Clark At Large

As reported by Wealth Manager Editor-in-Chief Kathleen McBride in her Friday online column (wealthmanagerweb.com), a new salvo as been fired in the attack against a fiduciary duty for all financial advisors. Now that the dust has begun to clear from the wreckage of healthcare reform, Congress is once again turning its attention to the business of running the country, including the back-burnered reregulation of financial services. At what I can only assume is the behest of the Financial Services Industry (SIFMA, et al)—who have likely not been idle during this legislative hiatus—Sen. Tim Johnson (D-SD) has introduced an amendment to the Senate version of financial rereg that would replace the stated “’40s Act fiduciary duty” with a study of the “obligations of Brokers, Dealers, and Investment Advisors.” For those of you who don’t spend much time inside the Beltway, that’s Washington speak for “buried deeper than John Edwards political career.”

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Another blog comment that advances the fiduciary discussion comes from an old friend, Stan Hargrave, posting in response to my blog #110 “Real World Woes….” Stan’s a recovering CPA who’s one of the best, most ethical financial advisors I know. He’s also done a lot of expert testifying in arbitration cases, so his observations about brokers and clients in litigation carry a lot of weight. In fact, I can’t take issue with anything he says, except, of course, his conclusion. (Are you beginning to see a pattern here?)

His description of brokerage clients not only parallels my observations, but is consistent with the picture painted by many folks who work with the financial public: They sign documents (including risk tolerances) without reading them, don’t look at monthly statements, don’t know the difference between making returns and getting their own money back, and “just want someone to trust, but don’t know what that means.”

What Stan has described is the textbook “consumer” in a classic professional/patient-client relationship. Do you really think any of us are different when we go to a doctor or lawyer? We don’t really understand what they are telling us, until they get to the “So here’s what you need to do” part. Sure, we’re advised to get “second opinions” about major medical procedures. So now we have conflicting suggestions about what we need to do from two doctors we don’t understand. Feel better? (The same thing happens when I follow the golf pros’ advice to read my putts from both sides—looking from the ball to the hole, and then from the hole to the ball: now I see the ball rolling in two different directions. Brilliant.)

Given his right-on capturing of the plight of financial consumers—they don’t know anything about finance, don’t want to know, and just want a professional to tell them what they need to do—I’m a bit puzzled at Stan’s conclusion that “most of these ‘fiduciary’ discussions are why off the mark and don’t add much to solving the issues on both sides.”

What could be more of a bullseye than requiring clients’ “advisors” to be true professionals, and to stop taking advantage of their clients’ ignorance of matters financial? This disparity between people’s ignorance and professionals’ knowledge, and the inherent potential for abuse, is precisely why professional standards—including the fiduciary duty—were created in the first place. What could be a more perfect solution?

In his response to my January 8 blog, Jay Martin raises an interesting issue about whether a fiduciary standard can or should be applied to securities sales. He writes: “I, for one, am thoroughly confused how sales can or should be fiduciary.”

The implication here is that it shouldn’t be, and I couldn’t agree more. But then he goes on to imply that the standard of “caveat emptor” is sufficient to protect financial consumers in sales situations, and that’s where I have to respectfully disagree.

“Buyer beware” works great in situations where the consumer is an equal party to the transaction and—and this is the important part—understands the nature of the relationship: that the salesperson is trying to sell a car, a cell phone, a putter, an upgrade to a suite, etc. However, when it comes to securities “sales” we all know that’s not the case (whether we admit it or not).

In my own recurring straw poll of asking people over the years, including “sophisticated” investors, lawyers, business executives, high-net-worth folks, and so on, if they think their broker has a fiduciary duty to put their interests first, not one has ever answered “No, they don’t.”

That’s no accident. Since I started covering advisors, Wall Street has spent billions of advertising dollars suggesting, implying, or inferring that what you get from brokers is investment advice. Over those same years, in response to various regulatory initiatives or proposals, the industry has as much as admitted that if they had to fully disclosure the nature of the sales relationship, it would affect sales.

That should be our first clue that something’s amiss. For caveat emptor to work in a consumer securities transaction, the consumer should be made aware that “their” broker neither works for them nor has any duty to act in their best interest. But when brokers, or other “financial advisors,” cross over the sales line into giving advice, that’s when a fiduciary duty should apply to the relationship.

What constitutes advice? Financial planning industry leader Harold Evensky recently defined it the clearest, simplest, most elegant way that I’ve ever heard, using what Harold calls the “you” standard: When a broker or any other kind of “advisor” tells a client “here’s what you should do:” buy a mutual fund, sell a stock, hedge a position, etc., that’s advice. If you simply give them product information, that’s sales.

“But if we do that,” I hear brokers and insurance agents across the country crying, “no one will buy anything.” Maybe that’s our second red flag.