As I write this, the financial reform bill is in conference committee to reconcile the Senate and House versions of the proposed new law, which is expected to be finalized and presented to President Obama just in time for Independence Day. At this point, a fiduciary duty for all financial advisors (which appears in the
House bill but not the Senate bill) is still a possibility. In fact, the Obama Administration just released a list of five items it considered essential for financial reform: At the top is a fiduciary duty for brokers. As Deputy Treasury Secretary Neal Wolin put it in a speech on May 27 at the annual FINRA conference: "Clients receiving investment advice don't distinguish between broker/dealers and investment advisors and neither should the law."
Right now, though, it's still a less than even chance that we'll get a level fiduciary playing field this time around. Since the last time around occurred in 1940, you might think that doesn't bode well for finally getting financial consumers the protections they need and deserve from their advisors, regardless of whether she's a broker, an insurance agent, or a financial planner. Yet, as I sit here staring out at the Sangre de Cristo Mountains (playwright Eugene O'Neill said that the hardest thing about being a writer is convincing your wife that you're really working when you're looking out the window), I can't help but think that a fiduciary duty for all advisors is an idea whose time has finally come. In fact, I suspect it's another inevitable step in a long transition from product sales to a truly independent profession of financial advice.
My seemingly unfounded optimism stems from reflecting on the history of financial advice (the product of staring at the mountains), at least as far back as the start of the financial planning movement in 1971. I know, I know, those guys who met in the Chicago O'Hare Hilton were dyed-in-the-wool mutual fund salesmen looking for some way of selling funds during a down market when they couldn't give them away. But the solution they hit upon--comprehensive financial planning--was far more than merely a powerful new marketing tool (which indeed it was). Either through sheer brilliance or the intuition of good salesmen, in "financial planning," those guys hit upon the single solution to three major and related societal challenges that Americans were only just beginning to face: people were living longer (driving up the costs of retirement and medical care); Social Security and defined benefit plans were becoming increasingly untenable; and everyone would have to assume responsibility for their own retirement.
The Genesis of a Profession
In addition to creating a better way to sell financial products, those fund salesmen started the snowball of client-oriented advice down the mountain, where it continues to gain momentum. Once they started talking about giving advice on complex and often arcane subjects to a largely unsophisticated (in financial matters) public, they were really talking about a profession. And all true professions have, among other things, independence from outside influence, and a clear duty to use their superior knowledge for the clients'/patients' benefit, instead of their own.
While every major financial downturn from the Arab Oil Embargo in '73 to the Sub-Prime Collapse drove more clients to turn to advisors with a long-term, comprehensive perspective, the next major step toward independent advice came from technology: The desktop personal computer. It's hard to overemphasize the impact of the information revolution; on our society in general, and on financial advice in particular.
The computers on their desks enabled advisors to run calculations and analyze data that had formerly tied them to large institutions. The emergence of the Internet cut the cord: access to information, products, and tools far beyond the offerings of even the largest institutions was now available to any advisor, anywhere. The practical barriers to independent advice were down.
Riding on that technology wave came innovation after innovation, such as Schwab Advisor Services (which recently reclaimed its original name), which allowed advisors to deduct fees directly from client accounts, eliminating monthly billing. Even more important, it led to Schwab OneSource--the open mutual fund marketplace that sounded the death knell for proprietary products, and in my view, for wirehouses in general.
A Better Business Model
With a more powerful sales model (financial planning), access to a world of information and financial products, a system to painlessly receive client fees, and stronger, more client-oriented, client relationships, more and more advisors were asking themselves why they needed to split their revenues with a wirehouse, or even give up 20% to an independent B/D? As more advisors set up their own firms, either as RIAs or with a B/D affiliation, it became clear first to them and then gradually to the rest of the financial services world that independent advisory practices were actually a better business model.
It turns out (not unpredictably) that with a small office in a nice office park, an owner/advisor has far greater incentives to keep overhead low, staff to a minimum, and marketing efforts tied to successful results than do W-2 employees of large corporations. In short, the independent model is by far the most efficient way to deliver financial and investment advice. That's especially the case for the now-wealthy baby boom generation who never trusted institutions much, anyway. That's why we've seen banks, rollup firms, consolidators, and even some brokerage firms such as Raymond James all moving
toward owning or distributing through independents over the past 15 years or so.
The next step toward truly independent advice was the large-scale conversion to fee compensation. I can't help thinking about the parallels between the current fiduciary issue and the movement toward fee compensation some 20 years ago. As some of you may remember, fees were emerging as a far better business model for advisors and brokers (recurring, compounding revenues, a closer identity with clients' interests, etc.). Naturally, there was some institutional resistance to such a major change in the securities business; At first, charging fees on AUM was limited to a few "crazy" independent RIAs and financial planners.
But, in the early '90s, practice economics and client-orientation drove the fee movement to expand. And through the dogged efforts of NAPFA, Ron Rog?, Charles Schwab & Co., and others, the financial media began to catch on to the consumer benefits of fee compensation. Once explained clearly, the fee advantage was also an easy concept for financial consumers to understand. From that moment on, the handwriting was on the wall. Never ones to miss an opportunity to give clients products they want, Wall Street leaped onto that bandwagon--by 1999, Merrill Lynch had converted to fees, shortly followed by the other wirehouses.
So, What About Fiduciary?
Which brings us to the current debate over a fiduciary duty for brokers. To my mind, based on the long-term move toward independent advice, what's happening in Washington today is not so much a "debate" as an acknowledgement that the fiduciary duty for advisors has won the war (just as fees did in the '90s); now we're just down to the short strokes of how it will get formally implemented.
Just as with the "fee debate," the tipping point came when the national media finally "got" the difference, and started to explain it clearly to the public. I've long suspected that if consumers understood that their brokers did not have the duty to put their interests ahead of the brokerage firm's, there would be a citizen's revolt. It looks to me that that revolution is about to take place. Due to the discussions over financial reform, the coverage of when and if brokers or other advisors have a fiduciary duty to their clients has been overwhelming (to see what I mean, just Google it). Every media outlet from the New York Times to CNBC has covered the issue extensively (see "Different This Time" sidebar).
After all, Washington is rarely a leader: Most of the time, Congress is more than happy to merely jump on whatever bandwagon of popular trends happens to be passing at the moment. At present, in the aftermath of the Mortgage Meltdown, that bandwagon is mostly a knee-jerk Wall Street Reform. But included in that reaction to an immediately passed crisis (don't get me started), is at least one solution that has been percolating in the consciousness of consumer advocates, regulators, and some astute members of the media for some time: the fiduciary duty. We can debate the pros and cons of doing the right thing for the wrong reasons (see my May 5 blog on Goldman Sachs) another time, but regardless of the reasons, the "F" word in now firmly in the minds of the media and increasingly in the minds of the public. As consumers increasingly demand a fiduciary duty from their advisors, I can't help but believe it will be very hard even for Wall Street to get that genie back into the bottle.
Bob Clark, former editor of this magazine, surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at firstname.lastname@example.org.