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Wall Street Needs to Put All Clients First

The fiduciary rule shouldn't apply just to retirement accounts; it should apply to all investment accounts, no matter the size and type.

By Barry Ritholtz

(Bloomberg View) --President Donald Trump has asked for 180-day review of the U.S. Department of Labor’s new rule requiring that those who give investment advice on retirement savings accounts put client interests ahead of their own. It is, of course, reasonable to assume that this is the prelude to the new administration's effort to kill the so-called fiduciary rule.

If there is an actual shortcoming  to the rule, it is this: The fiduciary rule shouldn't apply just to retirement accounts; it should apply to all investment accounts, no matter the size and type. It's probably doubtful that Trump's review will come to this conclusion.

Yet this is what the Securities and Exchange Commission staff who reviewed this issue recommended in 2011. This makes sense for a country facing what former Yale University endowment Chairman Charles Ellis called “a looming retirement crisis.” The Obama administration estimated that the retirement advice in which brokers recommend investments that put their interests ahead of their clients' cost investors $17 billion a year. My less conservative estimates are at least three times that.

Even the big brokers who originally opposed the rule are coming to appreciate the advantages of the fiduciary standard. The Wall Street Journal reported “the brokerage industry, which had largely accepted the rule as law, had already spent hundreds of millions of dollars to prepare for its implementation.” In other words, the financial industry is ready to live with the rule.

Let's look, though, at some of the arguments the financial industry makes against the rule:

No. 1. It won't be profitable to give investors good advice: Where to begin with this one? Somehow, the implication here is that giving investors advice that's bad for them is fine because the financial industry makes more money that way. But the industry trend is toward lower costs anyway, and retirement accounts should be no different.

No. 2 Disclosing fees and incentive payments is problematic: Let's tackle this by invoking Charles Munger's idea -- invert the fiduciary rule to see what would happen. This would mean brokers could take undisclosed kickbacks to push certain products, and place their interests ahead of their customers -- recommending mutual funds and other products that earned them the highest fees, rather than served the interests of clients.

Once you put it that way, it sounds pretty bad. But actually, this is how the industry has been run historically.

The biggest impact of the fiduciary rule is to require disclosure of these conflicts. It would be far better for investors -- and the industry, in the long run -- if those conflicts were simply prohibited.

No. 3 We can balance the priorities: If a broker serves multiple masters -- the firm, his or her own pecuniary interests and the investor -- two of those three will not come first. The mathematical definition is that if you are not putting investors first, then you are making them second or third.

No. 4. The cost of being a fiduciary will be passed on to investors: This argument might have been true at one point.. That changed on May 1, 1975, when brokerage commissions were deregulated. As a result, smaller investors gained access to a host of cheap new products. Today, inexpensive automated, software-driven robo-adviser services are available at the click of a computer mouse -- and they already are fiduciaries.

No. 5 Confusing multiple standards: Maybe there's some merit to this. It's confusing for investors to understand which standard their financial adviser, consultant or broker must meet. Just to take one example -- suppose you're meeting with a broker and you have both a retirement account and a regular investment account. Does your broker go instantly from wearing their fiduciary hat while discussing the retirement account, then change head wear when talking about other investment accounts?

The answer to all of the issues is to adopt the SEC's recommendations and make the industry operate under the fiduciary standard.

Jack Bogle, the founder of Vanguard Group Inc. and the person who did the most to promote low-cost indexing, put it best earlier this week in a New York Times op-ed with the headline "Putting Clients Second":  

The now-endangered fiduciary rule is based on a simple — and seemingly unarguable — principle: that in giving advice to clients with retirement funds, stockbrokers, registered investment advisers and insurance agents must act in the best interests of their clients . . .  It simply doesn’t seem like a good business practice for Wall Street to tell its client-investors, ‘We put your interests second, after our firm’s, but it’s close.’

Bogle is correct. It’s likely too late to stop the principles behind this financial rule. But delaying its implementation will be expensive for the middle-class investor. It should come as no surprise that if the rule is put on hold it will most affect voters who supported Trump.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”

To contact the author of this story: Barry Ritholtz at [email protected] To contact the editor responsible for this story: James Greiff at [email protected]

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