Elizabeth’s note: Many of the comments submitted to the SEC by broker-dealers, insurance agents and some small and hybrid RIAs on the topic of the fiduciary standard rang an alarm bell on profit margins. Without commissions, some of the letters argued, the market of investment advice for middle-class or even upper-middle class investors will dry up — the fees required to make a decent profit would just be too high. In this piece, the third in his series attempting to sway the SEC in the run-up to the commission’s report, due out Jan. 17, RIABiz’s one-man think tank columnist, Ron Rhoades takes issue with that idea, pointing out that the RIA world features many successful small business models offering advice to Middle America.
In an e-mail to me yesterday, Ron wrote, “It seems to me, as I reflect about this issue, that many in Wall Street firms who are opposed to the application of the fiduciary standard are upset that fiduciary compensation is not too high – but rather that it is too low. In other words, applying the fiduciary standard would prevent them from buying yachts. Unlike many Wall Street investment bankers and traders and product sellers, professional advisors are bound by the mandate that their compensation is reasonable. Professionals who do well can afford boats, but not yachts.”
Central to the broker-dealer community’s argument is that the fiduciary standard of conduct is somehow “too expensive” for the average American.
Let me reply …......... HOGWASH!
What broker-dealers really mean is, “I can’t make the high profits I make now, if you subject our advisory activities to a fiduciary standard.”
Yet there are many advisory business models that are both profitable and successful in serving the needs of “Middle America.”
Take, for example, Mark Berg of Timothy Financial Counsel Inc., located right in the heart of America in Chicago and Wheaton, Ill. Using a team approach, this firm, founded in 2000, provides hourly-based financial planning and investment advice to hundreds of clients. The firm has neither income nor net worth requirements. For many clients they offer, depending upon the clients’ needs, a flat fee for the initial planning, which includes investment recommendations as well as comprehensive financial advice. Thereafter check-ups and follow-up questions are answered typically for hourly fees. So successful is this firm that many investment advisor-only firms outsource the financial planning portion of their client engagements to Timothy Financial. In keeping with its strong fiduciary oath neither the referring firm nor Timothy Financial provide compensation to the other.
A more well-known group of financial planning and hourly-based financial planning firms is that of the Garrett Planning Network. By providing coaching and the opportunity to network with like-minded financial advisors, Sheryl Garrett provides both new entrants to the financial and investment advisory profession, as well as brokers transitioning to a fee-only business model, with a wealth of information, marketing training, practice management skills, and support. The benefits for clients? Access to financial and investment advice for reasonable hourly fees. For the latest on the Garrett Network: Eavesdropping on the Garrett retreat: A white-knuckle drive; why independents aren’t winning assets as fast as they should be; and six steps to building client trust.
How the numbers work
But … the broker-dealer community says … a customer with only $25,000 to invest surely can’t be served under an hourly-based model. Yet, if that customer were to purchase a mutual fund and pay a 5.75% commission, the customer would pay over $1,400 – more than the base flat fee plan offered by Timothy Financial Counsel, and more than the hourly-based financial advice of many, if not most, Garrett Planning Network members. And here’s the rub … the client gets FARMORE for LESS!!!! They are not just sold an investment product, but rather they receive all-important financial advice. And, since there are no “hidden” means of compensation (ongoing trails from sales of annuities or from 12b-1 “service fees,” brokerage commissions (including soft dollar payments) paid back to the broker-dealer firm for trading within the fund, the hard-to-understand-why-it-has-not-been-banned “payment for shelf space” arrangements, and the still-common “sales awards.”
Even larger “wealth management” RIA firms often provide services to “middle America.” For example, Trovena LLC, a wealth management firm providing services to entertainers, athletes, and other high-net-worth individuals and executives, created an entire division of their firm, OnCubic, to provide services to clients of lesser means. For a low minimum quarterly fee, clients with – effectively – as little as $60,000 to invest can enjoy many of the benefits of Trovena’s well-researched and admired investment strategies.
Other large firms provide services through similar programs. This author’s firm always provides some financial or investment advice to whoever makes it to our door. Whether the advice be as simple as “pay off that credit card, don’t invest,” or a referral to a no-load, low-cost mutual fund company, several hours of free consultation, or a referral to a fee-only hourly based financial planning firm, all prospects walk away with the prospect of receiving what they truly need. And, we often take on as clients widows who don’t come close to meeting our “minimums” – because as professionals, we believe it is our duty to look after those in need.
But … are there enough hourly-based investment advisers?
It’s interesting that the broker-dealer community argues that there is an insufficient supply of hourly-based financial planning firms, or other “low-cost providers” – so much so that the fiduciary standard can’t be applied.
In reply, I would first note that the number of fee-only investment advisory firms continues to grow. The National Association of Personal Financial Advisors (NAPFA), the nation’s largest association of fee-only financial planning and investment advisory firms, enjoyed strong growth in its membership over each of the past ten years, despite its high membership standards and the recent recession.
Second, there are now well over 100 colleges and universities churning out graduates with specialized education in financial planning, qualifying graduates to sit for the Certified Financial PlannerTM exam. From my conversations with students in several different programs, it is obvious that nearly all of them desire to work within a fiduciary business model.
Third, we must realize that the over-abundance of non-fiduciary “financial counselors” and any shortage of fiduciary investment advisers is the result of the SEC’s own past actions. First, the SEC permitted registered representatives to hold themselves out as “financial advisors” and “financial consultants,” despite the fact that these titles evoke in the minds of brokerage customers an advisory relationship of trust and confidence. Second, the SEC permitted the large broker-dealer firms to provide much more than “merely incidental” investment advice without being subject to a fiduciary standard. Basic economics dictated the result – a fostering of a higher-expense (for the customer) business model.
