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Will the DOL Finally Show that Fiduciary Advice Is Better Business?

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Of the three Washington “heavyweights” who appear destined to have an impact on the lives of independent advisors, I suspect the one who isn’t new that will have the greatest influence over the coming years. Rep. Jeb Hensarling, R-Texas, will take over the House Financial Services Committee from outgoing chair Spencer Bachus, and Elisse Walter will temporarily replace Mary Schapiro as chairwoman of the SEC, but it’s Phyllis Borzi, who, thanks to the reelection of Barack Obama, will keep her job as assistant secretary for the DOL’s Employee Benefits Security Administration, and consequently continue to lead the battle of extending fiduciary protection to all financial consumers.

You might remember that the DOL’s proposal, to extend the ERISA fiduciary standard to financial advisors involved in pension plans and IRAs, met with vehement opposition from the securities industry, sending Borzi scurrying back to the drawing board. Borzi, apparently reenergized by continued support from the White House, now plans to release a revised proposal in early 2013. The cornerstone of the new proposal is expected to be a “substantial economic analysis” to counter what has become the securities industry’s key argument in opposition to a fiduciary standard for brokers: the economic impact it would have on the brokerage industry.

As I’ve written before, this seems to be at least on a macro level a curious argument: That putting the interests of their clients ahead of their own would serious compromise their brokerage businesses. But apparently the obvious implications of this claim have escaped the attention of the mainstream media, and therefore, seem to be a non-issue in Washington. Consequently, the battle over the reregulation of brokers—in Congress, at the SEC, and at the DOL—seems to revolve around how much a fiduciary standard for brokers will cost the brokerage firms which employ them.

Historically, this issue has been the issue for independent financial advisors: it is way more lucrative to sell heavily loaded proprietary products to clients (as all those big buildings on Wall Street and in Hartford attest). But as most independent advisors became independent to better serve their clients (at least in the old days, back in the ‘70s and ‘80s), they continually faced financial conundrums in the form of heavily loaded life insurance, limited partnerships, variable annuities, and wrap accounts. 

The independent advisory world started to overcome these financial conflicts in the late ‘80s, as the U.S. economy continued to surge, reigniting public interest in stock investing and mutual funds. Within a decade virtually the entire independent industry had converted to the new business model of managing client portfolios made up of various mutual funds for a fee. That eliminated many of the early financial conflicts, and proved to be a much steadier, and way more profitable, business. The transition to the asset management model revolutionized the advisory business: enabling AUM to grow over time, generating formerly unheard of revenue levels, and creating businesses that had real transferable value.

Although resistant at first, eventually Wall Street began to warm to this better (at least economically) business model for advice: by the late ‘90s, led by Merrill Lynch, the wirehouses began to convert substantial portions of their salesforces toward fee-based advice and away from selling securities. This trend has accelerated every year since, resulting in massive changes in the retail brokerage industry as it strives to stay relevant, and launched the growing flood of breakaway brokers, who have concluded they will be financially better off in independent businesses.

This little history lesson is important today because it is against this backdrop that the current reregulation debate is taking place: The changing nature of retail financial advice has reached a critical mass, publicized by the Mortgage Meltdown, and brokerage firms are now struggling to adapt to the new business model. Consequently, their focus on the “economic impact” of upgrading to the new fiduciary advisor standard is in reality nothing more than a resistance to the new realities of the advisory business by clinging to the old brokerage model.

The economic reality is that fee-compensated asset management is economically a far better business than the old transaction-based retail brokerage: that’s why local independent advisors are now able to build firms worth dozens of millions of dollars, and why brokers are breaking away in droves to join them. Hopefully, Phyllis Borzi’s new economic impact study will clearly reflect this economic reality, and we can get on with the process of bringing the brokerage industry into the 21st century.


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