The Trustworthy Investment Manager's Twelve Days of Christmas

Poster by Xavier Romero-Frias, Wikimedia Commons

W. Scott Simon keyboarded The Twelve Days of Christmas of a Modern Prudent Fiduciary nine years ago. Then and now, there's more to investing like a true fiduciary than "putting the customer first."

Decline and Fall of the Fiduciary Standard

Efforts to impose a fiduciary standard on brokers handling 401(k) accounts have been losing ground. Proposed regulations have been so watered down that some brokerage firms figure they'll make more money, not less. With Republicans controlling the new Congress, even the emasculated fiduciary standard is likely to be deferred or discarded.

For a reminder of the high hopes motivating the standard's proponents in 2009, see Fiduciary Standards for Broker-Dealers.

Did a JPMorgan Broker Turn Fiduciary?

After losing his job, a JPMorgan broker turned whistle-blower, saying Morgan had pressured him to put clients into the bank's funds when better choices were available. The New York Times has jumped on his story, here and in a James B. Stewart column.

After JPMorgan fired the broker, client complaints concerning his behavior showed up. The complaints were not written by disgruntled clients. That's the sort of fun fact that draws media attention.

The Trust Officer and the Orphan

This week's fiduciary feel-good story, spanning almost half a century, from Ron Lieber in The New York Times.

Retirement Investing: Plan B?

"We shall fight on the beaches, we shall fight on the landing grounds…." Oh, wait! That was Winston Churchill in 1940, not opponents of the Labor Department's proposed fiduciary standard for investment advice.  Nevertheless, they showed their fighting spirit at last week's hearings.

Requiring fiduciary-quality advice would not reduce costs, representatives of the investment-products industry contended. They repeated their warning in TV commercials. Workers seeking fiduciary guidance would have to pay up, shelling out the same one percent annually as richer folks. And the industry's fierce resistance ("We shall never surrender!") would send compliance costs through the roof.

Perhaps some sort of fiduciary standard for investment advisers to 401(k) plan investors may yet emerge. But the pale, anemic regulation probably won't be worth much. 

So it's time for Plan B: If sellers of investment products can't be turned into fiduciaries, perhaps they can be sidelined.

Plan B proponents advocate drastic steps to simplify retirement investing. They would replace today's  jungle of retirement plans and accounts with just one vehicle. John N. Friedman calls it the Universal Retirement Savings Account. Investment choices ideally would be limited to low-expense index funds or life-cycle funds. 

Unfortunately, history shows Plan B is a bad bet. Government efforts at simplification almost always fail– look at the Internal Revenue Code. Restricting investment choices to a few simple, inexpensive products is equally difficult. If this is a free country, shouldn't investors be free to buy pricey investment products without interference from the Nanny State?

Anybody got a Plan C?

It's Not Easy Being Fiduciary

Investment advisers who aspire to the fiduciary life don't have it easy, as Steven G. Blum explains here.

What about online investment services, so-called robo advisers? Are they fiduciaries? Yes, writes Norb Vonnegut. Robo advisers stand on the buy side – that is, the client's side – not the sales side.

But as Vonnegut illustrates, even human fiduciaries can succumb to temptations offered by the sales side. Remember when bank trust officers were criticized for pushing the bank's own products? In Vonnegut's example, the tables are turned: a trust officer puts a client in an outsider's relatively expensive S&P index fund instead of the bank's lower-fee version.

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Norb Vonnegut has written novels skewering brokers (Top Producer) and hedgies (Gods of Greenwich). I hereby remake my resolution to read them. 

The Unbearable Complexity of Almost Everything Financial

"The complexity of our financial lives is so extreme that we must painstakingly manage each and every aspect of it,"laments Ron Lieber in The New York Times. He cites Social Security.

In my parents' time, the breadwinner claimed Social Security when he retired, his stay-at-home wife claimed her spousal benefit, and that was that. Today? Couples need to study a book or two and seek expert counsel or risk leaving money on the table.

If Social Security has become too complicated, "tax-favored" retirement plans have become a national disgrace. We have pensions (often underfunded) and 401(k)s (often overpriced). We have IRAs and spousal IRAs and self-directed IRAs and Roth IRAs and SEP IRAs and rollover IRAs and stretch IRAs and …..

Yet everyone agrees, few Americans are putting aside enough for retirement. Those who do must contend with thorny thickets of rules and regulations. As a result, financial planners devote more and more time to questions relating to the transfer, withdrawal and bequeathing of retirement funds.

Meanwhile, basic investing leaves people utterly bewildered: Thousands of mutual funds. More than a thousand exchange traded funds. A confusing, ever-growing array of packaged investment products. (If a fund is formed to invest in a portfolio of hedge funds that invest in other hedge funds, do you call it a fund of funds of funds?)

