In any business relationship, there is a desire of the seller to convince the buyer to purchase their product or service, which presents a fundamental conflict of interest for the seller’s objectivity about whether his/her products or services are really in the buyer’s best interest. But beyond the inevitability of some conflict of interest simply by virtue of the seller/buyer relationship itself (which can never be fully eliminated), there lies a wide spectrum of how manageable (or unmanageable) additional conflicts of interest may be, which is influenced not only by the actual product or service being offered, and how it is compensated, but also by the stories that are told to justify the value of what is being offered.
In our 19th episode of Kitces & Carl, Michael Kitces and financial advisor communication expert Carl Richards talk about these conflicts of interest, and the dilemma that financial advisors face when determining where to draw the line between a ‘manageable’ conflict of interest and one that is ‘unmanageable.’
Advisors whose livelihoods are based on the commissions they generate by selling financial products are often held up as a case-in-point example for such ‘unmanageable’ conflicts of interest. For instance, it may be difficult for an advisor to avoid recommending an annuity with a higher commission payout rate, or the company product that counts towards a year-end bonus. This is not to say there is anything wrong with salespeople, as they do play an important role in facilitating the purchase of products for those who want to purchase one; however, consumers themselves can help manage this conflict with a clear understanding of the customer-salesperson relationship in the first place. It is clearly recognized from the start that the salesperson has very little, if any, stake in the customer’s best interest, and is simply trying to make a sale, and the prospective customer can judge accordingly.
Yet the reality is that sales-based compensation isn’t the only fee structure where conflicts of interest exist. For example, an RIA and its advisor’s compensation is typically based on the amount of assets they have under management, which can present a significant conflict of interest when advising a client to use some of their assets to pay down their debt (or not). Perhaps such conflicts are more manageable for an advisor who “simply” manages investments (since the relationship is generally clear – the asset manager’s objective is clearly to manage the client’s money, and earn the fees being charged accordingly). However, for the financial advisor who offers “comprehensive” financial planning services, the nature of the conflict of interest becomes more problematic. Because now, along with the advice that’s being provided comes the implied understanding that such advice will be in the client’s best interest (by definition of being ‘advice’). Which in turn can complicate the story advisors need to be able to tell their clients, because the asset management fees earned may not seem to reconcile with the financial planning advice they’re being asked to provide. Yet fiduciary advisors need to be comfortable with explaining that apparent gap, in the interest of honest, full disclosure.
Ultimately, the key point is that conflicts of interest will exist regardless of the models or methods financial advisors decide to use. But not all conflicts of interest represent the same depth of conflict, with some more easily managed than others. Which means it’s most important to determine whether the conflict of interest is manageable and still reasonably aligned with the fiduciary responsibility of the advisor, or not. Particularly as both practice models and fiduciary standards evolve, the discussion of what it means to do the right thing as a fiduciary is an important conversation for the financial services industry as a whole to have.
***Editor’s Note: Can’t get enough of Kitces & Carl? Neither can we, which is why we’ve released it as a podcast as well! Check it out on all the usual podcast platforms, including Apple Podcasts (iTunes), Spotify, and Stitcher.
Kitces & Carl Podcast Transcript
Michael: Greetings, Carl.
Carl: Michael, how are you?
Michael: I’m doing well. I’m doing well. How are you today?
Carl: Things are good. Yeah. It’s a beautiful day in New Zealand.
Michael: You’ve got “entrepreneurship” oozing out of your head almost literally.
Carl: We should explain so that people know. That’s an oil on canvas. It’s not a chalkboard. I would change it if it wasn’t. It’s an oil on canvas and the co-working space that I used asked for it. It’s just there. I can’t change it.
Michael: Okay. Well, it’s very appropriate imagery for literally being co-working space for entrepreneurs.
Carl: That’s exactly right. That’s exactly right.
Michael: So I’m looking forward to today’s discussion. I think we have to go down the road that we have been down a few times before. You tweeted again.
Carl: They’ve got to take that thing away, the toot machine!
Michael: And kicked the hornet’s nest. There’s a whole bunch of buzzing that I thought we’d talk about today.
Is There Always A Conflict Of Interest When Money Is Charged For Advice? [02:00]
Carl: Fees and conflict, is that what you want to talk about?
Michael: Yeah, about fees and conflicts. About this comment you made, “When you charge money for advice, conflicts of interest always exist. Charging money for advice is a conflict.”
