As the debate around the fiduciary standard continues, lawmakers have once again expressed concern about whether the application of a fiduciary standard may raise the cost of advice for consumers, cutting off access to investment advice for the middle class.
Yet even as this anti-fiduciary argument persists, a closer look reveals just how ridiculous it is. The RIA marketplace is not less profitable than the brokerage world due to its fiduciary compliance costs; in fact, brokers are finding the fiduciary RIA world so much more appealing that the breakaway broker trend has persisted for years.
Instead, the real challenge is that the market for advice is so complex, consumers have trouble choosing at all, and as research has shown, such environments of “information asymmetry” can lead to a “market for lemons” where the quality declines as dishonest businesses drive the honest ones away. In turn, this suggests that in the end, applying a consistent fiduciary standard for those who offer advice may actually be the single best way to drive down the cost of advice for consumers!
Last week, members of the House New Democrat Coalition submitted a letter of new Department of Labor Secretary Tom Perez, urging caution from the DOL in its rulemaking process that its widely anticipated re-proposal of expanded fiduciary rules for advisors. The Democrat letter urged that the new rule “…be done in a way that does not restrict access to critical investment assistance…” and that the original rule “could have significantly restricted the availability of investment help to low- and middle-income individuals and small businesses.” The letter echoed statements earlier this year made by the Congressional Black Caucus, which similarly sent a letter to then-acting-Secretary Seth Harris, also claiming “At a time when many Americans are struggling to ensure a secure retirement, we have concerns that the Department’s re-proposal could severely limit access to low cost investment advice.” Notably, the Congressional Black Caucus letter is widely reported to have been ghost written by anti-fiduciary industry lobbyists,
Amongst all of the anti-fiduciary arguments that have been put forth by the industry, this “access to financial advice” tactics seems to have gained the most traction, in part because it plays directly to Democrats who might otherwise have advocated for a fiduciary standard as acceptable consumer-protection regulation. But perhaps the greatest reason this anti-fiduciary tactic has sustained is simply that it remains because the Financial Planning Coalition and other groups lobbying for the fiduciary standard have allowed these assertions to go unchallenged.
Yet sadly, the reality is that it doesn’t take a very close inspection of this argument to realize how specious it is. The primary way that the argument is usually applied is to state that with a higher fiduciary standard on all advisors, it will be more expensive to comply with the rules, and that greater compliance costs will choke off access of the middle class. Yet there is little evidence to actually substantiate that a fiduciary standard is a more costly standard. E&O insurance costs are not drastically higher for today’s RIAs compared to brokers. The RIA model is not less profitable than the broker model due to compliance costs; in fact, the RIA fiduciary channel is the fastest growing channel for advisors, and brokers are breaking away from the brokerage firm model to the RIA model already. Are the lobbyists really trying to suggest the steady march of brokers out of wirehouses to the fiduciary RIA model is something they’re doing to voluntarily raise their own costs? Or is the reality that those brokers are realizing that the fiduciary RIA model can actually be more profitable for them?
The key distinction here is to realize that just because a fiduciary standard is more stringent than a broker’s suitability standard doesn’t mean it will be more costly to oversee and enforce. In fact, arguably a fiduciary standard can actually be less costly to enforce, for the simple reason that it requires less investigation the way that today’s murky suitability standard does. In other words, a black-and-white line can be cheaper and easier to enforce than a gray one.
In fact, as George Akerlof showed in his Nobel Prize winning research, in situations where there is information asymmetry and the sellers know more than the buyers, and there is insufficient regulation and oversight, a “market for lemons” results, where dishonest sellers offering “lemons” (e.g., a defective car) actually drive honest dealers out of business. The ultimate conclusion from Akerlof:
“The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”
In practice, it seems this is exactly the cycle that plays out in the world of financial advising. Good, honest advisors struggle to find and gain clients in the midst of other good advisors and a subset of lower-quality or outright predatory “advisors”; the end result is that too many low-quality and predatory advisors make money, good advisors are driven out of business, and it becomes even more difficult for the remaining good advisors to succeed. Thus is the sad state of affairs in today’s marketplace, where advisors charging $150/hour struggle to grow, but salespeople hawking questionable annuity products with multi-thousand-dollar commissions can thrive.
As I’ve noted in the past, for most advisory firms the single greatest cost of doing business amounts to the “cost of client acquisition” – how difficult and expense and time-consuming it is to find new clients. Our industry’s low standards continue to drive up these acquisition costs as consumer trust in financial services is continually eroded. Which means that in turn, the best way to lower the cost of advice for consumers is actually to raise the standards for advice.
In other words, in markets where there is such information asymmetry, minimum barriers to entry – such as requiring CFP certification as a minimum standard to call onesself a financial advisor – are a necessary evil to ensure consumer protection, which is the exact reason why every other expert profession has a minimum competency standard and other hurdles that must be cleared to be recognized as a professional.
Notably, though, this doesn’t necessarily mean that financial services salespeople should be stricken from the marketplace. Salespeople do still serve a function in the delivery of products. Instead, the ultimate outcome we should be seeking is simply to make the distinction between advisors and salespeople more clearly, where the public can choose between salespeople that are clearly labeled and hold themselves out as such (and are subject to an appropriate suitability standard), and advisors who are also clearly labeled and are held to a fiduciary standard that requires them to act in the interests of their clients – a distinction that allows consumers to choose not between fiduciary and suitability, but simply to choose between an adivsor or a salesperson… with clarity helping to lower the cost of financial advice itself.
So what do you think? Would the fiduciary standard really result in a higher cost for advisors, or could it actually lower costs with a clearer regulatory line? Is the middle class at risk to get less advice in a world with a fiduciary standard, or would fiduciary actually expand access to advice?