In "the landscape of confusion and tedium that characterizes our financial lives," Lieber observes, "every task seems to require its own multichapter management manual."

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Most investors won't read the manuals; they will seek human guidance. They are most likely to turn to brokers, who can't always offer disinterested help. Hence the well-intentioned movement to transform investment salespeople into fiduciaries.

Can this 21st-century alchemy succeed?

It's Not Easy Being Fiduciary

The NY Times reports on the plight of two Deutsche Bank private bankers who were forced out because they balked at pushing DB products – notably, a fund of funds. (Funds of funds answer the perceived demand for investment products that carry even higher annual expenses than regular hedge funds.)

According to this petition to the Supreme Court of the State of New York – we don't have DB's side of the story – the two found "staying fiduciary" was a losing battle.

As big banks try to grow bigger, sales tends to overwhelm service. One result: a marketing opportunity for smaller, fiduciary-minded institutions. 

Private Bankers Are Not Fiduciaries

J.P. Morgan's investment specialists are held to fiduciary standards. Morgan's private bankers are not. Do private bankers push the bank's own funds when cheaper or better alternatives might be available? In recent months both the Office of the Comptroller of the Currency and the Securities and Exchange Commission have been investigating.

The WSJ story notes that Morgan's funds most often outperform their Lipper averages. And because the bank charges an extra 0.5% annually for holding outside funds, Private Bank clients may find Morgan's own funds less expensive.

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See the SEC's page of advice for mutual fund investors here.

Seeking a Fiduciary? Good Luck!

Jill and Joe Investor should look for investment guidance from someone acting as a fiduciary, not a commissioned salesperson. Sound advice? In reality it's becoming harder and harder to act upon.

When advisers work on commission they may pledge to "demonstrate our commitment to putting customers first." But as Reuters notes, it's a commitment with an asterisk. And increasingly, brokers aren't working for commissions alone. Instead they have become "fee-based" advisers. That's not the same as "fee only." But not necessarily so different, either. The WSJ ($) cites an Aite Group study of almost 400 registered representatives (who traditionally work on commission) and registered investment advisers (who traditionally work for fees). The results show that Jill and Joe Investor face a daunting challenge:

Brokers working on commission reported getting, on average, about 20% of their revenue from advisory and consulting fees.

"Fee-based" advisers got almost 60% of their revenue from commissions.

And advisers most closely resembling "fee-only" got over 15% of their revenue from commissions.

In real life, Jill and Joe don't pay much attention to the distinction between fiduciaries and investment salespeople. Can we blame them?

Reinventing Investment Service

When the going gets tough, investors need fiduciaries, as we posted recently. Private banks and trust companies and legions of registered investment advisers can fill the bill. Provided you're High Net Worth.

Not so rich? Can't afford fees and expenses of two or three percent a year?  That's a problem. To obtain guidance inexpensive enough to please John Bogle, you would need to settle for an adviser whose previous job was flipping burgers.

O.K. Let's think outside the box. How about a virtual fiduciary? See The Wealth Manager For Rich Geeks.

This virtual fiduciary is called Wealthfront, and its CEO says, “We add very little value, and we price accordingly.” Wealthpoint offers ETF portfolios created by algorithm.  Fees and expenses are minimal.

Check out Wealthfront's inviting web site, a marvel of simplicity. Notice the promotional video. 

For comparison, I visited Vanguard, Fidelity and T. Rowe Price online. Each site was full of information, but none offered a simple, easy path for putting one's money to work. (I'm guessing fund companies would find it difficult, for legal and other reasons,  to create such a path.)

With skimpy stock and bond returns expected for a while, a truly inexpensive investment service has clear appeal. Even John Bogle might applaud a service that takes advantage of ETFs while removing the temptation to trade them.

Is Wealthfront on to something?

Related Post: Wealthfront's CEO is the same Andy Rachleff we linked to in "Private Banking " Dissected.

Should the Prudent Investor Always Follow the Crowd?

Child: The other kids are doing it, why can't I?

Parent: Just because everybody's doing it, doesn't make it right.

Ron Lieber wants those overseeing 401(k) plans to think like the parent. See Why 401(k)'s Should Offer Index Funds.

Most plans – over 60 percent – don't yet offer a basic menu of low-expense index funds. Lieber offers a hypothetical example showing how that lack might cost an employee $100,000 or more over a working lifetime.

According to Erisa, 401(k) plans should be investing with the “care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”

As long as most company plans don't offer a basic menu of index funds, do the people overseeing Galactic Gidgets' plan have a fiduciary duty to offer their employees an index funds option? If  not, would that duty automatically kick in once a bare majority of other plans do offer such an option?

Sell Like a Fiduciary, Quack Like a Pony?

In Dear S.E.C., Please Make Brokers Accountable to Customers, Tara Siegel Bernard begs the regulator to transform broker-dealers and annuity salespeople into fiduciaries. But the problems she acknowledges raise doubts that the fiduciary standard can stretch that far. Maybe there's a simpler solution: Require brokers to call themselves brokers – not "financial advisers" – and stop misusing the term "wealth management."

See also Flawed fiduciary duty and the appended comments, including this from John Olsen:

… the question [is] whether ALL investment advice - even broker-rendered advice that is "solely incidental" to that broker's "conduct of his business as a broker or dealer and who receives no special compensation therefor" [Investment Advisors Act of 1940, Sect. 202(a)(11)(C)] - ought to be subject to the FIDUCIARY standard that generally applies to "investment advice". Sect. 913 of Dodd-Frank specifically states that the charging of commissions is not, per se, a violation of fiduciary duty. But the question remains as to whether the rendering of advice by someone compensated by commissions is subject to that fiduciary duty.

Related post: Dogs and Cats, Fiduciaries and Brokers

“I Sell Investments. May I Help You?”

'Clueless' investors think brokers are fiduciaries, survey says.

Well, of course. Those clueless investors have never met a "broker." All they encounter at wire-house offices are "financial advisers."

See the comment from CA Adviser appended to the above article. I tend to agree. The effort to turn brokers into fiduciaries is probably misguided:

[T]hey should focus on real reform. Stop the obfuscation, stop the total lack of disclosure, stop the misleading titles given to sales personnel….

There is nothing wrong with being a salesman, it's just time to call salesmen, "salesmen" again, that's all.

Related post: Dogs and Cats, Fiduciaries and Brokers.

Dogs and Cats, Fiduciaries and Brokers

As a little kid, I was allowed to name two kittens my mother's Persian had produced. To show my precocious sophistication, I chose "Scotch and Soda."

Scotch grew up to be big, handsome and smart. To humor me, he would even obey commands. Scotch realized I was too young to know cats don't like to do doggy stuff like "Come!" and "Fetch!"

Scotch came to mind when I read Trusted Adviser or Stock Pusher? in The New York Times. Maybe attempting to impose fiduciary standards on brokers and insurance agents isn't the good idea I thought it was. Maybe the Sell Side should not and cannot be expected to act like Buy Side advisers. Like Scotch the handsome Persian, some may play along, but it's not in their nature. And it's not their job.

Congress seems to be having similar second thoughts. Are we caving in too easily?

Part-Time Fiduciaries: The Back Story

For much of the 20th century, Wall Street's herds of brokers handled investment transactions, marketed securities underwritten or packaged by their employer and offered "incidental investment advice."

How did we arrive at today's broker, typically doing business as quasi-fiduciary for a fee? The New York Times provides an informative time line. It starts in 1934, when Congress gave the SEC authority to oversee brokerage firms.

Congress Conceives the Temporary Fiduciary

"Investment adviser groups are up in arms about a one-sentence provision buried in the sweeping financial services reform legislation approved last week by the House of Representatives," reports Investment News. The bill would impose fiduciary duty on brokers offering investment advice. But . . .

Nothing in this section shall require a broker or dealer or registered representative to have a continuing duty of care or loyalty to the customer after providing personalized investment advice about securities.

Discount brokers prompted the "hat-switching" provision, according to lobbiyists.

Will Banks Miss Their Brokers?

Citigroup's decision to convert their in-branch brokers to fee-based advisers (see preceding post) draws approval from Reuters' Matthew Goldstein.

Will other banks bow to threats of legislative or regulatory action and follow suit? To borrow a phrase from one commentator, are "guys who are transactional" an endangered species?

Such a change could impact bank earnings. As mentioned here last year, bank brokerages have been highly profitable. That's partly because the mass affluent tend to be less sophisticated, less cost-conscious. As Robert Frank notes in The Wealth Report, millionaires get the better deals.

Fiduciary Standards for Broker-Dealers

Brokers make their living handling transactions and accounts for investors. Dealers trade securities. Can broker-dealers also function as fiduciaries? That's the dream of John Bogle and others, and the dream sounds good.

But as the Securities Law Prof warns, realizing the dream won't be easy.

Will it even be possible?

18,500 New Fiduciaries?

Could Smith Barney's 18,500 brokers (a.k.a. "financial advisors") suddenly turn into fiduciaries? The Wall Street Journal reports on the prospect:

Buried in President Obama's proposed regulatory overhaul is a change that could upend Wall Street: Brokers would be held to a higher "fiduciary" standard that would compel them to place their client's interests ahead of their own.