As I wrote in my last blog, Is Fiduciary Sales an Oxymoron?, I believe that the central issue of the current fiduciary debate is whether brokers can realistically be expected to act as fiduciaries for their clients. To close the loop on that discussion, there are three additional issues that warrant some discussion. In his comment to that blog, Joe Lyons raised two of them:
“Your title sums it up just fine! No amount of disclosure can make a commissioned sales person a fiduciary. People will not understand what the disclosure means to them and the effect on their wealth over time. They don’t know what a broker is and don’t understand that their broker is an agent for his employer. Unless the compensation to the sales person is the same, regardless of what they sell, it is wishful thinking to believe they can act as a fiduciary.”
So much as been written about the ineffectiveness of disclosures as remedies for advisor conflicts that I wouldn’t address it here but for the fact both the SEC and DOL incomprehensibly have come to the conclusion that disclosure is the only remedy for advisory conflicts of interest. (“Incomprehensibly,” that is, unless one concludes that both organizations are desperately looking for a way to give brokers the “cover” of a quasi-fiduciary standard.)
As Mr. Lyons points out, if clients don’t understand how the financial services industry works, and how “their” broker fits into it, together with financial principles such as the power of compounding and the time value of money, they can’t possibly understand the full implications of the conflicts being disclosed.
Joe raises another key issue: that brokers are agents (or representatives) of their brokerage firms. To my mind, this is the issue in the broker fiduciary standard debate. Many participants in this discussion have argued that the “problem” with commissions is the conflict created by their variability.
One such observer is Ron Rhoades, advisor, attorney, scholar and former chair of NAPFA, who wrote in his April 15 column on financial-planning.com:
“I have long opined that the problem with commissions and other compensation structures is not their existence, but the fact that economic incentives exist to recommend higher-cost investment products over lower-cost products. It is difficult for fiduciaries to justify higher-cost investment products that are substantially the same, given the enormous weight of academic evidence that higher fees, on average, translate to lower returns for investors.”
Yet as Joe Lyons points out, the problem with commissions goes far beyond unequal compensation. The larger conflict of interest created by commissions is that most brokers have to be employees of their brokerage firm to get them. Which, among other things, means that there can be far greater financial incentives to act in other-than-the-clients’-best-interest than the prospect of a higher commission. As with any employee/employer relationship, brokerage firms have many ways to reward their employees for “benefiting” their firm: better offices, technology, clerical support, expense accounts, company cars, annual bonuses, etc.
Broker-dealers also control which brokers get client referrals: both by volume and wealth of the prospective clients. There also are opportunities, and possibly financing, to take over the clients of retiring brokers. And let’s not forget the opportunities for advancing into management: who can fault BDs for promoting the brokers who are the biggest “team players”?