Money Stuff

Should Financial Advisers Act Like Salespeople?

Also sex blockchain, CFDs, Hovnanian and Uber's Ripley.


A big problem in the financial industry is that lots of its clients think that they are dealing with advisers, while the industry thinks they are dealing with salespeople. If I have bonds, and I don't want those bonds, and I am a salesperson, and I convince you to buy those bonds from me, then that is good, that is my job, everything is great. If I have bonds, and I don't want those bonds, and I am your adviser, and I convince you to buy those bonds from me, then that is bad, that is the opposite of my job, that is a conflict of interest. And if think I'm a salesperson whose job is to sell you stuff that I don't want, and you think I'm an adviser whose job is to help you buy stuff that you should want, then all of our interactions will be fundamentally dishonest and terrible and dangerous.

Should brokers generally be fiduciaries for their customers? No, of course not, that would be stupid. A broker's job is to buy a bond from one customer and sell it to another. If the broker has to promise both customers that she is giving them undivided loyalty and the best possible advice, how can she broker that trade? A broker's job is not to act in each customer's best interests, or to represent that every transaction will work out well for every customer. A broker's job is to honestly intermediate transactions.

Should people who call themselves financial advisers generally be fiduciaries for their customers? Yes, the answer is yes, obviously. This does not end the discussion -- the specific contents of a fiduciary standard for broker-advisers matters -- but the basic issue is very simple. If you call yourself a financial adviser, then your clients will think that you are acting in their best interests, and if you are not then you are deceiving them, no matter what you say in the fine print.

Anyway the Securities and Exchange Commission might create a fiduciary rule for brokers:

The SEC has struggled for years to harmonize the rules brokers and investment advisers face when they serve retail clients. Use of the term “financial adviser” has muddied the waters further for less sophisticated investors, who may not understand the “buyer beware” culture that pervades the securities business.

SEC Commissioner Michael Piwowar has pushed for banning the “financial adviser” title unless a broker has accepted a fiduciary duty to act in the investor’s best interest, according to a person familiar with the matter. Mr. Piwowar told a conference audience in March that the name “means absolutely nothing” today.

It will of course matter what the rule says. (Will it impose a fiduciary standard, or forbid advisers from being compensated more for selling some products rather than others, or what? Will it apply to all retail brokers, or those who call themselves advisers, or what? And what exactly does it mean to act in investors' best interests?) It will matter how the rule interacts with the Department of Labor's somewhat moribund fiduciary rule, which on the one hand applies only to retirement accounts, but which on the other hand may turn out to be stricter than whatever the SEC comes up with. All of this is potentially complicated and controversial, but it is hard to argue with the basic idea. If you call yourself an adviser, people are going to think you're an adviser, so you should be one.

Discount brokers.

For instance:

Advisers at some of the biggest discount brokerage firms make more money if they steer clients toward more-expensive products, according to disclosures from the firms and people who used to work at them. That means customers could end up with investment products and services that are costlier than they need.

“Clients hear the representative doesn’t work on commissions, and they think that means a rep doesn’t work on incentives,” said Jeff Weeks, former manager of a Fidelity Investments branch in Austin, Texas. 

The really weird part is what the brokerage firms have to say about this. The correct response is something like: Sure, we are an investing store, we try to sell you investing products that you will like, but obviously we prefer to sell you products that make us a lot of money rather than products that make us a little money. That would be a straightforward acknowledgment that retail brokerage is a business and that brokers are salespeople and that the brokers' incentives -- like those of salespeople anywhere -- are not always perfectly aligned with the customers' desires. 

But no one wants to say that, so you get stuff like this:

“The internal controls we have in place flag someone who is conducting their business” improperly, said Andrew Tappe, executive vice president at Fidelity, who helps oversee its 197 branch offices. “We monitor their activities closely, investigate immediately if we see any concerns, and take prompt action.”

But why would Fidelity have "concerns" about its salespeople selling products that are profitable for Fidelity? That is good, that's what Fidelity wants, that's why it pays incentives for doing it. It's the customers who should have concerns, and they're not monitoring the activities closely.

At Schwab, “We never want a financial consultant to feel they have to sell one product over another from a compensation standpoint,” said Joe Vietri, head of the firm’s branch network. “Our whole business is rooted in trust and in always doing what’s in the best interest of the client.”

Well, you know, the whole business except for the compensation structure. The compensation structure is rooted in profitability and doing what is in the best interests of the firm. That is totally normal! It's how most businesses operate! Most businesses try to sell you stuff that you want, because that is a good way to get you to buy it, but they also try to sell you stuff with large profit margins, because that is a good way to make money. But in the financial industry there is this weird taboo on admitting that you are running a business; everyone goes around claiming that they are trusted advisers who only act in the best interests of their clients, while also objecting to any effort to regulate them as fiduciaries. 

