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April 22, 2015 at 09:42 AM
(Bloomberg View) — In 2011, the Securities and Exchange Commission published a study, mandated by the Dodd-Frank Act, which concluded that all financial advisors and stock brokers should be placed under “a uniform fiduciary standard.” Basically this meant that brokers and advisors would have an obligation to put the interests of clients first and must disclose any conflicts of interest that might compromise that duty.
Wall Street was none too happy about this. The industry spent tens of millions of dollars lobbying to prevent this standard from becoming the law of the land. Indeed, of all the regulatory reforms that have come out of Dodd-Frank, nothing seems to displease the financial industry more than the proposed fiduciary rules.
Although other reforms may be inconvenient and clunky, the proposed rules probably would cut Wall Street’s fees, potentially by a lot. This is a radical change from the current rules, which allow a universe of products, costs and behaviors that history teaches us are contrary to the client’s best interest.
The reason for jousting over standards comes amid the awful results that investors have had in their tax-deferred retirement accounts. As too many studies have confirmed, the typical 401(k) or individual retirement account investor barely earns 2 percent a year on their savings. In the years since the Employee Retirement Income Security Act (Erisa) rules went into effect in the 1970s, the average portfolio with a 60-40 split of stocks and bonds should have returned almost four times that much.
Although poor investor decisions are part of the problem — chasing hot money managers, jumping in and out of funds, trying to time the market — high fees associated with conflicted advice have also been a persistent drag on returns.
The present approach is to blame. It has created two wildly different standards of acceptable behavior for investment professionals, who in turn are governed by two different sets of regulations and regulators. The terms used to describe the standards are “suitability” and “fiduciary.”
There is plenty of confusion about the two standards. As Bloomberg News has reported,”Three out of four U.S. investors mistakenly think that financial advisors at brokerage firms are required to put clients’ interests first, said a survey by several consumer and financial planning organizations.” Obviously, this is a problem.
The SEC enforces the standards for fiduciaries, which tend to charge fees rather than commissions. But much of the industry is governed by an organization called the Financial Industry Regulatory Authority, or FINRA, which was set up, managed and funded by broker-dealers. If that makes you wonder whose interests are considered foremost by this organization, well, your suspicions are well-founded. Since FINRA is financed by the broker-dealers it is supposed to discipline — a prima facie conflict of interest — should anyone expect it to be able to police conflicts of interest?
FINRA and its industry backers — no surprise — prefer the suitability standard, meaning that an investment recommendation has to be consistent with the interests of a client. This is, of course, a laxer standard than one that places the interests of investors first. The SEC, consumer and groups representing individual investors prefer this stricter fiduciary standard.
Here is what a fiduciary standard should consist of, according to a group called the Committee for the Fiduciary Standard, which is backed by fiduciary advocates and investment advisors:
