On Sec­ond Thought

I wrote a beau­ti­ful let­ter to the SEC. Now that I’ve learned a few things, I wish I could re­write it.

Financial Planning - - Contents - BY BOB VERES

I wrote a beau­ti­ful let­ter to the SEC. Now that I’ve learned a few things, I wish I could re­write it.

When the SEC came out with its pro­posed best in­ter­est stan­dard for bro­ker-deal­ers (and, by ex­ten­sion, for their bro­kers and reps) a few months ago, I wrote a de­tailed com­ment let­ter in re­sponse.

It was a beau­ti­ful let­ter. I elo­quently pointed out that the “best in­ter­est” stan­dard de­tailed in the pro­posal was ex­actly the same as the cur­rent “suit­abil­ity” stan­dard that I help­fully copied for the SEC staff from the FINRA web­site.

If noth­ing sub­stan­tive was go­ing to change (I ar­gued), then it was cer­tainly mislead­ing to give this same stan­dard a new name and sug­gest that bro­ker­age firm rep­re­sen­ta­tives ac­tu­ally had to act in the “best in­ter­ests” of their cus­tomers.

More­over, the pro­posed dis­clo­sure did a ter­ri­ble job of help­ing con­sumers dis­tin­guish be­tween peo­ple who rep­re­sent the in­ter­ests of a large bro­ker­age firm and those who, em­brac­ing a fidu­ciary stan­dard, work in the best in­ter­ests of their clients.

Why not sim­ply cut through para­graphs of mean­ing­less blather and de­clare, straight­for­wardly, that ad­vi­sors who reg­is­ter with the SEC are fidu­cia­ries and sit on the clients’ side of the ta­ble?

Across the ta­ble, bro­ker­age rep­re­sen­ta­tives are agents of the firm and sit along­side their branch man­ager watch­ing out, first and fore­most, for their best in­ter­ests on the com­mis­sion grid, not to men­tion, the wire­house’s bot­tom line.

But now I be­lieve that I, along with ev­ery­body else, was sucked too deeply into the de­tails. Con­se­quently, we missed a big­ger, clearer pic­ture.

Let me il­lus­trate for you the big­gest mis­take that the SEC is mak­ing — and, in­deed, has been mak­ing for my en­tire 36-year ca­reer in this busi­ness.

To ex­plain, I’ll take you back to some con­ver­sa­tions that took place when I was ed­i­tor of this mag­a­zine back in the 1980s.

It was af­ter hours at the In­ter­na­tional As­so­ci­a­tion for Fi­nan­cial Plan­ning’s an­nual con­ven­tion, in the ho­tel lobby, where drinks were be­ing served.

My ta­ble in­cluded sev­eral prom­i­nent IAFP board mem­bers who also hap­pened to be high-pro­duc­ing ex­ec­u­tives at dif­fer­ent bro­ker­age firms. They were ed­u­cat­ing me, a naive young jour­nal­ist, about the real world of their pro­fes­sion.

One of the things they told me was that ev­ery fi­nan­cial trans­ac­tion has a win­ner and a loser. Other bro­kers have since given me this in­sight into their view of the fi­nan­cial mar­kets.

And over the years I’ve re­peat­edly heard the un­funny joke that a great in­vest­ment ben­e­fits the cus­tomer, the firm and the bro­ker, all at the same time. The punch line: Well, two out of three ain’t bad.

The in­sight here — which I don’t think has pen­e­trated the staffers at the SEC and, like­wise, didn’t re­ally be­come clear to me un­til af­ter I’d fired off my beau­ti­ful com­ment let­ter to the

Now I be­lieve that I, along with ev­ery­body else, was sucked too deeply into the de­tails. We missed a big­ger, clearer pic­ture.

com­mis­sion — is that the bro­ker­age ser­vice model is es­sen­tially preda­tory.

Of course, bro­kers have to prey by the rules. When they rec­om­mend an in­vest­ment where they and the firm will win, and the cus­tomer will lose, they have to make sure that the in­vestor ac­tu­ally needs an in­vest­ment prod­uct that is at least sim­i­lar to the one they rec­om­mend.

“Win­ning” can be in­ter­preted nar­rowly: The in­vest­ment might ac­tu­ally make money for the cus­tomer, but the bro­ker wins by get­ting the cus­tomer to pay more than he or she would have had to pay for sim­i­lar types of in­vest­ments.

In the end, the client takes own­er­ship of an in­vest­ment that an­nu­ally siphons off more money to the com­pany than would have been si­phoned off by sim­i­lar prod­ucts read­ily avail­able in the mar­ket­place. This point per­fectly ex­plains why the bro­ker­age firms so ve­he­mently op­pose hav­ing to live un­der a fidu­ciary stan­dard.

The ar­gu­ment is that the stan­dard would be too vague and too com­pli-cated, which is ab­surd, since tens of thou­sands of fee-only RIAs al­ready man­age to op­er­ate un­der those vague and com­pli­cated stan­dards with­out any vis­i­ble sign of in­con­ve­nience. The fidu­ciary stan­dard rep­re­sents a mor­tal dan­ger to the en­tire wire­house busi­ness model. Un­der a fidu­ciary stan­dard, they could no longer, legally, prey on the pub­lic. On a deeper level, we al­ready knew this. We de­scribe bro­kers who call them­selves ad­vi­sors as "wolves in sheep's cloth­ing," which a aa­tory im­age. We say that bro­kers have to "eat what they kill." But I don't think the is­sue has been ar­tic­u­lated clearly to the pub­lic, and cer­tainly not in the SEC’S new reg­u­la­tory and dis­clo­sure pro­pos­als.

The key dis­clo­sure that the pub­lic needs in or­der to safely nav­i­gate the fi­nan­cial jun­gle is that they have a choice (a fa­vorite term of bro­ker­age lob­by­ists) be­tween tak­ing ad­vice from a preda­tor or a guide.

Bro­kers are not, sim­ply, agents of the firm, as I sug­gested in my com­ment let­ter to the SEC.

Rather, they are hired preda­tors who, in many cases, will feast on their cus­tomers’ as­sets at ev­ery op­por­tu­nity and won’t be overly con­cerned about help­ing them reach their des­ti­na­tion.

The guide, in stark con­trast, will fo­cus on help­ing them reach their des­ti­na­tion first and fore­most, ide­ally with as­sets in­tact.

Now that I have this big­ger pic­ture clear in my mind, I wish I could take back my com­ment let­ter and re­place it with a bet­ter one.

I can now see that the big­gest mis­take that the SEC has been mak­ing as a con­sumer pro­tec­tion or­ga­ni­za­tion is to al­low pre­da­tion of any kind into the fi­nan­cial mar­kets.

There should be no win­ners and losers in the world of fi­nan­cial ad­vice; the SEC should long ago have ban­ished the whole no­tion that you can prey on your cus­tomers as long as you care­fully fol­low a set of rules cre­ated pri­mar­ily by the bro­ker­age firms them­selves.

Onnl­lyyafft­ter I fired off my beaut­ti­if­fu­ull­c­coom­meen­nt­tlelet­teter,ri, Ico­con­c­nl­cul­dued­dedth­tah­tathte­hber­borkoekraer­gaegme om­doedl eisl pis­rep­draed­toar­tyo. ry.

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