After the traumatic events of the last few years, some of your clients (and perhaps you, too) may be experiencing a crisis of confidence in our economic system, institutions and leaders. The Wall Street Reform and Consumer Protection Act, aka Dodd-Frank, is intended to promote greater trust and transparency with mandates that include the creation of a new Consumer Financial Protection Agency, but its intended and unintended consequences are still unclear.
To explore this brave new world, I asked some expert observers to weigh in: Investment Advisor columnist Mark Tibergien, CEO of Pershing Advisor Solutions in Jersey City, N.J.; Matthew Lynch, president and CEO of Capital Analysts in Cincinnati; Elliot Weissbluth, CEO of HighTower Advisors in Chicago, and David Tittsworth, executive director of the Investment Advisor Association in Washington, D.C.
Olivia Mellan: How important is transparency in the delivery of financial services. Does it really promote trust? Do we need more of it?
Mark Tibergien: One of the biggest issues clients are wrestling with is whether they can trust their advisors. They’ve discovered that neither religious affiliation, country club membership, nor community involvement is evidence of a trustworthy character. So unfortunately, advisors have to go to greater depths to open up the way in which they do business for their clients.
Matt Lynch: I think there’s a difference between disclosure and transparency. The movement towards transparency serves the purpose of improving financial literacy. The adult population is not financially literate. We’ve taught them to live on borrowed money. So part of what we have to do is to educate our population and encourage accountability. There needs to be a culture of accountability around financial decisions. The most important thing is to do what we can do to improve financial literacy—and transparency serves that objective.
David Tittsworth: Another word for transparency is disclosure—a bedrock principle of U.S. securities law. It’s a very important part of fiduciary duty. The basic notion is that you need to disclose information to your clients so that they understand the transaction or the activities that you are recommending.
OM: What stands in the way of having more transparency?
MT: What stands in the way is legal gobbledygook. More words do not mean more clarity.
ML: A good example is the debate over 12b-1 fees. These fees, and a whole host of expenses embedded in mutual funds and in revenue sharing, are essentially hidden from advisors. For an advisor to operate as a fiduciary, he or she has to know about them. But the prospectuses and ADVs are long, detailed and unreadable, so the advisor doesn’t read them, and neither do the clients. Only the attorney and the judge in litigation read them.
Elliot Weissbluth: Let’s focus on the efficacy of transparency. If a doctor gave you the chemical compound of a prescription medication and asked you if this was a suitable drug for you, he would be providing complete transparency—but it would be utterly useless to you. That’s why many professions have the legal doctrine of “learned intermediaries” or “fiduciary duty.” It’s not just a high-sounding marketing idea or slogan; it’s a legal obligation that creates liability. Many health care patients don’t have full transparency. The doctor says, “You have a condition; take this pill or undergo this surgery and we believe it will help you.” But you don’t understand how the pharmacology actually works. In fact, it’s probably mostly opaque to the doctor, too, who gets his information from the pharmaceutical company. Drug companies have a duty to the doctors, and the doctors have a duty to their patients. And patients, when they go to their doctors, understand that the doctor puts the patient’s interests first. We see a similar dynamic between investors and financial advisors who are legally bound to put their clients’ interests first.
CLIENT RIGHTS AND RESPONSIBILITIES
OM: Some advisors have always kept their clients informed in writing about how and where their money is invested, but a large percentage of clients don’t read this detail or care about it. Their attitude is something like, “Hey, I trust you. You don’t have to tell me all this stuff.”
ML: Transparency involves giving your client enough information so they know whether you are serving their needs well. But even when advisors subscribe to the idea of transparency, the information they provide can be unreadable and filled with technical jargon.
Today, even the wealthiest clients don’t know what they don’t know about their advisor, and what he or she is doing. So at the end of the day, advisors are borrowing credibility to build trust, and they tend to leverage the brand equity of the national institution they work for; or in more independent channels, they borrow the prestige or trust of other clients.
MT: At some point, investors need to bear some responsibility for going along with unrealistically high returns, not asking questions and not educating themselves.
ML: It’s a two-way street. You have these psychological contracts between the client and the advisor, and within that there is trust that might exist. But this is conditional trust, based on whether the client feels that the advisor is meeting the client’s needs. The movement towards transparency will give everybody a chance to re-evaluate their business model in terms of whether it’s truly aligned with their goals. Does it serve me? Does it serve my clients? We should all be able to align our interests so that everybody does well.
DT: Studies indicate that people tend to engage people whom they trust. If I trust you, I don’t want to have to read all the details. But with the transparency argument, part of what investment advisors should be doing is to educate their clients so that they understand the basics and know whether they are being well-served.
MT: I think it’s prudent to develop a “Client’s Bill of Rights and Responsibilities.” Clients need to know what their rights are, but they also need to take responsibility for verifying and understanding what their advisor is doing for them. If your doctor told you your child was sick, you’d do as much research as possible. When it comes to money, people claim they’re mathophobes, or just incapable of understanding it. They say, “Well, that’s why I go to an investment professional.” But even though you go to a doctor for a diagnosis, you still do all kinds of fact-finding. You don’t abdicate—except when it comes to your money.
OM: What we are saying, then, is that in some contexts, transparency is meaningless. If clients don’t understand how complicated financial vehicles work, giving them information that they don’t know how to interpret and process is useless. Complete transparency, if it means divulging details that the client has no way of interpreting or understanding, isn’t really what builds trust. It’s educating your clients so that they can partner you in the process.
FIDUCIARY DUTY VS. SUITABILITY
OM: How do you see the debate over fiduciary duty vs. the suitability standard?
EW: I see it in terms of trust, not transparency. It’s important for people to understand the duties that are owed to them as a consumer. Many people confuse a relationship with a broker and a relationship with an advisor. I don’t believe that one is intrinsically good and the other is intrinsically bad.
Here’s a simple analogy: When I go to a butcher, I expect him to recommend the best cuts and types of meat. I don’t expect him to say, “You have high cholesterol; I’d recommend going to the fish salesman over there and ordering salmon.” I’d go to a dietician or nutritionist for that kind of advice. The current regulation, which proposes to convert brokers into financial advisors, is like trying to make butchers into dieticians. It’s not their job and it’s not consistent with their training or their core business.
DT: Fiduciary duty requires that you act in the client’s best interest at all times. The suitability standard means that you will recommend appropriate investments. The fiduciary standard is a higher standard—in addition to recommending suitable investments, you have to disclose conflicts of interest, including whether or not you will personally benefit from a recommendation. If brokers do any aspect of financial planning or give investment advice, they should be held to the same fiduciary standard as investment advisors.
ML: I think most financial advisors at wirehouses believe they already function in the best interest of their clients. They are good people who want to serve their clients well. It’s not like “better” people become RIAs and “worse” people become registered reps within broker-dealers. Fundamentally, nobody enters the business thinking they would do a better job for clients in one role or the other; they just enter the way they enter.
The problem is with the institutions that are trying to preserve the status quo. Their way of doing business goes back to the 1940 Investment Company Act. They’ve evolved their financial models over generations, with products and services that were not necessarily designed to serve the best interests of their clients. It’s an inherent flaw in the design of the industry, not a problem of bad people.