Executive Summary
As the debate around the fiduciary standard continues, lawmakers have once again expressed concern about whether the application of a fiduciary standard may raise the cost of advice for consumers, cutting off access to investment advice for the middle class.
Yet even as this anti-fiduciary argument persists, a closer look reveals just how ridiculous it is. The RIA marketplace is not less profitable than the brokerage world due to its fiduciary compliance costs; in fact, brokers are finding the fiduciary RIA world so much more appealing that the breakaway broker trend has persisted for years.
Instead, the real challenge is that the market for advice is so complex, consumers have trouble choosing at all, and as research has shown, such environments of "information asymmetry" can lead to a "market for lemons" where the quality declines as dishonest businesses drive the honest ones away. In turn, this suggests that in the end, applying a consistent fiduciary standard for those who offer advice may actually be the single best way to drive down the cost of advice for consumers!
Last week, members of the House New Democrat Coalition submitted a letter of new Department of Labor Secretary Tom Perez, urging caution from the DOL in its rulemaking process that its widely anticipated re-proposal of expanded fiduciary rules for advisors. The Democrat letter urged that the new rule "...be done in a way that does not restrict access to critical investment assistance..." and that the original rule "could have significantly restricted the availability of investment help to low- and middle-income individuals and small businesses." The letter echoed statements earlier this year made by the Congressional Black Caucus, which similarly sent a letter to then-acting-Secretary Seth Harris, also claiming "At a time when many Americans are struggling to ensure a secure retirement, we have concerns that the Department's re-proposal could severely limit access to low cost investment advice." Notably, the Congressional Black Caucus letter is widely reported to have been ghost written by anti-fiduciary industry lobbyists,
Amongst all of the anti-fiduciary arguments that have been put forth by the industry, this "access to financial advice" tactics seems to have gained the most traction, in part because it plays directly to Democrats who might otherwise have advocated for a fiduciary standard as acceptable consumer-protection regulation. But perhaps the greatest reason this anti-fiduciary tactic has sustained is simply that it remains because the Financial Planning Coalition and other groups lobbying for the fiduciary standard have allowed these assertions to go unchallenged.
Yet sadly, the reality is that it doesn't take a very close inspection of this argument to realize how specious it is. The primary way that the argument is usually applied is to state that with a higher fiduciary standard on all advisors, it will be more expensive to comply with the rules, and that greater compliance costs will choke off access of the middle class. Yet there is little evidence to actually substantiate that a fiduciary standard is a more costly standard. E&O insurance costs are not drastically higher for today's RIAs compared to brokers. The RIA model is not less profitable than the broker model due to compliance costs; in fact, the RIA fiduciary channel is the fastest growing channel for advisors, and brokers are breaking away from the brokerage firm model to the RIA model already. Are the lobbyists really trying to suggest the steady march of brokers out of wirehouses to the fiduciary RIA model is something they're doing to voluntarily raise their own costs? Or is the reality that those brokers are realizing that the fiduciary RIA model can actually be more profitable for them?
The key distinction here is to realize that just because a fiduciary standard is more stringent than a broker's suitability standard doesn't mean it will be more costly to oversee and enforce. In fact, arguably a fiduciary standard can actually be less costly to enforce, for the simple reason that it requires less investigation the way that today's murky suitability standard does. In other words, a black-and-white line can be cheaper and easier to enforce than a gray one.
In fact, as George Akerlof showed in his Nobel Prize winning research, in situations where there is information asymmetry and the sellers know more than the buyers, and there is insufficient regulation and oversight, a "market for lemons" results, where dishonest sellers offering "lemons" (e.g., a defective car) actually drive honest dealers out of business. The ultimate conclusion from Akerlof:
"The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence."
In practice, it seems this is exactly the cycle that plays out in the world of financial advising. Good, honest advisors struggle to find and gain clients in the midst of other good advisors and a subset of lower-quality or outright predatory "advisors"; the end result is that too many low-quality and predatory advisors make money, good advisors are driven out of business, and it becomes even more difficult for the remaining good advisors to succeed. Thus is the sad state of affairs in today's marketplace, where advisors charging $150/hour struggle to grow, but salespeople hawking questionable annuity products with multi-thousand-dollar commissions can thrive.
As I've noted in the past, for most advisory firms the single greatest cost of doing business amounts to the "cost of client acquisition" - how difficult and expense and time-consuming it is to find new clients. Our industry's low standards continue to drive up these acquisition costs as consumer trust in financial services is continually eroded. Which means that in turn, the best way to lower the cost of advice for consumers is actually to raise the standards for advice.
