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Fiduciary vs. Broker: It’s a Matter of Cost

By Bob Clark

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My last blog, Are Brokers Really as Anti-DOL Fiduciary as Their BDs?, was about a survey by the Institute for the Fiduciary Standard of “advisors’” attitudes about the DOL’s fiduciary proposals. The survey found that on the three major concerns of the Financial Services Institute—acknowledging fiduciary status, reasonable compensation, and disclosing fees and expenses—67 percent, 81.5 percent, and 55.4 percent of the 251 brokers polled were either “neutral about them, or found them reasonable.”

Those findings prompted Institute president Knut Rostad to conclude: “The reason why brokers and BDs appear to hold such divergent views of core fiduciary requirements may be that brokers don’t like hearing the notion that putting investors’ best interests first is ‘unworkable.’”

In response to that blog, the commenter Watching Out posted a couple of interesting points. I’ll address them individually. 

Watching Out: “There is a difference between the behavior of a firm and its reps. I am somewhat positive, or maybe a little hopeful, that you would agree that a vast majority of brokers do the right thing for their clientele.”

I have no doubt that many brokers do want to do right by their clients. Yet it seems to me that there are pretty big differences between what “the right thing for their clients” means in the brokerage world, and what it means in the independent advisory world.  

In my experience, brokers do try to recommend “investments” that make money for their clients (that’s how they keep them as clients). Yet  financial services is different from other industries: while we call investments “products,” they aren’t really products, like a car or a computer. Instead, investments are contracts: clients give their money to financial services firms (BD, bank, insurance company, RIA, etc.) and those “advisors” promise to grow it into more money, which clients can take back at some later date, or dates. 

Contrary to a car or computer, where no matter how much you pay for it, you still get the “product” you wanted to buy, in financial services, the costs paid by the investors—both up front and ongoing—greatly affect what the investors ultimately end up with. Consequently, investors’ “best interests” depend to a much larger degree on the costs of financial services “products” than they do in many other daily transactions.

As we all know, the “suitability” standard, which governs the “sales” of investments to clients, does not require brokers to consider costs in their recommendations; which is required of RIAs, under the ’40 Act. How much do brokerage clients “over pay” due to this lack of cost consideration? 

Well, according to a recent study by the FSI and Oxford Economics (see my August 19 blog, How Not to Conduct a Legitimate Study on DOL Fiduciary Costs), the DOL’s new Rule (requiring brokers to act in their clients’ best interests) would cost just “independent” BDs some $3.9 billion—and that’s just on transactions involving IRAs. 

Granted, some of that cost is for increased monitoring of brokers: but if the “the vast majority of brokers” are already “acting in their clients’ best interests,” why do BDs need to increase their oversight? It also seems reasonable to conclude that a good chunk of that nearly $4 billion is lost revenue from sales that do not meet the “best interest” standard. 

Next, Watching Out asked: “Isn’t the move to ‘best interest’ or ‘best’ anything a journey along a minefield of definitions?” 

I’m sure it feels that way to brokers who have, for years, been working under the much less restrictive suitability standard. Yet RIAs have been operating under the “best interest” fiduciary standard since 1940—with great success. In fact, despite considerable caterwauling in the early ‘90s, the brokerage industry has transformed itself to allow brokers to manage client assets under a fiduciary standard. 

The simple fact is that managing client assets for an ongoing fee is a much better business model than one-off selling of investment products: it’s a transition from “salesperson” to “financial adviser.”

To my mind, it is this “transition” that has caused the rift between brokers and BDs, which was identified by the IFFS survey. Just as BDs initially resisted allowing brokers to manage client assets, the industry’s culture as “sales firms” blinds it to the very real advantages of transitioning away from commission sales, altogether. As for the concern that AUM fees are too costly for “smaller clients:” I think we can all agree that the “robo advisory” platforms have solved that problem.