Carl: Yeah, I was trying to make a nuanced point. And I don’t think humans do particularly well with nuance in Twitter, I guess.
Michael: It is 280 characters.
Carl: Yeah, it’s not easy to reduce the information, but that’s my whole life, right? Trying to reduce things down. And when you try to reduce things down, you’re talking about the simplicity on the other side of complexity, and you can’t capture all the nuance. I was trying to make this nuanced point that there is no fee model that is conflict-free. And that has to be carefully managed. There’s a lot of stuff to talk about around it and that would be interesting even to maybe talk a little bit about some specific fee models and where conflicts arise. That was the goal.
What I wasn’t intending to do, by any stretch, especially because I used an hourly fee example (I said, “Oh, you think hourly is conflict-free? Have you ever wondered why your attorney takes so long?”) – I was certainly not trying to pick on hourly. I think there are certain fee models that get really close, in terms of alignment, and hourly has got to be among the top one, two, or three on the list, right? So I wasn’t meaning to pick on that. I was just meaning to point out that there’s a conflict when you charge money. I also wasn’t meaning to even suggest that we don’t deserve to be paid, or that we should all be charity workers. What I was trying to point out is that we need to be aware that there’s a conflict and to start talking as an industry. We’ve been talking about this for decades. We should continue talking about how we manage that and what it means to the relationship with the client.
Michael: So I think it’s a fair point. There is, at a most fundamental level – any business relationship at some point has a conflict. “I want you to hire me and pay me and give me money to do a thing for you. And hopefully, I can be awesome at the thing and do the thing that gives you good results that will make it very valuable, and you’ll want to do more things with me in the future.” But, yeah, I think it’s fair at the high theoretical level to make the point that any business relationship between a buyer and a seller, or a provider and a purchaser, has some fundamental conflict in that, “I want you to pay me for my services, so I’ve got to convince you that I’m going to be valuable, and hopefully, we’ll do that in an appropriate, reasonable, ethical way and then actually deliver the stuff.”
So I think it’s a fair point at that level. The caveat to me, and I think maybe indirectly some of the flack that you got back, because one of the first responses for this was like, “Are you for real? What do you want? Go run a charity.” If you don’t want any money to exchange hands, just do it all for free.
To me, the point and the essence of what really crops up – this is what you find if you go down the rabbit hole of the actual fiduciary laws and where all the common law stuff came from around fiduciary rulemaking – is that there are always conflicts out there in some way, shape, or form. A business relationship is a conflict. The issue is that there are conflicts that reasonable professionals can manage, and there are conflicts that are so fundamentally conflicted that it’s not reasonable to expect the average person to be able to handle it on their own. Therefore, those either must be eliminated because you remove them from the equation or must be eliminated because a regulator or a lawmaker says, “This is not permitted. This is illegal. We’re not going to allow this, because this is deemed an unmanageable conflict of interest.”
Unmanageable Conflicts Of Interest [06:36]
Carl: Give us some examples of unmanageable conflicts of interest in our profession. First, let me just say one thing really quickly. This is not unique to our profession. People pointed out like, “What about dentists?” Every time I go to the dentist – and I have the best dentist in the world, I think; we’ve been going in for 10 years – when he suggests 15 different things, I wonder like, “Hey…”
Michael: Do I really need the super-special new drug that’s like a filler to make my gums better and more healthy, whatever it is? Yeah.
Carl: And that thought crosses my mind and then I go, “Oh, yeah, that’s right, it’s Dr. So-and-so. He takes care of us. It’s not a problem.” My attorney, I pay the retainer, they bill against the retainer – gosh, that took a lot longer than I thought it would! People have been thinking about this for years; this is still an issue. So we’re not alone. It’s an okay conversation to have. And no, we aren’t suggesting you run a charity. Because clearly, one of the manageable conflicts is the fact that we should be paid.
Michael: Yeah, by some means. Like, get the fee for my services in some way. If I can’t manage, I’m going to try to say I’m valuable and hope that you pay me for the thing that I’m saying is valuable. We have to do this dance.
Carl: And we’re going to have an agreement. We’re going to settle on what that value is. That is not the problem. So give us some examples of unmanageable conflicts in our profession, our industry.
