You Can't Afford Your Broker, at Any Price

The very reason that conflicts of interest are valuable enough to buy brokers homes in nice suburbs is that most people erroneously believe that they already have a fiduciary relationship with their brokers. 

The Department of Labor is moving toward making brokers and related jobs "fiduciaries" for their clients, the Wall Street Journal reports. Basically, they would have to offer advice with your best interest at heart, and should avoid conflicts of interest -- such as accepting fees to put people into low-return, high-fee investment vehicles. Think of your doctor or your lawyer: You're pretty glad they can't take money to steer you in a certain direction, aren't you?

But industry professionals warn that if they're given fiduciary status, a lot of their revenue will disappear, meaning that they will no longer be able to afford to service small accounts:

The heart of the matter: Fiduciaries should avoid conflicts, but brokers are generally required only to disclose them.
"Having a completely conflict-free relationship doesn't work in practice across most of the brokerage industry," says John Taft, head of RBC Wealth Management in the U.S., which manages $250 billion.

For example, when your broker's firm underwrites an initial public offering of stock, he and the firm earn far more by selling some of those shares to you than selling you something else. When your broker buys you a bond out of his firm's inventory of your broker's firm, rather than on the open market, the firm also tends to make more money.

Industry groups have argued that if brokers can't have any conflicts, like earning higher fees on some investments than on others, then they no longer will be able to afford handling small accounts.

"The [brokerage] industry is saying, in effect, 'If you don't allow us to continue to give conflicted advice, we won't be able to give any,' " Assistant Secretary of Labor Phyllis Borzi, who oversees retirement benefits, told me. "But there are lots of people out there who are already acting as fiduciaries, and they're not bankrupt. They're making money."

I'm generally sympathetic to arguments similar to the ones the industry is making. And that's the case here, to a certain extent: I believe that Assistant Secretary Borzi is wrong, and the industry is right, about the likely outcome of this rule change. Fiduciary relationships are expensive, and changing the status of brokers will raise the direct cost of having a broker give you advice.

On the other hand, when I hear that brokers won't be able to service small clients any more, my basic reaction is "Good." Essentially, brokers are arguing that they can't afford to give you honest advice; their livelihood depends on being able to steer you into investment vehicles that pay them kickbacks. Sorry, commissions and referral fees. And where do the fees come from? Why, your pocket, ultimately; there's a reason your broker has to be paid to tell you that this is a good idea. This sort of free advice you can't afford.

Unfortunately, the very reason that these conflicts of interest are valuable enough to buy brokers homes in nice suburbs is that most people erroneously believe that they already have a fiduciary relationship with their brokers. Oh, they may not put it in quite those terms. But they do not, by and large, understand how much of a brokerage firm's income comes from steering them into the investment-of-the-month. Which is why brokers find it relatively easy to steer them into the investment-of-the-month.

This relationship encapsulates everything that people think is wrong with Wall Street. And people are starting to notice. If Wall Street wants to keep operating without its clients marching on them with pitchforks and torches, this sort of thing needs to change. They're going to fight the Labor Department hard on this, but in the long run, it will probably be better for them -- and their clients -- if they lose.

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