October 13, 2010

The Big Sting Objection to a Fiduciary Standard

 

“Kid, to pull off the big con, you don’t only have to take the mark, you have to keep on takin’ ‘em, so that they don’t even know they’ve been taken.”
—Harry Gondorff,  in “The Sting”

Normally, I wouldn’t respond to comments like J.P. posted to my last blog. Not to put too fine a point on it, but they’re mostly the same old tired rationalizations for why “Doing what’s best for the client” isn’t really what’s best for the client. And like most of these defenses, J.P.  starts off with the standard “[clients] don't really care how we are paid, or whether or not a particular product is proprietary,” and concludes with what is apparently considered the haymaker: “Because every business model carries with it an inherent conflict of interest.”

Today, however, with the SEC in the process of determining whether—and how—brokers should be held to a fiduciary standard, these old arguments take on a renewed significance. So at the risk of repeating things I’ve written many times over the past years, the flaws in these “seemingly” rational arguments warrant further illumination. 

While J.P. writes “..we are all missing the point…,” it seems to me that it’s J.P. and all those who believe (or at least make the same arguments) as he does who are off the mark. Of course, studies show that financial consumers don’t care about advisory compensation or whether a particular product is in-house or third-party: That’s because they don’t understand the significance of those facts.

Caveat emptor is no more appropriate for financial consumers that it is for doctors’ patients or lawyers’ clients. That’s because professionals—including financial advisors—have a specialized body of knowledge that gives them a tremendous advantage over the people they serve, who can only rely on that knowledge. Real professionals are required to use their knowledge for their clients’/patients’ benefit, not their own. Advisors should be no different.

As experienced financial advisors know all too well, the vast majority of their clients are woefully ignorant of even the most basic financial principles, such as the power of compounding, the harmful long-term effects of those seemingly insignificant basis-point costs, the real conflicts inherent in the financial services industry, and the most important and telling of all: That many “financial advisors” do not have a duty to put their clients’ interests ahead of their own. As last month’s Opinion Research Corp. study showed (see my 9.21 blog): 60% of retail investors think that insurance agents have a fiduciary duty to their clients; 66.7% think that stockbrokers have a fiduciary duty; and 76% think that anyone who calls themselves a “financial advisor,” “financial planner,” or “investment advisor,” has a fiduciary duty.

These folks didn’t get these misconceptions by accident. They’ve been taken advantage of for years, and they don’t even know. Shame on all of us if we let this “sting” continue.

Reprints Discuss this story
This is where the comments go.