Michael: So I’ll answer this in two ways, the modern conflict and the historical conflict. So the modern conflict, frankly, is commissions. And I’ll pick on very high commissions, in particular, just because it helps to emphasize and clarify the point. These things all exist on a spectrum, but that’s part of the point, that at some point, you have to decide where the dividing line is on the spectrum.
So when I started in the business, the early versions of indexed annuities were just coming out. This was 20 years ago. Some of them were pretty simple, high quality, plain vanilla, very straightforward products. Like I remember Jackson National had a really simple, straightforward product. It paid a couple percent. It had a really straightforward formula. Everybody knew what they were getting. We got compensated a little to implement it.
Then another company, who I won’t pick on and leave nameless because they’re still around, had a version of this contract with a 20-year surrender charge and a 20% upfront commission. I kid you not, this was a real product. Bearing in mind that 20 years ago, you could get over 6% in the money market, so high interest rates hid a lot of sins. But this was a contract with a 20-year surrender charge and a 20% upfront commission, and flat-out paid way less than anything else that was available in the marketplace. No kidding, because only 80% of the client’s money goes to work on day one, and the company’s got to extract 1% a year for the next 20 years to make back the commission that was paid upfront.
And so you had this ultra-high-commission product. It was very controversial at the time, in part because the question became, “Who sells this thing, besides someone that just found a legal way to extract 20% of their client’s net worth in one meeting?” It’s okay to get paid something. It’s okay to have a product that has some moving parts. But you literally had products that paid 3% and products that paid 20% in the same marketplace next to each other. And so somewhere between, “I’m going to get paid 3% to help this client implement something for the next 10 years,” and “I’m going to get paid 20% for this client to be locked up for 20 years,” somewhere in between those two is where we go from manageable conflicts of interest to unmanageable.
And in fact, one version of the thing at the time (this was still the day when you sold A-share and B-share mutual funds that might have paid you 4% or 5%) was a low-cost annuity that was actually cheaper than some other options in the investment marketplace, in a world where we were all more commission-based. But there was this 20% thing out there.
And so that, to me, is sort of the modern version. It’s not about not getting paid for the time that you spend, but at some point, the thing is so outlandishly high compared to whatever else is in the marketplace that it becomes hard to figure out what the justification is for selling it. Unless you asked anybody who actually sold it, who was still unequivocally convinced that they’d helped a client out of a situation that they were previously in, that was even worse, “Because they were buying tech stocks and the world was going to blow up, and I helped them with this annuity product.”
Carl: This is an interesting example. And I’m trying not to take us down a different rabbit hole, but I have a theory that I want to understand. Because I’m wondering. I was just sitting here thinking, is that product illegal? Right? Okay, we can debate all day long about whether or not it’s immoral, incorrect, doesn’t fit, or not good for the client, but is it or should it be illegal? And as soon as I thought that, I also thought, well, I’ve had this theory that there are jobs in the world that create adversarial relationships, where people are trying to sell you something. There are lots of jobs like that.
Like if you have somebody at the Toyota dealership that you’ve been buying cars from for five or six years… I know Toyota salespeople that have families that have been coming to them for 20 years. But the average salesperson that sells cars – you know when you walk in that you’re in an adversarial relationship. You’ve got to be on guard. So here’s my theory. Is the difference between that person who sells cars and an “advisor,” which I’m putting in huge air quotes, is that you don’t know to expect that? Like the “whole industry” (and again I’m using air quotes) – through advertising and things we write like, “Oh, we’re honest” – is pretending to be, we’ll use words like “independent” or “objective”, instead of going so far as to say “unconflicted”. So now nobody knows. It’s like walking into a car dealership and expecting…
Michael: Well, no, no, it’s that you’re walking into an automotive consultancy that provides you guidance on the best transportation for your family’s needs.
Carl: Yeah. I’ve always compared it to walking into the Toyota dealership expecting the Toyota salesperson to tell you that a Honda would be better if that indeed were the truth. You’re just not going to expect that. And so, my theory is a huge problem. Look, I may be wrong, I’m sure I’ll hear about this if I am. I have this theory that charging a commission is not wrong, just don’t pretend like you’re objective. That’s wrong. Right? So my question is, is that – I hate even to use that example because it’s so outlandish – but is charging a commission, a 3% commission, a 6% commission for an annuity, is that illegal? Should that be illegal or is there like a job for that? And do we just need to be better about the industry knowing that’s what that person does? Over here, we do this. Does that make sense?
