Every good salesperson knows that if you’re selling schlock you focus on price; if you’re selling quality, you don’t talk about cost until you’ve “sold” the prospect on the benefits of the product or services you’re selling. That’s because, until people understand what they are getting, they can’t possibly evaluate the fairness of the price.
At the end of June, SEC Investor Advocate Rick Fleming submitted his Office’s “policy agenda” for 2017 to Congress. It’s a lengthy, 55-page document (the 338 footnotes alone take up 12 pages), that tackles issues from disclosure for public companies to exchange access fees; from reforming the municipal securities markets to corporate governance. Of particular relevance to the advisory industry, Fleming and his team also added this item:
“We will begin to consider whether investors understand the fees and expenses they pay for an array of products and service providers, including funds, investment advisers, and broker-dealers. As part of this initiative, we will explore whether the various fees and expenses could be disclosed more effectively.”
The Report doesn’t offer further explanation of what that “initiative” or those “disclosures” might involve, except three-plus pages devoted to a thorough dissection of how various fees and costs of mutual funds, ETFs, and other investment funds can affect long-term investors’ portfolios, including fees charged by “intermediaries”:
“We believe that individual investors should be aware—or should be made aware—of the different types and layers of intermediary fees associated with the management, operation, and custody of their investment or retirement accounts. These may include management fees, custodial fees, transaction fees, and commissions, among a whole spectrum of other potential expenses.”
Conspicuous by its absence in these “initiatives,” and in the Report as a whole, is any discussion of the value provided by the various services mentioned: particularly those provided by “intermediaries” commonly known as brokers versus those offered by investment advisers. Consequently, without concern for the relative value of the advisory services provided, the Investor Advocate is likely to continue the brokerage industry’s tactic of disclosures that favor “advisors” who provide the lowest cost advice, rather than those who, by acting in the best interests of the clients, recommend investment portfolios with the lowest overall costs.
What’s missing in the Advocate’s analysis are the potential costs to investors of recommendations by “advisors” who do not have a duty to offer advice in the best interests of their clients, or those who are required to do so in only a limited part of their client engagements.
At least since the passage of the Dodd-Frank Act in 2010, the brokerage industry has advocated the comparison of the total cost to investors of ongoing, annual asset management fees with those of one-time upfront commissions. And while ignoring that many brokers also collect annual 12b-1 fees, that commissions do cost less.
But what they don’t consider—and apparently neither will the SEC’s consumer advocate—are the additional benefits of advice that’s in the clients’ best interest at all times.
While the Advocate’s Report is right to focus on the total costs to investors in managed portfolios, it’s unfortunate that it stopped there rather than to also consider the many other “hidden” costs to retail investors.
As all advisors know, financial services is a complex industry fraught with layers of financial conflicts at the advisor and distributor (broker-dealer) levels, as well as with the asset managers themselves.
From heavily loaded proprietary products to expensive actively managed funds that pay marketing fees to brokerage firms, to very heavily loaded insurance products, brokerage firms find ways to boost their bottom lines at investors’ expense—and highly incentivize their brokers to recommend those products.
Unfortunately, it’s very difficult to identify many of those additional revenue streams, and even harder to identify the ways brokers are compensated for pushing them: higher payout percentages;, larger “carried” notes; promotions; higher quality referrals; support staff, etc. How could anyone determine why a given broker received any of these?
That’s why looking only at the “cost” side of advisor/client relationships provides a skewed view of those transactions. The more meaningful disclosure would be to make absolutely sure that all investors fully understand the nature of their relationships with their advisors. Who does the advisor really work for—the investor or the brokerage firm? What responsibilities does the advisor have to the investor? And what does that mean the advisor can and cannot do?
Having spent many years giving presentations to, and fielding questions from, retail investors, I have no doubt that if investors really understood the difference between what they’d get from full-time fiduciary advisers versus non- or part-time fiduciaries, they’d take the “fiduciary only” every time: and happily pay more for her/him.
That’s because it’s common sense to value professionals who act in our best interest, whether they are doctors or lawyers or investment advisors.
It seems to me the most valuable “initiative” the SEC Investor Advocate could undertake in 2017 would be to make sure that every investor in America understands the difference—so they can make a fully informed choice.