At the annual Schwab Impact conference, the general sessions and the educational ones cover the gamut of advisors' concerns: Greg Valliere's comments on the markets and the economy in light of the coming elections; Condoleezza Rice's take on the international political and economic scene; the latest thinking of money managers like AQR's Cliff Asness and Sam Dedio of Artio Investments. But there was another undertone to the meeting that may suggest that forces are moving that will benefit all advisors' clients.
As the SEC continues to study “gaps” between broker-dealer and investment advisor regulation it is worth noting that practically no one on the broker-dealer, bank or insurance side of what Vanguard’s venerable founder, John Bogle, calls the industrial financial complex of big bank-brokers, securities product manufacturers, insurance companies (often the same companies) or their lobby group, SIFMA, has spoken about the client’s needs and their experiences with intermediaries.
We understand that this is no surprise. The money tied up in this complex, Mr. Bogle has stated, is hundreds of millions of dollars every year. But as it is a “zero sum game,” he notes, and this money comes directly from the pockets, college funds and retirement accounts of regular Americans:
As Mr. Bogle stated in a speech on 2009:
“But Wall Street marketers and entrepreneurs loved this new system of speculation in complex products, quantification, innovation, and unconstrained risk, for it made them billions in profits. So it was easy for Wall Street insiders to wallow in the wealth it generated for themselves, and ignore its destruction of their clients’ wealth. Revenues of our stock brokerage firms, money managers, and the other insiders soared from an estimated $60 billion in 1990 to some $600 billion in 2007.”
It is time to address this.
Ordinary Americans are paying an enormous price for the investing that they must do in order to send kids to college or retire. Because many of these fees have been hidden inside products sold by Wall Street professionals who have not had to disclose the actual costs to the investor, and often are sold under the guise of advice, these ordinary Americans do not understand the extent of the costs they are paying. In fact, the vast majority of ordinary American investors think they do not pay for advice. It truly is, as Mr. Bogle titled his book, a “Battle for the Soul of Capitalism.”
Something must be done.
At Schwab Impact on Thursday, BlackRock Managing Director and Head of the U.S. Private Client Group, Michael Lewers, actually said in a short speech how important BlackRock’s fiduciary duty is to clients, and how seriously they take that duty. In a 90-second speech, he said the word "fiduciary" at least five times. Thank you for that, I applaud you. It is time that more companies follow your lead and start thinking about the client-centric experience. The registered investment advisors (RIAs) in the crowded auditorium know how important this is—they live it every day.
Sales is important too, just don’t disguise it as advice
At a dinner on Wednesday, the head of a large independent BD-RIA firm also noted that there is enormous value in great salespeople. I agree. We also agreed that there is enormous value in great fiduciary advice to investors, and that advice to individual investors should be fiduciary. We further were in violent agreement that these two functions should not be blended. To put it bluntly, the selling of product to investors under the veil of advice needs to stop. If you are going to sell, then sell, above board, and be proud of it. Call yourself a sales professional. Don’t say you are an advisor and then advise a client to buy a product that is in your interest rather than theirs. That’s just “fraud,” as my dinner companion said.
The Wall Street model is broken, but long-term thinking can fix it
It will not be fixed until the differences between sales and advice are clear marked. Ads, titles, job descriptions and the culture all need to reflect these important differences. Americans should be able to choose whether they want advice that is in their best interest or a securities salesperson to work with—in a clearly understood way. This is powerfully different than the “choice” that Wall Street’s lobbying group, SIFMA, wants to preserve.
The necessary changes may mean that the advice functions of a bank or insurer are separate from the company in the same way that a family doctor does not work at a pharmaceutical company—the manufacturer.
In the short run, this would change the broker-dealer product manufacturing model in the following way: a client-centric experience would disclose all costs to the client—product fees, advisory fees, shelf space fees; whatever the fees or commissions, they would be disclosed. Anyone titled or acting as an advisor would be a fiduciary. Titles that confer a relationship of trust would default to the fiduciary standard of care. Salespersons for the product manufacturers would not have an advisory title, but rather a sales title. Wear it proudly.
This model, it is said, would lower Wall Street firms’ profits. It may. In the longer term, however, firms would benefit from regaining investor trust and asset gathering by real advisors who have a fiduciary relationships with clients. This worked in the financial world before, with actual banks, trusts and investment advisors. It can work again.
Firms with advisors would need to disclose total costs to the investor and put the clients’ interests first. They'd need to act with prudence; that is, with the skill, care, diligence and good judgment of a professional. Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts, avoid conflicts of interest. Fully disclose and fairly manage, in the client's favor, unavoidable conflicts.
Those of you who follow this blog know that I am a member of the Committee for the Fiduciary Standard and will recognize that those are the five core principles of the fiduciary standard.
Who should regulate advisors?
There is also the issue of which entity should regulate RIAs and anyone else who provides advice to individual investors. This is under review by the SEC under Section 914 of Dodd-Frank financial re-regulation, as Investment Adviser Association Executive Director and Executive Vice President David Tittsworth reminded me when we sat down to talk on Wednesday at Schwab Impact. The SEC is the current regulator for most RIAs; states regulate smaller ones. Aside from the proposed change that will take RIAs with under $100 million in assets under management (AUM) from SEC supervision and move them to state oversight, there is a proposal that FINRA, the broker-dealer self-regulatory organization, also be the SRO for RIAs.
Tittsworth says that “it is the Investment Adviser Association’s position that the SEC be the regulator for RIAs. The principles-based fiduciary [supervision] overarching [investment advisors] is very different than the rules-based product-services model on the broker-dealer side. The SEC needs more resources,” to oversee advisors, Tittsworth argues.
The SEC’s unique opportunity
The SEC has a unique opportunity to change the culture of Wall Street to a more client-centric one, to set out principles, rules and guidance that will affect the financial lives of all Americans for generations to come. What the SEC does over the next several months will affect ordinary Americans’ ability to retire, send children to college, get back on their feet after the financial disaster, and to not be taken advantage of by a system that is clearly broken and at its worst can subject our ordinary citizens—especially older Americans—to abuse.
Client-centric broker and insurance advice models and investor-centric thinking will help. For advice providers, the authentic fiduciary standard, no less than that of the Investment Advisers Act of 1940, is essential. We hope the SEC will make the most of this seminal opportunity and do what is right for investors.