The Value Of Salespeople And Their Role In A World Of Uniform Fiduciary Rules [15:26]
Michael: Well, it does. So to me, that’s why I’m one of the people that has actually argued very hard for the past 10 years against all of these uniform fiduciary rules that keep getting proposed, including essentially what the Department of Labor did. I don’t think there’s such thing as advice that’s not given in a fiduciary manner. The definition of the word “advice” is that it’s advice for you. That’s what makes it advice. You can’t have advice that’s not in the best interest of the person receiving the advice. It’s the definition of the word “advice” – it’s for that person. But there’s still a role for salespeople. And there’s nothing wrong with salespeople getting paid as salespeople. I’ve always viewed the issue as being that we need to clarify the decision and the choice between when am I working with an advisor and when am I working with a salesperson, and let each of them clearly label themselves for the nature of the role in the relationship, and then for people to be able to understand how they want to handle it.
There’s a group of people out there like, “No, I don’t need a comprehensive financial plan. I don’t want to pay someone a bunch of money. I just want to buy a thing, and I have a person that can help me buy the thing. And I don’t mind that the person gets paid for selling me the thing, I just want it to be a reasonable salesperson who explains features and benefits so I can buy the thing.” Like, I bought a car that way. I buy my suits that way. And I could buy some financial products that way when I know what’s going on. Right? I know what the deal is when I walk into the car dealership. Elliot Weissbluth at HighTower had a popular video that went around a couple of years ago about the difference between dieticians and butchers. I understand when I go on the butcher, it’s always meat. The answer is always meat. I’m not expecting objective vegan dietary advice from the butcher. I go to the dietician for this. Right? We know what our circumstances are.
And part of the challenge I think we have in the current landscape is the dividing lines have become blurry. There were some rules that were put in place under the Investment Advisers Act of 1940 that were supposed to separate these. The SEC has kind of allowed the line to get blurrier and blurrier over the span of about 20 years so no one thing they did looked bad, but you look back 20 years later and it’s like, these used to be separate categories, and now, they’re so blended together that literally, I can charge you a 1% fee-based wrap. I can charge you a 1% trail on a C-share. I can charge you 1% on advisory accounts. And from our end, it’s just like, I get paid 1%, I give you advice. Those are completely different product categories that were never supposed to co-exist in an advice realm.
Carl: Yeah. That, to me, is my theory that if we fix that, we fix a lot of these other problems. I think you and I want to have an interesting conversation around some of these different fee models. But I think if we fix that, because like you said, you can’t call yourself an advisor, by definition, giving advice and not have it be in the client’s best interest. Those things don’t compute. So I think the huge dilemma to me is that you don’t know what you get. If you’re going to call yourself a certain thing, you better behave a certain way, so that clients know what to expect when they show up. I’m going to see this person who calls themselves this thing, and it means I’m going to get this type of advice.
Michael: But in the context of fees, or fees versus commissions and conflicts of interest, the essence of the issue comes down to when this introduces a conflict that would be very difficult for any rational person to manage. And so this comes to bear on a couple of different ways. It’s one of the reasons why the angle of the Department of Labor was not necessarily that all commissions must be gone, but it was that all commissions must be reasonable.
You could probably manage the conflicts around a 3% upfront, it’s a lot harder to manage 20% upfront and not succumb to the temptation. But also that any products in a similar category had to be on the same keel. If you’re going to get paid a commission, it’s got to be the same commission no matter what you use in the category. Because otherwise, you’re immediately introducing a very challenging conflict, which is, I got these two things that are virtually identical. The only difference is one of them pays me more than the other. In a best-interest world, it’s hard to explain why the second one should even exist, but if it does, you’re just winding yourself up to get in trouble. So let’s make the compensation the same across the category so then at least we are eliminating that portion of the conflict. You may leave the commissions, but we’re eliminating the differential compensation across them.
Does The AUM Model Present Advisors With A “Manageable” Conflict Of Interest? [20:39]
Carl: Yeah, yeah. Yeah, yeah. Well, let’s talk about some of those conflicts. So should we just…maybe we’ll just pick AUM.
Michael: Got a mortgage?
Carl: In an AUM model…
Michael: You’ve got a mortgage? Because I encourage you to keep it.
Carl: Yeah, yeah, yeah. Where does the conflict show up? And that was one that consistently would show up for me. Clients would say, “You know, I’d really like to pay off my mortgage.”
