A Conversation on Conflicts of Interest

“Currently, plaintiff attorneys are jumping on this issue, and the courts are sorting out the answer, in their slow, deliberate way. I do believe that platforms like Active Share and others will eventually be acknowledged to provide proof of value. But we’re not there yet, and in the legal void, many industry lawyers are rightly advising their advisory and broker-dealer clients that the safe play at present is to use low-cost ETFs. It’s an unfortunate situation, but I have to say, it’s one that, in my view, the financial services industry brought upon itself by failing to be cost-conscious on behalf of its clients.

“Ultimately, I suspect that the best defense for advisors recommending higher-cost investments will be that they work at independent, stand-alone advisory firms, which are paid solely by their clients’ AUM fees (or flat fees), and therefore have nothing to gain from one investment recommendation rather than another, other than when their clients’ portfolios grow larger.

“In contrast, brokerage firms that sell proprietary products, underwrite securities that they then sell, or take marketing fees from specific product manufacturers will have a much harder time demonstrating the appropriateness of these higher-cost products.

“As for your point that ‘in other industries, people who have higher profit margins are considered astute business people,’ it’s important to make a distinction between ‘business people’ and ‘professionals.’ For hundreds of years, Anglo-American society and law has recognized the difference between business transactions (such as buying a truck) in which both sides understand that one side wants to make a sale for as much as possible while the other side wants to pay as little as possible, and professional relationships (such as doctors, lawyers, clergy, accountants) in which one party depends on getting sound advice that is in their best interest. In getting said advice, the professional, with far superior knowledge and experience, is in a dominant position, and therefore is held to a high standard of client or patient care.

“In financial services, the line between salespeople and professional advisors is often blurred, with clients believing they are getting advice in their best interest, when in fact they are being sold a product. There’s nothing wrong with sales, as long as the investor isn’t led to believe they are getting advice. Unfortunately, in the financial services industry today, that line is often blurred.”

Reader: “First, I am all for acting in the best interest of clients. [But] I am also a small government person: To have a truly free world each individual must take on a certain amount of responsibility themselves, separate and apart from the government. I like your example of the Chevy truck. But unlike the investment world, a person is free to pay $10,000 more for the truck if they so choose as long as they can get approved for the loan or they have the cash. Sure, it will perform the same as the person who got a better deal.

“But what about that extra $10,000? What’s the opportunity cost? Could that person have used it to pay for a year’s room and board for their college student? What kind of quality of life are they missing due to ‘overpaying’ for this truck? Could that $10,000 have been better deployed elsewhere? […] Furthermore, why do trucks like the Cadillac Escalade even exist for $90,000? What possible justification could there be for such egregious overpricing? This line of questioning on the car purchase may seem ridiculous, but that is exactly what we in the investment world are faced with when we are questioned about decisions our clients made.

“And therein lies the rub. In a free world, people must have the opportunity to make a wrong decision — whether they buy a $90,000 Escalade or a variable annuity. In both instances, the client may be satisfied with the decision and feel it was worth it. Why should someone else question it? Yet car dealers and salespeople are not at risk of getting sued because the person used his child’s college fund to buy a truck. Yes, we should do what’s in the best interest of the client, [but] the burden should not fall solely on the advisor.”

Clark: “I agree: People do need to take responsibility for their own decisions. Yet I doubt that many people would think that an investor who was seeking fiduciary financial advice and went to a broker who was holding him- or herself out as a ‘trusted financial advisor,’ and whose firm spends millions of dollars to advertise the quality of the ‘advice’ provided by its ‘financial advisors,’ somehow ‘made a bad decision.’ People also have to take responsibility for their actions.”