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Barry Ritholtz Sees DOL Fiduciary Rule as a ‘Test Run’

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“We never like to do anything on a Friday — especially a summer Friday,” famed advisor Barry Ritholtz quipped during a Wednesday phone interview with ThinkAdvisor to discussed the Friday effective date of the Department of Labor’s fiduciary rule.

A supporter of the rule, Ritholtz — chief investment officer of Ritholtz Wealth Management, a guest commentator on Bloomberg Television, host of the popular Bloomberg Podcast Masters in Business as well as a Bloomberg View columnist — readily admits, however, that the rule isn’t perfect.

As former CEO and director of equity research at FusionIQ, a quantitative research firm, Ritholtz is no stranger to both sides of the Street, but he’s basking in fiduciary fervor. “Having been through the suitability side, brokerage rules, compliance, [the Financaial Industry Regulatory Authority] and all that messy craziness, this [fiduciary realm] is delightful,” he said.

“There’s no ambiguity, there’s no gray. There’s no giant compliance machinery as a practitioner. Anytime a question comes up: ‘Hey, is this in the best interest of the client?’ No. Then we don’t do it. Yes. Ok, then it’s an option.”

Ritholtz, who also pens The Big Picture blog , shared his views with ThinkAdvisor about the rule, the political willpower at the SEC to finally push through a fiduciary rule of its own, and also what he views as broker-dealers’ “forgotten role.” Following is an edited version of our conversation:

THINKADVISOR: As a practitioner in the industry, what do you think about the rule going into effect?

BARRY RITHOLTZ: There are multiple aspects of this [rule] that are interesting. The first being, my firm, Ritholtz Wealth Management, is a registered investment advisor. We embrace the fiduciary rule.

When people say that [the fiduciary rule is] expensive and complicated, it’s not that they’re wrong, they don’t know what they’re talking about. If you’ve been on both sides of the Street, the machinery to make sure rules of suitability are followed appropriately and enforced is massive. It is massive. I have friends at Morgan Stanley and UBS and Merrill Lynch and other big firms — they get random emails from people in compliance saying: ‘You said such and such in this email.’ So if you’re trying to thread the needle, [the brokerage side is] much more complicated than what’s a clean, black and white question: ‘Is this in the best interest of the client or not?’

From a client’s perspective, of course they want fiduciary, and in fact the surveys seem to continuously show that clients think that their brokers and non-fiduciaries are fiduciaries because of all the titles they have — investment advisor, investment counselor.

Someone had suggested a simple way of cleaning up the rules was making sure the titles weren’t ambiguous — allowing either: you’re an investment advisor with the term fiduciary on the business card or on the business card, you’re a broker and this is not a fiduciary relationship.

You could eliminate a lot of regulation just by eliminating that confusion from the end investors’ minds.

By the way, I’m not naïve. I know why so many people object to the fiduciary rule: It cuts into their cost structure. It’s not a coincidence that when the secretary of Labor’s op-ed in The Wall Street Journal came out [recently], you saw brokerage firms take a little bit of a dip and you saw the insurance companies that sell a lot of annuities that certainly aren’t in the clients’ best interest — those stocks took a big whack. So the bottom line is: The objections that we’ve seen raised mostly have to do with how much the advisor can get paid.

Are you in favor of the rule as currently drafted? Opponents of the rule, along with some advisors, have said they’ve seen instances of clients’ being pushed into higher cost advisory relationships because of the rule.

I haven’t seen that at all. … This relates back to the big firms. We’ve seen Merrill Lynch and Morgan Stanley and Wells Fargo and others tell their entire staff of brokers and advisors, ‘We will not pay you on accounts under $250,000.’ So when they say that to people, think about the average IRA or 401(k), you’re eliminating 90% of the accounts out there by telling people, ‘I’m not going to pay you on these accounts.’

Now, if they have $1 million elsewhere, and there’s a $200,000 401(k), then Merrill Lynch will pay the advisor — by telling them they’re not going to pay them, they’re saying: ‘We don’t want these accounts.’

So long before the fiduciary rule was promulgated, people on the big firm brokerage side were moving away from small accounts. I’m sure there are a handful of situations where it can be said, in this situation, here’s a person who had a relationship and for whatever reason the broker has decided that it wasn’t worth taking on the additional liability from a fiduciary relationship. I’ve got to think those are few and far between.

The reality is, if someone doesn’t want your account because they don’t want the fiduciary liability, I’m imagining what they’re saying is: The fee structure doesn’t work for the broker anymore; the whole thinking underlying the $17 billion in fees [argument justifying the fiduciary rule] was to drive the cost structure lower. So if they’re sending people to robo-advisors or automated advisors or lower cost advisors, that’s the entire point. It’s not that people are losing access to advice, they’re losing access to expensive advice. I think that’s a key difference. The point [of Labor’s fiduciary rule] was to make this a less desirable line of business for expensive advisors.