Michael: Yeah. Like, cool, that’ll cost you $30,000 of fees on that client over the next 10 years. Three hundred grand hoovered out of their portfolio to pay off a mortgage.
Carl: Is that manageable or unmanageable?
Michael: Well, so I think this actually begins to highlight part of the challenges that our industry gets as our models evolve. In a pure investment environment, my only job is to put on the blinders and manage your pot of money. Yes, I think that’s a manageable conflict, because it’s really just the fundamental business conflict. If all you ever did was hire me to manage your money and I gave no other advice, then when you say, “Should I pay off the mortgage,” we’re back in car-salesman world. We all understand how this works. I’m going to tell you no because all I do is manage your money, and I would like to hold on to it.
Carl: And I’ll build a fancy plan or even just a model that tells you why it’s even better, right? We’re going to average 7.5% a year, and cost of capital is 3%.
Michael: But we’re clear on the relationship. I do think this is one that, frankly, has gotten harder for advisory firms as we get more holistic in our advice and the value proposition shifts from “I manage your pot of money”, which we all get, or “I’m going to try to hold on to the pot of money, take my advice with a grain of salt”, to “No, no, no, I’m a comprehensive wealth manager. I’m giving you advice holistically on everything, (but my billing is driven by the AUM side, please don’t disintermediate me too much).” So I honestly think it’s becoming more problematic. It’s not something that keeps me up horribly at night right now, in part because, frankly, the clients that are very driven to pay down their debt just tend to say, “Damn it,” and do it anyways. Because it’s not about the returns at that point, it’s a personal motivator driver.
And obviously, this varies to some extent by the client, but for a lot of clients and advisors, it might be a non-trivial amount of money, but it’s not “I’m no longer going to be able to work with this client if they do this.” It doesn’t blow up the relationship to the point we can’t work together, which to me is the level where you’re really going to get an unmanageable conflict. I do think, at a minimum, it falls in the category of getting closer and closer to being a problem. Because the more holistic our advice gets, the more clients I think actually rely on that advice. And our direct compensation incentive is to not pay down that mortgage. Obviously, it gets a little easier right now because the mortgage is actually a really, really low interest rate. But strictly speaking, I would probably call that a justification.
So yeah, I think this gets harder as the fee models change. But, as you made the point earlier, it’s not like this is a unique phenomenon to only assets under management, right? The hourly model, I have my challenges. No matter what your problem is, it’s highly complex and will require a great deal of research, right? What you always hear every time you go into your accountant or your attorney is, “Well, it’s complex. I’m going to have to dig into this a little.” We set up the billable hours. Until you put them on an open-ended retainer, and then everything gets solved really fast. Because if I’m paying you the same dollar amount no matter what every month or year or whatever the retainer is, now it’s in your interest to solve my problems quickly. And all of a sudden, the advice gets a little bit faster and more expedient.
So there is some tension to any model. I think a part of it is acknowledging it. The question becomes, “When do we go so far down the conflict road that it’s not even vague and ambiguous? This just can’t be good.” And I think that’s part of why you’re seeing right now the focal point the regulators are taking so hard is the one that is the easiest to prove. You had a choice of two things that were functionally identical, and one was just more expensive and paid you more.
AUM Advisors Need To Be Comfortable With Their Stories [25:24]
Carl: Yeah. And I think that pointing to specific product placement is really easy to see. I just think this is a really interesting and important conversation for people. Let me just talk a little bit about AUM. So fundamentally, I believe the price we charge and the way we do it is a story, and that we need to be comfortable with the story that we’re telling and what it says about us. It’s not necessarily a fact, it’s a story. And the most important part to me about that story is that if any part of your story relies on clients not knowing something, like how long it took you to do the work would be an example, you just have to count on them knowing it. If they want to, they’re going to find out. I’m not even talking about you specifically, I’m just talking about an industry.
So let me give you an example of a story… I’m not picking on AUM, and I don’t know that ‘relic’ is the right word, but AUM is a ‘tradition’ that has been passed down from our fathers and mothers in the industry. And it made sense at one point, clearly; now the question we’re just all wrestling with in the industry is, does that story still make sense? I’m not saying it doesn’t, but here’s where I found myself once 10 years ago. I had a client who had a crazy amount of money with me, and I’m just going to call him Sam (because that’s my son’s name). So Sam had a crazy amount of money with me. It was a part of his big chunk of money from his business, and we were incredibly competitive. We earned this money because our fee was really, really competitive. And the fee was $120,000 a year. It was an AUM fee.
