On your side.

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Imagine: Brokers Who Work for Investors

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.”
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 In 2011, the Securities and Exchange Commission published a study, mandated by the Dodd-Frank Act, which concluded that all financial advisers and stock brokers should be placed under “a uniform fiduciary standard.” Basically this meant that brokers and advisers would have an obligation to put the interests of clients first and must disclose any conflicts of interest that might compromise that duty.

Wall Street was none too happy about this. The industry spent tens of millions of dollars lobbying to prevent this standard from becoming the law of the land. Indeed, of all the regulatory reforms that have come out of Dodd-Frank, nothing seems to displease the financial industry more than the proposed fiduciary rules.

Although other reforms may be inconvenient and clunky, the proposed rules probably would cut Wall Street's fees, potentially by a lot. This is a radical change from the current rules, which allow a universe of products, costs and behaviors that history teaches us are contrary to the client’s best interest.

The jousting over standards comes amid the awful results that investors have had in their tax-deferred retirement accounts. As too many studies have confirmed (see this and this), the typical 401(k) or individual retirement account investor barely earns 2 percent a year on their savings. In the years since the Employee Retirement Income Security Act (Erisa) rules went into effect in the 1970s, the average portfolio with a 60-40 split of stocks and bonds should have returned almost four times that much.

Although poor investor decisions are part of the problem -- chasing hot money managers, jumping in and out of funds, trying to time the market -- high fees associated with conflicted advice have also been a persistent drag on returns.

The present approach is to blame. It has created two wildly different standards of acceptable behavior for investment professionals, who in turn are governed by two different sets of regulations and regulators. The terms used to describe the standards are “suitability” and “fiduciary.”

There is plenty of confusion about the two standards. As Bloomberg News has reported, "Three out of four U.S. investors mistakenly think that financial advisers at brokerage firms are required to put clients' interests first, said a survey by several consumer and financial planning organizations." Obviously, this is a problem.

The SEC enforces the standards for fiduciaries, which tend to charge fees rather than commissions. But much of the industry is governed by an organization called the Financial Industry Regulatory Authority, or FINRA, which was set up, managed and funded by broker-dealers. If that makes you wonder whose interests are considered foremost by this organization, well, your suspicions are well-founded.  Since FINRA is financed by the broker-dealers it is supposed to discipline -- a prima facie conflict of interest -- should anyone expect it to be able to police conflicts of interest?

FINRA and its industry backers -- no surprise -- prefer the suitability standard, meaning that an investment recommendation has to be consistent with the interests of a client. This is, of course, a laxer standard than one that places the interests of investors first. The SEC, consumer and groups representing individual investors prefer this stricter fiduciary standard.

Here is what a fiduciary standard should consist of, according to a group called the Committee for the Fiduciary Standard, which is backed by fiduciary advocates and investment advisers:

-- Put the client’s best interests first

-- Act with prudence; that is, with the skill, care, diligence and good judgment of a professional

-- Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts

-- Avoid conflicts of interest

-- Fully disclose and fairly manage, in the client’s favor, unavoidable conflicts

These seem straight-forward if you are an investor advocate. But unlike the SEC, FINRA advocates on behalf of broker-dealers, not investors. I have noted before, that the fiduciary rules would protect investors from broker malfeasance, while suitability rules protect brokers from investor lawsuits.

The fiduciary rules, as noted above, would cut lucrative fees to the broker-dealer industry, though they would work to the advantage of investors. It is no surprise that broker-dealers have been very aggressive in lobbying against them and at great expense.

This fight has been brought to a head by an ingenious move by the White House to bypass the usual Wall Street lobbyists by using the Department of Labor and existing Erisa laws to propose new rules governing conflicts of interest. Instead of having to go through a corrupt Congress that is well greased by the financial industry, this is backdoor regulation that would impose a fiduciary duty on those who give advice about retirement accounts.  

We should all applaud this move. The bottom line is that someone has to pay for all of the people who are going to retire in the next 20 years, and a lot of it is very likely going come from Uncle Sam. Trying to reduce the drag on investment returns from high fees on private retirement savings means that much less that the government will have to pay. If nothing else, true fiscal hawks should like the new rules for that reason alone.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Barry L Ritholtz at britholtz3@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net