There’s a TV commercial for the broker Charles Schwab where a cloyingly clever millennial stalls his hidebound father’s investment advice with a simple question: “How much does [your broker] charge?”
“I don’t know,” says the father. Well, the son says, the world is changing. Investors expect more transparency.
The question is whether Donald Trump can stop it or not by up-ending a rule designed to force brokers to come clean with their clients.
There is a growing focus among investors on the fees they pay for financial products in the post-crisis world, thanks to the rise of low-fee digital brokers and an obsession with index funds. Even traditional investment advisors like Schwab are trying emphasize their low fees.
And, with corporate pensions taking up a smaller and smaller share of retirement savings, tax-preferenced investments are more important than ever. But right now, many investment advisors for small investors must only recommend “suitable” products to their clients. Last year, the Obama administration bought into the transparency trend by mandating that any investment advisor must meet a fiduciary standard of acting “in the best interest” of their clients.
This simple change ignited quite a firestorm in the investment industry, with financial lobbyists predicting doom and bad results for investors. Gary Cohn, the Goldman Sachs executive turned top economic official in the Trump White House, said that his boss would get rid of this new standard, telling the Wall Street Journal today that “it’s a bad rule for consumers.”
This is the same rhetoric the banks delivered when the Obama administration set standards for residential mortgages that can be sold to other investors. Banks said that consumer choice would be diminished, and it was: It became harder to access predatory loans given without income checks, that are interest-only or have escalating payments. It’s certainly paternalism, but it’s not obviously bad for home-buyers.
In the case of the fiduciary rule, the problem is similar: Investment advisors were recommending investments with high fees, including those produced by their own company or that provide them a kick-back for sales, to benefit themselves at the detriment of their customers’ returns. Others were simply trading more than necessary, generating churn to grow their commissions. The Obama administration estimated a $17 billion annual loss to small investors because of these practices.
The fiduciary rule makes it harder for brokers to make those transactions, because they have to justify them as being in the customer’s best interest. In practice, what the rule meant was an assault on commission-based compensation for brokers and a move toward fee-based compensation as companies sought to eliminate potential conflicts.
Indeed, a key exemption in the rule is that brokers can keep their compensation practices the same if they provide their clients “descriptions of material conflicts of interest, fees, or charges paid by the retirement investor, and a statement of the types of compensation the firm expects to receive from third parties in connection with recommended investments.” In other words, clueless TV Dad’s broker would have had to sit him down and explain where the money goes.
Naturally, bankers squealed as they realized their work would be less lucrative under the fee-structure demanded by the new rule, but the arguments put forth in favor of the “suitability” standard tend to fall flat: Concerns about the vagueness of the fiduciary standard or its inability to be tailored to customized investment plans have not stopped the many thousands of SEC-registered investment advisors or Certified Financial Planners, whose advice must meet a fiduciary standard, from providing tailored advice to their clients.
Indeed, such comparisons raise the question of why an investment advisor managing more than $100 million must obey the fiduciary standard, but someone managing a $50,000 nest egg doesn’t.
Despite Trump’s plan to eliminate the rule—which could take many months and must go through the Department of Labor, which still has no leader—many companies are planning on moving forward with the changes they implemented in order to meet its standards. Merrill Lynch has said it will no longer allow retirement investors to use commission-based accounts, while Morgan Stanley is planning to keep its own compliance moves intact.
“My expectation is that a lot of firms are going to continue installing a best-interest standard, regardless,” Brian Graff, head of the American Retirement Association, told Bloomberg, which certainly suggests that the apocalyptic response to the rule may have been overstated.
Some hope that the combination of banks adopting investor-friendly measures to meet the standard and Trump repealing it (and the costs of compliance) will be the best of both worlds. That may be asking too much of banks, institutions who too often have put their integrity ahead of a profit. In the meantime, be like the snarky millennial and follow the money.