these folks are professional salespeople, capable of convincing almost anyone that night is day. As garlic around my neck to protect against that, I’ve used as a litmus test throughout the re-reg process one basic question: What’s truly in the clients’ and consumers’ best interest? When I listened with an open mind, I realized that some of my long-held notions about financial consumers’ interests might be wrong.
Much of this re-education was a gradual process that involved many discussions and alternative points of view. But, one clearly enlightening moment came while reading the CFP Board’s comment letter to the SEC. Now, I haven’t been a fan of “disclosure” as consumer protection at least since my days of explaining personal financial concepts to groups of regular folks for Worth Magazine back in the early 90s. That experience gave me the same education that advisors get daily: Most people, including the wealthy, are woefully ignorant of even the most basic financial concepts.
Consequently, I’ve felt that financial disclosures were of little help, because most folks don’t possess the knowledge or perspective to fully understand what they are being told. Imagine my surprise when the CFP Board suggested disclosures for two practices that I was dead set against, and changed my perspective: sales commissions and proprietary products. The Board came out with hard-to-argue-with disclosures and requirements that would make each practice—at least to my mind—consistent with a fiduciary duty to the client. The key is full and accurate disclosure:
• For Commissions: The advisor must disclose the conflict of interest created because he or she works for the BD, not the client. Then, the burden is on the advisor to justify each and every transaction as being consistent with the client’s best interest. And finally, if the firm offers both commission-based and asset-based pricing models, the advisor has the obligation to recommend the pricing model that is in the customer’s best interest.
• On Proprietary Products: The advisor must make full disclosure of this conflict of interest, and obtain the customer’s fully informed consent to use them anyway. The advisor also has an obligation to be fully informed about any comparable products available in the marketplace, even if those products are not available through his firm. And, if comparable products are available on better terms to the customer, the advisor has the obligation to inform the customer about those products, even if the firm does not offer them. Lastly, the burden is on the advisor to justify the transaction.
I had to admit to myself that, with those disclosures, I wouldn’t have any problem with advisors charging commissions, nor would they conflict with a fiduciary standard. Now, with that said, it has been one of the perennial tactics of the brokerage industry to advocate in favor of disclosure to “protect consumers,” and then to write disclosures that are so empty and misleading as to offer little protection to anyone. The key to disclosures is the wording, which still leaves lots of room for abuse. But I’m now willing to concede that disclosure could work to protect consumers, if made fully and accurately.
I’ve also come around on the notion that all retail financial advisors who deal directly with the general public should have a fiduciary duty to their clients. Now don’t get me wrong, you still probably won’t find a stronger advocate for a fiduciary standard for all advisors. But, what about clients who genuinely don’t want advice? Should they be forced to go to an advisor rather than a transactional broker and probably pay more?
My broker-dealer friends have suggested that they shouldn’t, and upon reflection, I suspect they are probably right. There is certainly a place for brokers who simply execute clients’ orders. But again, in light of the brokerage abuses of the past, this practice would have to be regulated with clear and inflexible conditions. Any attempts on the part of a “broker” to suggest or recommend what a client should do, should automatically be considered “advice” and as such fall under the responsibilities of an advisor.
What’s more, the nature of the relationship must be fully disclosed: that the broker represents his or her firm, and is not required to act in the client’s best interest, but will simply make a best-effort attempt to fill the client’s order. The real danger here is that as technology and the Internet increasingly render securities transactions a commodity obtained at the lowest cost, it will be difficult for brokers to make a living without providing investment advice, with increasingly larger financial incentives to cross the line.
Finally, a senior Wall Street executive, with whom I’ve been in contact over the past six months or so, has been enlightening me on the benefits of dual registration. Since the late ‘80s, when clients started showing a preference for fee-based asset management, we’ve seen many advisors on and off Wall Street trying to straddle the fence between advice and sales. Brokers would wear “two hats,” sometimes serving as a client’s advisor, and at other times selling them products that may or may not be in the clients’ best interest. For obvious reasons, I’ve been firmly against this abusive practice.
However, my executive friend suggested we look at the problem from a different perspective: That of the client. What people want are reasonably priced solutions to their financial challenges. Those solutions often involve various kinds of insurance, and frequently for the higher net worth clients, sophisticated brokerage products. Is it really in the client’s best interest to be sent to an agent or broker to get what they need, when those outside firms have a history of high loads and expensive execution.
The current advisory practice of maintaining fee-only purity by referring clients outside for the business that advisors “won’t” do, doesn’t seem so client-centric to me anymore. While there are certainly important conflicts of interest to manage, I’m warming to the idea that clients are truly better served by having all the solutions they need provided by one advisory firm. Today, that’s called a hybrid firm, because the advisory firm would also own a broker-dealer to execute securities transactions, and often, an insurance agency.
As with my other new insights, there are important conditions that would ensure hybrid advisory firms maintain their client-centered focus:
- They should be stand alone firms, owned by advisors themselves.
- The advisors should all be RIAs.
- The firm shouldn’t sell any proprietary products, nor have any financial interest in any transaction other than getting its clients the best pricing and execution.
- Any affiliated broker-dealer or insurance agency should be wholly owned and controlled by the advisors—no outside influences.
In this type of structure, the firm’s clients would be able to get their financial needs met in-house, at the lowest possible cost. Such a firm would truly be in the client’s best interest, and would be able to protect its clients from the conflicting agendas of the financial services industry—possibly making hybrids the structure of advisory firms of the future.