Sex blockchain.

Sure I mean okay whatever I don't care it's fine:

LegalFling records sexual consent in a legally binding agreement, which is verifiable through the blockchain.

Sex should be fun and safe, but nowadays a lot of things can go wrong. Think of unwanted videos, withholding information about STDs and offensive porn reenactment. While you're protected by law, litigating any offenses through court is nearly impossible in reality. LegalFling creates a legally binding agreement, which means any offense is a breach of contract. By using the LiveContracts protocol, your private agreement is verifiable using the blockchain and enforceable with a single click.

Every sentence is ... a sentence. "LegalFling allows you to request consent from any of your contacts," the website says, and I hope it means your LinkedIn contacts. "Asking to sign a contract to have sex can be awkward," as opposed to the presumably non-awkward blockchain-based "sexual consent with the click of a button." "Only the transaction hash is stored and timestamped in the blockchain, so your privacy is guaranteed," because you wouldn't want SexCoin miners to have the unencrypted details of your sexual encounters. "Escalate a breach with a single click, triggering cease and desist letters and enforcing penalty payments," is also a sentence that appears on my computer screen right now. I hope the cease and desist letters arrive during the sex.

I tweeted about this thing yesterday, and some people took it a lot more seriously than it deserves to be taken. (I will bet you one SexCoin that no one will ever negotiate sexual consent on LegalFling's blockchain.) One objection that people raised is that sexual consent can be revoked at any time, and that memorializing it on an immutable blockchain does not correspond to actual human sexual behavior. The LegalFling model sort of imagines that people will come up with a clear list of sexual activities in advance, and write down and agree to that list, and that list will never change and it will be easy to tell what is on the list and allowed and what is off the list and not allowed. That seems implausible.

But this is not a problem of sex, it is a problem of lists. Human activity generally is varied and subtle and difficult to fully specify in advance; if you write down a list of what is allowed under any contract, that list will be incomplete and subject to interpretation and changes in circumstances. There is a utopian crypto-enthusiast belief that smart contracts on the blockchain will somehow eliminate this complexity, but that misunderstands the source of the complexity: It comes from human affairs, not from contract technology. "People who keep touting smart contracts as 'simplifying contracts' don't understand that litigating contracts is expensive because of human interpretation, not because someone forgot to write something down and get it notarized," tweeted Sarah Jeong.

Elsewhere in the endless crypto horror that is my inbox:

That is quite enough I think. I joked last year that "If you could only say one sentence for the rest of your life, 'smart contracts via crypto make this super doable' would not be the worst choice." It would be though, it would be the worst choice. It is universally applicable, but that is why it is the worst.


Elsewhere in financial salesmanship, the U.K. Financial Conduct Authority did a review of the retail contracts for difference market and did not love what it found. Retail CFDs are basically a leveraged way for individuals to gamble on stocks, and they tend to be a losing proposition. "The majority (76%) of retail customers who bought CFD products on either an advisory or discretionary basis lost money," says the FCA. Ah, the CFD providers say, that's no problem, because CFDs are marketed to sophisticated investors who understand the risks they're taking on. The FCA is skeptical:

Across the sample, we found the majority of CFD providers and distributors had a poor target market definition. Many relied on broad investor descriptions such as 'experienced', 'sophisticated' and 'financially literate', without setting out what these terms actually mean in practice. Most firms were also unable to adequately explain how the nature and risks of the CFD product was aligned to their target market.

In our view, excessively broad definitions of target markets may lead firms to conclude that CFDs are suitable and/or appropriate for the majority of potential customers, even when this is unlikely to be the case. 

Some people have a presumption that if you seek out complicated risky financial products, then you must have a certain informed appreciation for complexity and risk. It is possible that the opposite is true.


We have talked a couple of times about the situation at Hovnanian Enterprises Inc., which agreed with Blackstone Group's GSO Capital Partners to do a quickie default on its bonds so that GSO could get a payout on credit-default swaps that it had bought on Hovnanian. In exchange, GSO agreed to give Hovnanian new financing at attractive terms. This naturally enraged the people who had sold CDS on Hovnanian, and who will now have to pay out. They find this all very unsporting:

“We fear that the Hovnanian situation could embolden investors to pursue manufactured credit events with other corporate issuers, which would undermine the true intention and spirit of the CDS market,” said Adam Savarese, co-head of leveraged finance trading at Goldman Sachs.