Michael: This was a fairly small percentage on a really big pot of money.
Carl: Yeah, I’m not going to give you either number that will help you figure out how much it was. But it was a really small competitive fee, and it was still $120,000. It was a lot of money. One day after working together for two or three years (they loved me, we were great friends), Sam, the owner, the CEO and founder of the business, who I managed a bunch of money for personally and for the business, we were talking about the business money, the $120,000 a year. Sam had referred some friends to me, and he knew how much money the friends had (a fraction of what Sam had). And these friends, one of them was his CFO, would go to him, and of course, the CFO would say, “Oh, I just met with Carl…” So he’s always hearing that, and is thinking, “Jeez, my CFO is meeting with Carl all the time!”
So he said to me, “Hey, Carl, how much was your fee last year?” And I, like a proud, confident advisor, said, “Let me look.” I found it. And with no justification, and no defensiveness, I said, “I send you an invoice every quarter, but here’s a copy of the last 4 invoices, it’s $120,000.” And he says to me, “So just walk me through what you do for that.” “I help you avoid behavioral mistakes. We built this beautiful portfolio.” “No, no, no, what do you…like time-wise, what do you actually do?” I was like, “Well, I come…” He said, “So you come to the quarterly board meeting, right?”
Michael: Yeah. So it’s like two or three hours per meeting plus drive time.
Carl: Yeah. I asked, “For how long?” “You’re at the meeting for half an hour.” “Yeah, because I just come in and report and leave.” “How much prep do you do?” And I was like, “Sam, I know where you’re going with this, and let’s have a conversation about it.” But the number he worked out was like $5,000, $7,000, $8,000, $9,000 an hour. You’d better be comfortable with that story. That’s all I’m saying, is that you’d better understand what it means. And I think there are ways for me to envision being comfortable with that.
Michael: So, out of curiosity, did Sam renegotiate his fee that year? How did that go?
Carl: Sam didn’t. We did end a year or two later. Sam was an unreasonable client, we didn’t end for that reason, but Sam ended up saying to me in the middle of a down market, “All I want you to do is tell me when to sell before it goes down, and tell me when to buy before it goes up! Your job is easy!” And I was like, “Sam, it’s time for you to hit the road.” So that’s a longer story.
All I’m saying is we’d better be comfortable. That, to me, is the thing: if the fee that you charge relies on some piece of information that the client doesn’t know – and I’m not talking nefarious intent, I’m not talking hidden information… of course, all that, but even some just basic stuff – you better be comfortable. I’m going to use a word that I don’t mean, but you better feel like you can defend, and I mean that in the traditional sense of the word, that you can defend that position. That’s all I’m saying.
So pick a model that’s aligned with that story, because all of them are going to have conflicts, all of them. When somebody comes and asks me, “Should I pay off my mortgage?” My explanation always was, “Look, it’s pretty clear you really want to do this. And it may feel like a conflict to you, but I don’t see it that way. I see making you happy, giving you the best advice in the short-term, is in my enlightened long-term self-interest. Understood? Pay off your mortgage.”
Michael: Well, okay, but not everybody is as enlightened in their long-term self-interest. And everybody in our industry is good at telling a story.
Carl: I know, I know. It’s where it gets hard (and touché for the use of the “enlightened” word, for sure!). I know we’re really good at telling stories. We’ve got a huge problem. It feels like there’s a ‘disturbance in the force’, right? And we’re trying to sort out what it means and how we do it. When you do that, there are some real serious people who get really serious with me. “Oh, how could you even suggest that I’m not worth $8,000 an hour?” I’m just saying, hey, you better be comfortable with that story. That’s all. And I’m saying the same thing about retainer, and I’m saying the same thing about AUM. So where do we go?
The Dilemma Of Where To Draw The Line Between Manageable and Unmanageable Conflicts of Interest [32:11]
Michael: Yeah. Well, I think where we ultimately end out, frankly, is that I’m not sure that’s actually enough.
Carl: What’s not enough?
Michael: You better be comfortable with your fee and disclose it. The people that were selling that 20% annuity, someone out there, God bless, probably figured out a way to disclose it and explain it and still was a good enough storyteller to get someone to buy it, and I’d still have a concern about that.