You think that has worked, the way the rule is currently drafted?

The rule currently is clearly imperfect. Some of it has to do with opponents of the rule festooning it with a lot of junky things that I don’t especially like. There’s a list of these compromises, neither fish nor fowl solutions. …. I think we shouldn’t let the perfect be the enemy of the good. The rule is clearly not perfect, clearly flawed. But it’s a step in the right direction, and once it’s implemented, I think we could then revisit it again with some data under our belt and actually say: ‘OK, here’s how we need to streamline, fix, improve, et cetera.’

Regardless of the implementation of the rule, a lot of the midsize and large firms had been moving in that [fiduciary] direction anyway. As a perfect example, look at the percentage of accounts and assets at Merrill Lynch and Morgan Stanley that used to be brokerage-based and are now advisory-based. Go back 10 to 15 years, it was a tiny sliver of what they had — now it’s over a third, coming up on a half of their assets are managed on an advisory basis, with the fiduciary rule attached to it.

I think in general, the toothpaste is out of the tube; I also would make the argument that the move toward indexing that we’ve seen over the past five years especially, but really 20 years, has been a huge component of our RIA/advisory asset management, which has the fiduciary rule built into it.

But now some fee-only advisors have come out saying they are concerned about it?

So assets under management, meaning percentage, [these advisors] should be guided by the fiduciary rule already. If you’re an hourly person and you have a contractual relationship, this is another level of obligation, and I could see that being a cause of concern: ‘Hey, I never used to have anything other than ordinary liability and suddenly I have a heightened standard of care and therefore my liability goes up.’ I can’t say that any of the hourly, fee-based advisors that I know have been especially concerned.

But there are some unintended consequences being created by the rule, some in the industry have said.

No doubt about that. It’s a highly imperfect rule.

What do you think about the SEC coming back into the fiduciary fray again?

Remember how this began: Part of the Dodd-Frank regulation required SEC staff to do an analysis and make a recommendation, and here’s the thing that everybody forgets — the staff of the SEC came back and said, ‘Hey, this dual standard — some of us are suitability and some of us are fiduciary and some of us are a little of each — let’s throw all that out and make everybody fiduciary and we’ll all be much better off as a country.’ Everybody forgets — that was the original recommendation of the staff report that was mandated by Dodd-Frank.

The staff report said we should go fiduciary across the boards and the SEC at the time didn’t have the gumption or political will to implement what’s a fairly substantial change in how financial services are offered.

That’s a huge, huge, change. And I think the SEC said, this shouldn’t really come from a regulatory agency, this should be a piece of congressional legislation. I don’t necessarily, totally agree with that, but I totally understand it. That’s such a major change … I disagreed with the outcome, but I don’t think their reasoning was poor. The [SEC’s] position makes a lot of sense.

But now we have the DOL rule being implemented, the administration is pressing for action on the rule, and SEC Chairman Jay Clayton saying SEC is going to look at it. What do you think the prospects are for an SEC rule this time?

If we were to go pure fiduciary, it would be problematic. Firms that have been around forever, they would have to change the rules and change the way they do business. It would be a giant headache for them and cost them lots of revenue. Nobody’s in a hurry to implement this [fiduciary standard] across the board; you’re going to get Merrill Lynch, Morgan Stanley and JPMorgan and Wells Fargo angry at you, that’s a tough piece of [rulemaking] to get through.

My read of the DOL rule was that this was a compromise — that we’re only applying it to work-based retirement programs, so let’s try this and [see if it] does really save $17 billion per year. Let’s find out. It’s sort of a test run. If it turns out after a couple of years, this isn’t saving anybody’s money, it’s making things more complicated and people are losing access to advice, then it certainly would make sense then at that point you either revise or overturn it.

What else are you looking at beyond fiduciary?  

The brokerage side is fascinating. You need someone to underwrite IPOs, capital has to find its way to new ideas, new inventions have to be funded.  So there is a valid and valuable part of Wall Street that we have kind of forgotten about and moved away from. I think the brokerage side should focus on what they do best, and that’s syndication and underwriting and things like that.

In terms of investment management, I think that advisor side has shown that it’s better situated than the classic stock pickers.

The other thing that’s fascinating, … we have clients all over the country, we travel pretty frequently — I’m astonished that all of our clients want to talk about President Trump, and the fiduciary rule falls under that, but … they want to know what does [his presidency] mean for my portfolio, is there going to be tax reform?

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