Rules Were Made to Be Bent

Big news from the Department of Labor last week. The DOL issued the final version of their not-so-new rule that purportedly eliminates the “suitability standard” and forces all financial advisors to follow the “fiduciary standard.”

What does that mean, you ask?

Those terms describe the kind of advice you get from financial advisors like me. Recommendations from an advisor that follows the suitability standard need not be in your financial best interest. They only need to be “suitable.”

An example of a “suitable” piece of advice: if an advisor recommends an investment product that generates the highest payout for them, even though they have another product that would be better for you, that’s perfectly legal as long as it was suitable for you at the point of sale. They don’t have to tell you about potential conflicts of interest, nor do they have to monitor the investment to make sure it stays “suitable” for you. All they have to do is give evidence that the recommendation was suitable at the time they recommended it, based on the information you gave them.

The fiduciary standard doesn’t work that way. The fiduciary standard requires that the advisor put your financial interests before their own. In that previous example, the advisor following the fiduciary standard must recommend the second investment product over the first. In essence, they make sure you get the maximum possible benefit.

Can you guess which standard is followed most often?

If you guessed, “suitability standard,” you’d have guessed right. The vast majority of advisors follow the suitability standard. They are registered representatives of a broker dealer. Let me say that again: they represent the broker dealer. You can only serve one master.

Advisors that are not affiliated with a broker dealer, or independent registered investment advisors, by existing law, must follow the fiduciary standard. To be fair, there are very experienced, honest, and well-intentioned advisors at almost any firm you can name. But the reality is, many advisors rationalize certain decisions that under a different system, they’d be forced to make another way. I should know. I was a registered representative of an independent broker dealer for thirteen years. (I follow the fiduciary standard now.)

The broker dealer I represented taught me a great deal, and I value the experience I had there. But when the Global Financial Crisis (GFC) hit in 2008, I started reading things in the press that made me realize the broker dealer hadn’t told me everything, and that there were other ideas and strategies that my clients could really benefit from.

So I asked them if I could use these different planning software applications and financial products. They said no. I asked several different people in several different ways, but the answer was still unquestionably and unequivocally, no.

Why? Because they’d spent vast amounts of money on all the things they either produced or bought licensing for, and they didn’t want me or any other advisor using other tools and products. Number one, they’d have lost out on potential revenue as a result, and number two, they’d have had the financial liability of monitoring the use of these tools and products that they really didn’t know much about. It’s not that the company didn’t want their advisors to be objective. They just didn’t feel the need to let them offer anything and everything to their clients because there’d have been risk and lost revenue to do so.

The company ultimately answers to the shareholders. I completely understand the position, but in my opinion, this kind of accountability can be an issue because it limits the scope of what an advisor can do for his or her clients. And that’s why I left.

The independent broker dealers allow their registered representatives to offer lots of different investment and insurance products and use multiple planning applications. But they make the ones that are most profitable for the company more profitable for the advisor. So which do you think the advisors are going to recommend?

The DOL has been battling industry interests to pass this law for years now. And in fairness, some of the provisions in the initial proposal were absurd and would have resulted in a lot of wasted time and money. For example, in its original form, an advertisement placed by an advisor in the local paper that doesn’t provide any kind of advice or recommendation, would have been considered fiduciary investment advice and subject to regulatory requirements.

But at its core, the spirit of the rule is sound. Every professional should be held to a standard that requires they put their client or customers interest before their own. But isn’t that just good business? Wouldn’t you think someone that doesn’t do that go out of business in a hurry anyway?

Not if the clients don’t know any better. The problem is: they still won’t. No government rule is going to prevent hucksters from hucking. A cheater is going to find a way to cheat. And that includes the politicians who pass these laws.

Department of Labor Secretary Tom Perez, Senator Corey Booker, and Senator Elizabeth Warren cheered the announcement of this final version of the rule. Those who oppose the rule will say lawmakers like Booker and Warren are just using this for political gain. Maybe so, but I’d rather they reap their political gains by creating rules that benefit the average person than not. There’s a loooot of time left in this game, and there are a lot of other politicians that are going to go to bat for the industry in the coming months and years.

Where the initial version would have taken effect before the end of this year, the “final” version says some parts will take effect in April of 2017, and the rest in January of 2018. That leaves the industry lobbyists and lawyers plenty of time to kick the teeth out of it.

The industry says this will drive up costs for average Americans so they won’t be able to get advice. Hello! That point came and went years ago! The workers that put their hard earned cash in their 401(k) every two weeks are already paying through the nose. They just don’t know it. They’re starting to learn, but they’re still largely unaware, because the industry has fought tooth and nail to make it so.

Implementing this rule will unquestionably cut into industry profit margins, as they’re quick to point out. And that’s why I think this will eventually be watered down to a level where nothing effectively changes, or the industry will find some other way to siphon the money required to sustain their margins. Call me a skeptic, but I can’t believe they’re going to give in and allow investors a break at the expense of the margin.

The rule will also undoubtedly result in a fair amount of regulation that will be excessive and increase cost for me as an advisor, but I’m still all for this rule and I think the people that are fighting for it should continue their fight. Because we need them to.

Every financial advisor and broker dealer out there should be required by law to put their client’s financial interest first. But I’d be lying if I said I was hopeful that they’ll be able to implement it in a way that will result in mom and pop investors getting a truly fair shake. The government can’t make dishonest advisors and firms honest. Especially when the government is chock full of politicians who are getting money directly from them. That’s where the rule making really needs to start in my opinion.