Carl: I totally agree. And I think it’s really problematic for me to use the word “story” because yeah, you’re absolutely right, that’s what every crook and criminal in the world does. And you better believe they believe that they’re doing the right thing, even when they’re flat-out crooks. I’ve been amazed, when somebody is doing something absolutely wrong, I’m not even talking about in our industry anymore, but like wrong, they don’t really think.
Michael: Because we’re doing the right thing. Well, there’s a small subset out there that just actually wants to steal from people, but for most of the rest…again, that’s the point of why we call them conflicts of interest. Because not only can you potentially come up with a story that convinces someone on the other end, you can come up with a story that convinces yourself. And that’s part of what makes conflict so pernicious, and I think eventually gets us back into this realm of questioning if there a point at which some of these have to be banned?
And I’ll admit, I belonged in the camp that I’m personally not convinced that 0% commissions, 100% fees are the only way to draw that line. Even in the context of your client that you were talking about, if you also helped him implement some term insurance for one of his businesses and he got paid 400 bucks on the side and a commission for a term policy for a little buy-sell for his 17th business, is this actually a material conflict of interest because you earned a commission on top of your $120,000, $8,000 an hour fee? Probably not, right? There comes a point where the commissions, realistically, are small enough. They’re manageable. We in the industry lately have chosen just to make it a bright line between the two. I’m not necessarily convinced that that’s where the line has to be drawn either.
But part of the point of the challenge of this, and maybe where we wrap up, is just acknowledging like, this is part of why it’s so hard to draw the line. Because A, the whole point of why conflicts are problematic is, we can disclose them and convince ourselves and still do it, because that’s what happens when it’s a conflict. You can fool yourself accidentally along the way as well. But figuring out where to draw the line when you’ve got to manage a couple hundred thousand human beings serving millions and tens of millions of consumers, like, welcome to the unenviable job of a regulator that actually has to figure out where to draw that line.
Carl: Yeah, I agree. And I guess I’m using the word “story” hoping that this audience gives me the benefit of the doubt in terms of what I mean. Because to me, I think that’s still the right way among like a group of friends around a table to describe it. Like, “Look, we’ve got to be comfortable with that.” And I’m operating under the assumption that we’re all “honest,” in huge air quotes. Like, what does that even mean?
One of my favorite financial advisors in the world, his name was John. I don’t think he’s still in the business. But during all this movement to AUM, he refused because he bought individual portfolio stocks, like 20 or 30 of them, for clients. He was at a big brokerage firm. And he said, “We hold these things forever. It’s absolutely in their best interest.” You’ve seen those debates – American Funds was so popular around this – that if you buy an A-share where I pay 5% once and you hold it for 20 years, you’re way better off than charging a 1% AUM fee. So John would say, “Look, here are my commissions.” He would provide an itemized thing and say, “Versus if I had charged you this AUM fee, it would have been two or three times that, plus next year, plus next year, plus next year.” So there is John doing the best thing for clients by charging a commission. But there are not very many people like John. So that’s where we get back to this problem.
But in terms of like practically, what does an advisor do, I think as an advisor, we just have to tell the truth. And we just have to open, and I know we know the problems around disclosures, but we have to be open to this discussion. We can’t hide from this discussion. And we have to realize, even when it’s volatile (the discussion that is), we’ve got to have this discussion, because we’re working it out. I don’t know the answer. I like to come up with 50 statements and strong opinions, but I know they’re wrong. I know they lack nuance, I know we’ve got to figure it out, but we’ve got to be having the discussion.
Michael: Well, and again, I think the other thing to me is, as we wrap up, that for every John who does it right, there’s someone who’s going to rip 50% of that client’s net worth, because they’re going to flip into a new A-share for another 5% every other year for the next 20 years.
Carl: And be completely convinced somehow.
Michael: Each one at the increment made sense at the time.
Carl: If they’re not convinced themselves, they will definitely be able to tell a really great story to the client. I’m a huge fan of big-industry bodies having this debate on a global sort of level. And I’m looking at individual-level advisors one by one in the eyes and saying, “Hey, why don’t you do the right thing?” and “Hey, why don’t you do the right thing?” and, “Hey, why don’t I do the right thing?” and let’s see if we can change it that way, too.
Carl: It takes work, but you can do it.
Carl: Okay, man. See you.
Michael: Thank you, Carl.