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My 'beautiful' letter to the SEC I wish I could rewrite

When the SEC came out with its proposed best interest standard for broker-dealers (and, by extension, for their brokers and reps), 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 off 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.

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An attendee types on a cyrillic laptop computer keyboard at the CrytoSpace conference in Moscow, Russia, on Friday, Dec. 8, 2017. CryptoSpace is Eastern Europe's largest conference dedicated to blockchain technology and cryptocurrencies and runs Dec. 8-9. Photographer: Andrey Rudakov/Bloomberg

But now I believe that I, along with everybody else, was sucked too deeply into the details. 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 young naive 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 punchline: 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 — 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.

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“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 complicated, 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 certainly conjures a predatory 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.

Clashes over the Labor Department's fiduciary rule have carried over into the debate on the SEC's proposed regulation.
August 14

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. 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.

But I also believe that train has left the station. My new proposal would be that we preserve choice in the marketplace, and not raise (or, as the SEC’s proposal, pretend to raise) the standards that brokers and brokerage firms have to live up to. These giant, immensely profitable firms have too much lobbying and marketing power for anybody to stop them from preying on their customers. In the end, they will forbid the SEC from imposing a fiduciary standard on them. We should stop pretending that it will ever be otherwise.

But perhaps we can strip them of the sheep’s clothing, and let the public see the true role they play in their customer relationships.

Instead of saying that brokers are not fiduciaries, I propose that we raise the disclosure standards to tell the public, frankly, that the brokerage relationship is about winning and losing, rather than helping and facilitating. It’s about eating what the brokers can kill, and investors are potentially the carcass lying in the grass. Consumers are likely to lose when they fall prey to brokers, and likely to win when they are lucky enough to find a fiduciary guide to help them get safely to wherever they want their financial life to take them.

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