It seems to me that in America today, we’ve hit an all-time high for notions that make little or no sense being spouted—and extensively repeated—as if they’re the Theory of Relativity, Part 2.

Because this isn’t a political blog, I won’t elaborate, except to say that you can easily spot these ideas, when their advocates are quick to attack anyone who disagrees, but neglect to offer a hint of a rational argument in support of their original idea. 

Unfortunately, the financial services industry isn’t immune to this kind of “reasoning” either. (For example, a while back, I was compelled to take a hard look at the “flat” advisory fee movement when one of its leading proponents made the Orwellian statement: “AUM fees are commissions.”) And because the stakes are high in terms of client well-being, it’s important that we carefully scrutinize the thinking upon which financial “advice” is based—and delivered.

In my last blog (All Conflicts of Interest Are Not Created Equal) I explored some those ideas that serve to minimize the importance of eliminating (or minimizing) conflicts of interest in the delivery of financial advice. A reader named Kim O’Brien offered some pushback on my ideas about conflicts that are worth exploring further.

By way of background, this passage captures the essence of that blog: “I think most people would agree that individual, subjective biases that affect our judgments are very different than financial conflicts that increase or decrease someone’s compensation (either on a short-term or long-term basis, or both) depending upon what he/she recommends.” 

I went on to point out that we are all well aware of the consequences of financial conflicts of interest in our daily lives, as illustrated by this paragraph which was quoted by Kim O’Brien: “Only the most naïve believe that if you pay your landscaper by the hour, he/she will finish as quickly as if you paid them by the job. Or that lawyers on retainer spend just as many hours on each client, as would be reflected in an hourly billing arrangement.” 

O’Brien then made this observation: “So how is a financial advisor who receives an AUM fee for advising, rather than an hourly fee, different than a lawyer on retainer? A ‘corruptible’ fee-based [advisor] may have a financial conflict if they charge by the hour and STRETCH the amount of time necessary to complete the plan or if they are paid by the plan they shortchange the final output. Agree with the human element of conflict and the consumer is the best judge if the financial product or plan recommended was worth the cost. The DOL Rule favors one compensation model over [another] and in the end consumers lose, because they will pay more or have less access to advisors.” 

First, it sounds to me as if O’Brien might be confused about lawyers on retainer. I used them as an example because most corporations, institutions and other wealthy clients overwhelmingly prefer to pay their attorneys on a fixed ongoing retainer precisely because this arrangement eliminates the obvious conflict of hourly billing.

So a percentage of AUM advisory fee is very similar to a “retainer” in that it eliminates most of the conflicts inherent in other forms of advisor compensation. What’s more, the AUM fee has an advantage over “legal retainers” (and other forms of advisory compensation) in that it aligns advisors’ financial interests with those of their clients: when the clients’ portfolio grows, the advisor makes more money, too. This “identity of interest” doesn’t exist in any other form of advisor compensation.

I’m happy that O’Brien agreed with me that “…the consumer is the best judge if the financial product or plan recommended was worth the cost,” but that wasn’t exactly my point. The issue was biases that might cause one advisor’s advice to differ from that of another advisor: such as their training and/or experience. And my point was that the importance of those biases is generally up to the client to determine. 

As for judging the value of a financial product or plan, I’m not convinced that the vast majority of clients have the knowledge or expertise to make those determinations. Is a patient really qualified to determine if the outcome of their operation is within an acceptable range? I think consumers’ lack of financial expertise is exactly why the DOL included the requirements for “reasonable” advisor compensation and fees on recommended products.

Which brings us to O’Brien’s final point: “The DOL Rule favors one compensation model over [another] and in the end consumers lose because they will pay more or have less access to advisors.”

This is one of the most pervasive arguments put forth in defense of not being required to act in the clients’ best interests, and to my mind, the weakest.

What other profession would consumers choose advice that isn’t in our best interest because it’s cheaper? Would you go to a cheaper doctor if you knew they were going to treat you based on what a drug company wanted them to sell (expensive drugs) or what the hospital wanted (expensive operations)? How about a hair stylist whose focus was to get you out of his/her chair as fast as possible regardless of how you looked? Or an auto mechanic who would tell you that you needed what the dealership was pushing that week?

Yet with that said, the DOL, and the SEC, and even the ’40 Act aren’t telling brokers that they have to act in their clients’ best interests. They are saying that brokers (and anyone else) have to act in the best interest of their clients when they give financial advice. When you’re selling, just make the products suitable. Oh, and you have to let the clients know—in very clear terms—when they’re being sold and when they’re getting advice.

And I’m pretty sure that when they understand the difference, most clients will happily pay a bit more for advice that’s in their best interest. Who wouldn’t?