In other words, in markets where there is such information asymmetry, minimum barriers to entry - such as requiring CFP certification as a minimum standard to call onesself a financial advisor - are a necessary evil to ensure consumer protection, which is the exact reason why every other expert profession has a minimum competency standard and other hurdles that must be cleared to be recognized as a professional.
Notably, though, this doesn't necessarily mean that financial services salespeople should be stricken from the marketplace. Salespeople do still serve a function in the delivery of products. Instead, the ultimate outcome we should be seeking is simply to make the distinction between advisors and salespeople more clearly, where the public can choose between salespeople that are clearly labeled and hold themselves out as such (and are subject to an appropriate suitability standard), and advisors who are also clearly labeled and are held to a fiduciary standard that requires them to act in the interests of their clients - a distinction that allows consumers to choose not between fiduciary and suitability, but simply to choose between an adivsor or a salesperson... with clarity helping to lower the cost of financial advice itself.
So what do you think? Would the fiduciary standard really result in a higher cost for advisors, or could it actually lower costs with a clearer regulatory line? Is the middle class at risk to get less advice in a world with a fiduciary standard, or would fiduciary actually expand access to advice?
The real juggernaut has to do with insurance sales, not equities, stocks, bonds, mutual funds, alternatives etc. A fiduciary requirement would turn the insurance industry on it’s head.
Very well put. I made the move to a fee-only RIA about 12 months ago, and I’ve found that operating under the fiduciary standard certainly hasn’t raised any compliance costs, but definitely has made the process of communicating with clients more streamlined, eliminating the “shades of grey” that exist in the current broker/RIA hybrid arrangements. I’m not going to argue the pros and cons of fee-only vs. fee-based here, but by applying the fiduciary standard across the board at least creates consistency. And lawmakers should focus on the consumer: I don’t recall the source, but I remember seeing studies last year that indicated that CONSUMERS ASSUME their investment professional, regardless of compensation method, IS A FIDUCIARY, and generally are surprised to learn that this is not always the case.
The argument that fiduciary counsel in the consumer’s best interest is more expensive than conflicted advice counter to the best interests of the investing public is patently absurd both on the assumption that fiduciary counsel cost more especially when fiduciary counsel is far less expensive to the consumer than the commission sale of expensive retail packaged products..
The perpetuation the false choice that fiduciary counsel is more expensive has been a failing of fiduciary advocacy.
The fiduciary argument is about professional standing based on objective non-negotiable fiduciary criteria of statute, case law and regulatory opinion letters and 800 years of common law. Medicine and other professions are not based on hyperbole and the investing public is about to learn brokers are salesmen not advisors. In fact it is against the internal compliance protocol of the brokerage industry sanctioned by its regulators FINRA, SIFMA for brokers to either be accountable for their recommendation or to have any ongoing responsibilities to act in the consumer’s best interest. What consumer’s believe are recommendations are simply brokers making one aware of their investment alternatives. It is up to the consumer to determine investment merit on their own, regardless how limited the investor’s investment knowledge and experience may be. The broker does intend, imply or render investment advice in accordance to the brokerage industry suitability standard under the regulatory auspices of FINRA and the SIFMA.
SCW
I think the term Fiduciary is very hard to define. I might think one portfolio is ideal and you may think it is completely inappropriate. I do think the barriers to entry are too low in this profession. Someone coming out of school or switching careers should have to become a CFP or go through an apprenticeship before providing advice. I believe this would help the profession immensely. The series 6,7,66 are not difficult enough.
I feel bad for the middle class. I worry they will suffer the most due to the fact most advisors will not want to work with these families because they will not be profitable.
It is my belief that there should be a minimum requirement to call yourself a financial planner. That would be the CFP. I believe that financial planners should be held to a fiduciary standard, but only those who hold themselves out as financial planners should be held to a fiduciary standard. I believe that the CFP is a minimum and that anyone who works with individuals should complete the CLU courses and at least the CPCU personal lines course. I believe that anyone who wants to work with business owners should complete the ChFC courses.
Financial planning is a profession and needs to start restricting the use of the term to those who meet a certain minimum level of training and experience. Those who wish to engage in commerce can and should remain stockbrokers and not call themselves financial planners.
A point should be made. Fee-only compensation has its own problems. I was speaking to a couple of fee only planners and mentioned using a product that is sold on commission only. They said that they could not use such a product, even where appropriate for a client. When I asked how they handled this they replied “we just don’t tell them about it”. In my opinion these fee only planners had violated the fiduciary standard they were so adamant should be met.