“You can do your credit work but you may not know what is going on behind the scenes where someone could be trying to manufacturer a credit event,” said another fund that had sold Hovnanian CDS.

My own view is that, at this late date, if you are trading CDS you should expect it to have lots of legal complexity, and if the other side has cleverer lawyers than you do then that is your own fault. But that is perhaps a minority view, and it does make sense to worry that if CDS payouts do not match intuitive market perceptions of "default" -- for instance, if CDS pays out for companies that are actually paying their debts -- then that will damage the CDS market.

But the complaints about "manufactured credit events" are not quite right. Yes, definitely, GSO and Hovnanian worked together to manufacture a credit event: Hovnanian agreed to miss an interest payment on a small chunk of bonds (which will be held by its own affiliate) in order to trigger a default under the CDS contracts, even though it will have plenty of money to make that payment. But just manufacturing a credit event wouldn't hurt the CDS sellers much: Hovnanian's bonds trade near par, so if the CDS was triggered it wouldn't lead to big payouts. The CDS market is actually somewhat robust to the manufacturing of credit events.

GSO's innovation here was not just manufacturing a credit event, it was manufacturing a low-value bond: Hovnanian will issue new bonds to GSO, bonds that should trade at something like 50 cents on the dollar, which GSO can deliver into a CDS auction in order to get a big payout. They are messing not only with the mechanics of the default but also with its payout; they are disconnecting the economics of the CDS from the economics of the bonds it was meant to hedge. It is clever and I enjoy it, but it is not a great look for the CDS market.

Oh, Uber.

Here's what happened when Canadian authorities raided Uber Technologies Inc.'s Montreal office looking for evidence of tax evasion:

Like managers at Uber’s hundreds of offices abroad, they’d been trained to page a number that alerted specially trained staff at company headquarters in San Francisco. When the call came in, staffers quickly remotely logged off every computer in the Montreal office, making it practically impossible for the authorities to retrieve the company records they’d obtained a warrant to collect. The investigators left without any evidence.

Most tech companies don’t expect police to regularly raid their offices, but Uber isn’t most companies. The ride-hailing startup’s reputation for flouting local labor laws and taxi rules has made it a favorite target for law enforcement agencies around the world. That’s where this remote system, called Ripley, comes in. From spring 2015 until late 2016, Uber routinely used Ripley to thwart police raids in foreign countries, say three people with knowledge of the system.

The name is an allusion to "Aliens," in which Sigourney Weaver's Ripley character says "Nuke the entire site from orbit."

We have talked before about this particularly Uber form of regulatory entrepreneurship. It's not just that Uber sometimes ignores the law and dares the authorities to do something about it; it's also that Uber takes ambiguously legal practices that are common elsewhere and dials them up to uncomfortable extremes. Here's how Ripley started: After Belgian and French police raids discovered sensitive information on open computers, Sally Yoo, "then Uber’s general counsel, directed her staff to install a standard encryption service and log off computers after 60 seconds of inactivity." That's pretty normal: Encrypting information and logging people out of their work computers quickly are security precautions that lots of companies take. They don't want random visitors to be able to access their sensitive files. If some of those random visitors are the police, well ... Uber might not be the first company to consider the benefits of keeping those sensitive files from police. If the cops show up and find all your computers locked, you can say "well that is just our normal security procedure," and everyone will understand. (They may ask you to unlock the computers, but they did that to Uber too.)

But Uber's addition is the remote-lockdown service: Rather than relying on timeouts and general encryption, Uber explicitly built a system to counter police raids. "The innovation at Uber," I wrote about some of its other regulatory evasions, "is to make explicit what traditional companies leave implicit. It turns fuzzy human intuitions into explicit algorithms." Everyone knows that if the police raid your offices it's best if they can't just look at all your sensitive documents. Other companies have crude haphazard innocent-looking procedures that happen to keep the cops from looking at those documents. Uber built a whole system and gave it a swaggering name. It takes the procedure just one step further, but what a step.

Things happen.

VIX manipulation? (Earlier; also.) Warren Buffett’s influence over banks adds to succession risks. Trump Administration Seeks to Change Rules on Bank Lending to the Poor. Chinese Workers Abandon Silicon Valley for Riches Back Home. No Deal Brexit Could Cost 482,000 Jobs as City Recruitment Slows. Boards Seek Bigger Role in Thwarting Hackers. HNA Group Has So Many Companies It's Running Out of Names. Space fashion. Dolphin capitalists. Bill Gross: "Bonds, like men, are in a bear market."

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