Real Reasons to Be Offended

W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award.

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This month's column was supposed to be the second part of a series that examines the contents of an agreement between a K-12 school district and a large insurance company concerning the school district's 403(b) plan. But sometimes real life intrudes on our little sphere of existence.

Such is what happened last week when a White House memo (still not "officially" authenticated but not disavowed either) was leaked to the media. The memo, co-written by Jason Furman, chairman of President Obama's Council of Economic Advisors, for the administration's senior aides said that high costs and conflicts of interest inherent in the business models followed by brokers and the like cost retirement investors between $8 billion and $17 billion per year in lost money from their retirement accounts. According to the memo, those conflicts have cost investors in IRAs alone $6 billion to $8 billion (or 35 to 50 basis points) annually. For at least the last decade, stockbrokers and others have targeted the Golden Goose of IRA assets because they still constitute a larger amount of assets than those in retirement plans. They want to remain big players in the multi-trillion dollar IRA market, so having to take on the moniker of fiduciary has never been in their playbook.

The memo's leak generated a storm of protest from the usual suspects--those in the financial-services industry who just don't want to be fiduciaries--because, among other things, that would financially threaten their business model. These folks generally live on commissions in a transaction-oriented environment and often move on once the sale of a product is concluded. Many have little understanding of the ongoing nature of fiduciary services. A leader of one of the groups representing those who just don't want to be fiduciaries was quoted as saying last week: "The ignorance in the memo is shocking to me…For those who spend their lives in the industry, it is frankly offensive."

You're shocked? They're offended? Hey, I'm offended!

I'm offended by assertions made by the brokerage and insurance industries that manufacture and sell financial products and services that if they were to become fiduciaries they would not find ways to cost effectively service millions of smaller investors investing untold billions of dollars. Such assertions are just not plausible on their face.

I'm offended by the brokerage and insurance industries keeping low-income and middle-income investors with smaller accounts from benefitting from a financial system that fully embraces the fiduciary standard. After all, it is such investors who suffer proportionally more financial harm in a system dominated by the suitability standard under the Securities Exchange Act of 1934 ('34 Act). A multi-millionaire won't be damaged as much as a middle class investor who is sold, for example, an annuity loaded down with high costs. Arguments advanced by these industries that adoption of the fiduciary standard would somehow limit the investment choices open to low-income and middle-income investors and increase their costs just don't ring true.

I'm offended by those who call themselves "financial advisor"/"wealth manager"/"financial counselor"/"consultant," et al., who say that they would never hurt their clients, that they always have their clients' best interests at heart or that they always place their clients' interests ahead of their own--but who are not legally a fiduciary, either because they are not subject to the Investment Advisers Act of 1940 ('40 Act) or they fall through a loophole in the current, four-decades-old definition of a fiduciary under the Employee Retirement Income Security Act (ERISA).

Let me clarify. I'm not offended by their investor-first sentiments, which may even be truly held by a large number of, say, stockbrokers. I am, however, offended by those in the fiduciary debates who cite such sentiments as somehow "proving" their case that they need not be legally bound by the fiduciary standard because they already consider themselves a fiduciary. While nice sentiments are, well, always nice, the fact that a broker remembers the birthdays of its clients is moot to the real issues at hand. It's the law that's germane in determining fiduciary status.

For example, stockbrokers legally are agents (as a registered representative) to their principal, a broker/dealer. As such, stockbrokers have a fiduciary duty to their broker/dealer to maximize revenues for them. That revenue doesn't come out of the hide of the Easter Bunny but is paid by the stockbroker's clients. You know, those folks whose interests the broker says--whether sincerely or cynically--he or she has placed before his or her own. The suitability standard of the '34 Act, which governs a stockbroker in its non-fiduciary relationship with its clients, fades to black in comparison to the bedrock principle of the fiduciary duties owed by the broker to its broker/dealer. The unavoidable conflict of interest is created when the suitability standard comes up against--but must yield to--the bedrock of the fiduciary standard. As the law stands, a broker cannot avoid conflicts with its clients because of the fiduciary duties it owes directly to its broker/dealer. That's why the suitability standard, in comparison, has so little legal import in the fiduciary debates.

