First Rule of Running Other Peoples’ Money? Do No Harm

The enlightened view on managing other people’s money
Barry Ritholtz
Washington Post, March 20, 2016



I have long been an advocate for the fiduciary standard for financial advisers. As I’ve noted before, investors who seek advice on managing their assets are entitled to have an adviser put their clients’ interests first. This is the enlightened viewpoint on managing other people’s money.

Still some people insist that “the best interest of the investor” is not in their best interest.

My colleague Josh Brown calls this “The Most Horrendous Lie on Wall Street.” I agree.

Let’s look at the other side of the debate, to see what (if any) credible arguments exist against the fiduciary standard. The obvious answer — it’s about the money — explains some, but not all, of the opposition.

A little history: After the financial crisis, Congress passed the Dodd-Frank Act. Misaligned incentives were a large factor in the crisis, and the legislation mandated that the Securities and Exchange Commission perform a thorough review of the compensation structure of those who sell financial products.

In a 2011 study, the SEC staff published its conclusion that “all financial advisers and stock brokers should be placed under a uniform fiduciary standard.” This meant that brokers would have a clear legal obligation to put the interests of clients first — before even their own (gasp!) compensation. Further, anyone selling investment products or providing investment advice to the public must (gasp again!) disclose any conflicts of interest that might compromise that fiduciary duty.

That sounds like a reasonable set of rules. Doctors, after all, must “first, do no harm”; people who provide legal or accounting advice must put the interests of clients first as well. Why not apply those same standards to anyone who provides financial advice?

This is more than a mere matter of principle; a White House report found that conflicted investment advice costs the public about $17 billion a year in retirement accounts alone. Compound that over the next few decades, and it means looming retirement shortfalls are going to be trillions of dollars. The White House is rightly concerned that this will cost taxpayers in a big way down the road.

Here is where things go off the rails a bit: The SEC did not implement its own 2011 recommendations, courtesy of a political deadlock. A clever work-around emerged: 401k (and 403b) plans are a form of compensation, and as such are governed not by the SEC but by the Labor Department. Hence, it could implement new rules on how employer-issued retirement accounts are managed.
Of all the many regulatory reforms that Dodd-Frank created, nothing seems to have gotten the financial industry angrier than the proposed fiduciary rules.

If $17 billion sounds like a lot of money, it is — especially to the Wall Street firms that receive it. There are still tens of billions in fees for managing retirement accounts, but this is a juicy chunk of profits that is about to be regulated away. In response, the Street has spent tens of millions in an all-out lobbying effort to prevent this standard from taking effect.

The best way to understand any issue is to grasp all of the arguments about it. So on my blog, I asked readers, “What are the good anti-fiduciary arguments?” Some sent me to review the Twitter hashtag #Fiduciary. That led me to statements from two of Congress’s strongest advocates, pro and con — House Speaker Paul D. Ryan and Sen. Elizabeth Warren.

Ryan had called the new fiduciary rules “Obamacare for financial planning,” while Warren (along with Sen. Cory Booker) decried “high fees and hidden payments” in saving for retirement.

Politics aside, the arguments against the fiduciary standard fall into a few broad categories. (Let’s dismiss the wackier criticisms, like it will prevent advisers from discussing things in public or in the media. Helaine Olen demolished that silliness).

The main anti-fiduciary arguments assert that:

1 It would create a huge regulatory burden, especially for record-keeping and compliance issues; this will be costly to implement and will drive small firms out of business.

Let’s start with the regulatory burden, as I have firsthand knowledge about this: When we launched our small advisory practice in 2013 with five people and less than $100 million in assets, we did so as a registered investment adviser subject to the fiduciary rules. We previously had been a hybrid RIA/broker dealer, subject to mostly the less restrictive “suitability” rules.

The RIA legal and regulatory route was actually much simpler than that of a broker/dealer. We hired outside counsel, as well as a consulting firm to help us meet our compliance obligations. We created a practice manual, including our internal policies and procedures. There were lots of little tweaks — archiving emails, social media, etc. But all told, it was quite similar to what we would have had to do anyway if we were not subject to the fiduciary rules, i.e., were setting up a broker/dealer instead. Since as fiduciaries we were not recommending specific stocks or IPOs or syndicates or private placements or hedge funds or annuities, it was a much simpler process.

And here is the very interesting kicker: Any time a practice question came up about what to do, the answer was always: “Whatever is in the clients’ best interest.” Without the usual conflicts of interest, it was fairly simple stuff to manage.

2 Paying a per trade basis (brokerage model) is much less expensive than a percentage of assets (adviser model).

This argument works in theory but not in practice. Why? It’s a basic rule of economics that incentives matter. Give your employees a financial incentive to trade, and what tends to occur is lots more trading. (A recent research paper on broker misconduct makes that clear.) That increases turnover, costs and taxes, all of which work to diminish performance. So while this has some merit in the abstract — it’s not a terrible idea for people who only need a one-time portfolio set-up or advice — as a matter of actual practice, it’s difficult to see any true benefit. Instead, these folks might want to consider an hourly adviser and pay them once to set up a portfolio, with no further charges. That’s often even cheaper than the commission approach, without the risk of misaligned incentives.

3 It would reduce the availability of financial advice for people with smaller portfolios.

This is a rather disingenuous claim, as it has always been the case that smaller accounts see little love from Wall Street. A few years ago, giants such asMerrill Lynch, Wells Fargo and Morgan Stanley began discouraging advisers from serving clients with less than $250,000 in assets — either deferring commissions, significantly reducing them or ending them entirely.

Those are the three best arguments I could find; none holds much water. There is an old joke: Whenever people say “it’s not the money, it’s the principle,” it usually means it’s about the money. There are 17 billion reasons a year why that is true about the opposition to the fiduciary standard.


Ritholtz is chief executive of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, The Big Picture. On Twitter:@Ritholtz.

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