Why is this so? The average American was left with the impossible situation of being informed that they could receive “financial advice” and “investment advice” – but with no ability to discern any difference in the quality of that advice. In the classic thesis for which he won a Nobel Prize, George Akerlof explained, “There are many markets in which buyers use some market statistic to judge the quality of prospective purchases. In this case there is incentive for sellers to market poor quality merchandise, since the returns for good quality accrue mainly to the entire group whose statistic is affected rather than to the individual seller. As a result there tends to be a reduction in the average quality of goods and also in the size of the market.”
In other words, the SEC created the very consumer confusion which has been confirmed by so many studies (including the Rand study, commissioned by the SEC itself). In essence, the SEC encouraged providers of investment advice to migrate to the lower, non-fiduciary (and more profitable) standard of conduct, and away from the investment advisor-only business model. And, in the process, individual Americans – unable to discern the difference between those who represent the consumer (registered investment advisers and fiduciaries), and those who represent the product manufacturer (salespersons), were left with a large market of salespeople to deal with – even though the average American “thought” they could trust their “financial advisor.”
So prevalent is this trust in registered representatives of broker-dealer firms that I have personally observed dozens of my clients, throughout my 25-year legal and then investment advisory career, inform me that their “financial advisor” took them on “for free” and “has never been paid a dime.” Of course, that’s only because these clients did not understand all of the fees and costs of the products they were sold. Once I informed each client of the vast amounts that were really paid over the years, nearly all expressed outrage. (A few walked out of my office, refusing to believe me, for they had a long-standing relationship with their broker … or rather, “advisor”).
The SEC needs to correct the environment. The market will adjust, if the fiduciary standard is applied to all financial and investment advisory activities.
“Ron seeks a competitive edge … he wants to put broker-dealers out of business!”
Another commonly heard argument by broker-dealer firms is that all the advocates of the fiduciary standard desire is a competitive advantage. Nothing could be further from the truth.
If all that I (and so many of my colleagues who are also fiduciary investment advisers) desired was a competitive advantage, I would be arguing against the application of the fiduciary standard of conduct. Why would I want to create more competition for myself? Right now, I enjoy a competitive advantage … 99 times out of 100, when I analyze the investment portfolio of the customer of a traditional wirehouse brokerage firm, I discern that the solution our firm offers lowers the prospects’ total fees and costs – often by 30% to 70% (even when considering our investment advisory fees), reduces the tax drag on the client’s investment returns, and/or reduces various types of investment risks by orders of magnitude. In other words, the customers of broker-dealer firms are my favorite source of new clients – it is “easy pickings.”
But the current status quo is not good for Americans.
So many pro-fiduciary standard advocates see the substantial harm suffered by their fellow citizens. They have risen in support of the fiduciary standard for this simple reason – enough is enough!
“Big Guns” Oppose the True Fiduciary Standard
This is not to say it will be easy. Wall Street has rolled out the “big guns.” All of the major firms’ executives have already met with Chair Schapiro and the SEC’s working group studying the fiduciary issue. (One wonders if any of them shared a private plane for the trip to D.C., or even shared a limo, for that matter.)
In a more disconcerting move, there are those who “endorse” a “new federal fiduciary standard” – which is simply enhancing disclosures. The “new federal fiduciary standard” touted by so many Wall Street firms is not a true fiduciary standard at all. The late Justice Benjamin Cardoza, famous for not permitting an “erosion” of the fiduciary standard in his decisions, would likely roll over in his grave should the SEC permit the fiduciary standard to be eroded through Wall Street’s influence.
Will the SEC step up?
The fiduciary principle is the paramount answer to the question, “How do we restore trust by Americans in our financial institutions.”
The bona fide fiduciary standard of conduct currently found in the Advisers Act is the answer to the question: “How do we ensure that our fellow citizens will receive adequate advice to save and properly invest, in order to provide the necessary capital to our securities markets, which in turn will promote U.S. economic growth?”
Now is the time for the SEC to discharge the great duty with which it has been charged. It is time for the SEC to apply the fiduciary standard of conduct broadly upon all investment advisory activities, with the rigor and vitality of the SEC in its heyday, when the SEC was generally perceived to be the finest of our federal governmental agencies. See: One-Man Think Tank: What would Adam Smith say about the fiduciary standard?.
Americans need the SEC’s application of the fiduciary standard to all investment and financial advisory activities. Our fellow citizens need the help of trusted advisor as they seek to navigate the modern and complex financial world and endeavor to successfully provide for their own future financial needs. See One-Man Think Tank: With even governments abandoning pension plans, investors are being tossed to the fee-hungry wolves.
American industry needs the fiduciary standard, as the essential means to restore the trust of individual investors in our securities industry. Greater participation by individual investors in the capital markets will thereby provide capital at reduced costs to the firms in need of such capital for expansion, thereby creating jobs.
America itself needs the fiduciary standard, for the potential failure of individual Americans to save and properly invest, and the potential failure of the capital markets to attract the necessary capital to fuel our country’s economic expansion, would impose severe additional strains on both federal and state governments in the future.
Will the SEC, under the leadership of Chair Mary Schapiro, rise to the challenge? Stay tuned for the results of the SEC’s study of this issue, due out by late January 2011.
Ron A. Rhoades, JD, CFP® serves as Chief Compliance Officer and Director of Research for Joseph Capital Management, LLC, a registered investment adviser with offices in New York, North Carolina, Georgia and Florida. This article represents his views only, and not necessarily the views of any organization to which he may be affiliated.