I'm offended that the Certified Financial Planner Board of Standards still allows CFPs to be partial fiduciaries instead of requiring them to be undivided fiduciaries. CFPs are fiduciaries to the extent that they engage in the financial planning process, but once they leave that arena and turn to product sales to implement their recommendations, they become non- fiduciaries. Financial planning will never become a profession until the nonsensical spectacle of a CFP as a bifurcated being is ended. I say this--with some sorrow--as a CFP who has held the designation for 22 years (earned shortly after I got out of grade school, I believe).

I'm offended that the Certified Financial Planner Board of Standards has given cover to those who use the CFP designation to only sell products and never engage in the financial planning process, thereby avoiding association with anything fiduciary. To change this state of affairs, however, would get in the way of empire-building and the enhanced salaries that accrue to those doing the building.

I'm offended by the Bizarro World that forbids fiduciaries to retirement plans from offering low-cost and well diversified rollover portfolios to retiring plan participants but freely allows non-fiduciaries to sell such participants whatever latest goofy expensive investment products they can foist on them. In far too many of these cases, plan participants who have accumulated a tidy nest egg for retirement wind up investing their retirement savings with sellers of costly and risky products.

I'm offended by product peddlers in informal settings who sell to hapless unsuspecting investors. I like to work in coffee shops because there's a lot of activity there, which--apart from a good cup of Java--helps keep me stimulated. I have written most of my two books and many of my Morningstar columns (now almost 125) in such surroundings all over the country. To this day, I've never heard anyone selling Treasury bills there. Rather, the sales products are usually something complicated--and perhaps even sexy, but certainly expensive and risky--that few investors on the other end of the Big Sell really understand. Sure, they'll nod in agreement during the sales pitch, but usually they don't get it. You can just see it in their faces. And far too often, the peddlers of these products have no idea how they work or what their risks are, either. Nonetheless, many recipients of the Big Sell sign on the dotted line. It's enough to make a fellow choke on his latte.

I'm offended by news stories and columnists who cannot seem to grasp the difference between a broker (held to the suitability standard under the '34 Act) and an investment advisor (those held to a "best interests" fiduciary standard under the '40 Act). This lumping in one with another--yielding the generic "investment advisor"--confuses investors, which has been tremendously beneficial to those who just don't want to be fiduciaries. Even The Wall Street Journal Investment Adviser Blog includes the terms "broker," "insurance agent," and the ubiquitous "financial advisor" under the investment advisor umbrella.

I'm offended by commentators--even ERISA attorneys!--who say that sponsors of retirement plans are required to make decisions in the "best interests" of plan participants. The correct standard is the "sole interests" fiduciary standard under ERISA section 404(a)--not the "best interests" fiduciary standard under the Investment Advisers Act of 1940. OK, maybe I'm not offended by this one--more like the feeling you get when fingernails are dragged across a blackboard.

I'm offended by those in the media who can't get their facts right. Yes, I know that they're always under the pressure of meeting deadlines, but who isn't these days? Media types, please don't just parrot the line put out by flacks employed by the large entities with vested financial interests. Their bosses wish nothing less than to maintain their asymmetric information advantage over individual retail investors and participants in retirement plans. So get off your collective rusty-dusty, get informed, and give us the straight scoop.

I'm offended by surveys and "studies" conducted by those well-heeled industry groups with vested financial interests that always come to predetermined conclusions. Sometimes the conclusions turn out to be directly opposite of what the sponsors expected. But that didn't stop the purveyors of one such survey from blanketing the financial-services media with press releases that trumpeted the (nonexistent) findings that they wanted. I wrote about this in my October column. Their cynical headline, repeated endlessly by the financial media, became the narrative itself and accepted as Gospel truth after a few months' time (see my previously noted lazy media complaint). That headline was akin to saying that President Lincoln enjoyed the first two acts of the play at Ford's Theater. While true, that's not really the story. We all know that Lincoln's assassination changed the course of American history, but very few know the real story about such bogus surveys and their ilk.

I'm offended that when such surveys and studies are issued, their sponsors have the gall to insult our intelligence with headlines that are demonstrably false. They must think that we're all clueless.

I'm offended that the San Francisco Giants let the late innings of the sixth game of the 2002 World Series get away from them, thereby ensuring their ultimate loss of the Series. Wait, that's for another column…

The author is a freelance contributor to Morningstar.com. The views expressed in this article may or may not reflect the views of Morningstar.