Friday, March 28, 2014

The Illusion of Protection - "I'm a fiduciary, but, but, but ...."

A. Introduction.

Over and over again at conferences I hear, and over and over again in various articles I read: "Avoid conflicts of interest if you are a fiduciary. But if you don't avoid the conflict, then properly manage the conflict by disclosing it."

Sounds fair. But is it? Is this all the fiduciary standard requires? Mere disclosure of conflicts of interest?

I think not. In my view, based upon the research I've done, under the common law a bona fide fiduciary standard requires not just disclosure of conflicts of interest that are not avoided, but much more. Disclosure must be undertaken in a manner which is ensures client understanding. This means that the less the sophistication of the client, the greater the discussion which must occur around the conflict of interest. Also, the informed consent of the client must be obtained. And, even with disclosure, the proposed transaction must be substantively fair to the client. Courts set aside transactions by clients of fiduciaries when a transaction is not fair, either by casting it as an "substantively unfair" transaction to the client or by noting the client understanding and informed consent was not obtained. In summary, courts doubt that clients would ever consent to be harmed.

Yet, it appears that the SEC has failed to enforce the fiduciary standard correctly (as I have previously written about). And it also appears that many large Wall Street firms are putting themselves (and their advisors) at risk, by relying upon "mere disclosure" as the means of "managing the conflict of interest." The evidence of these practices is found in the SEC disclosure document required of these firms, which are publicly available documents.

B. Let's Examine the Morgan Stanley Private Wealth Management SEC Disclosure Document (Generally). 

As an example of what is taking place in the marketplace today, let's take a few minutes to examine the Form ADV, Part 2A (SEC-mandated disclosure document, which must be given to every client of an investment adviser) of a large, dually registered firm. While it is not my desire to pick upon any firm, I'll choose, more or less at random, the first firm that comes to mind - Morgan Stanley Private Wealth Management, a Division of Morgan Stanley Smith Barney LLC. The Form ADV, Part 2A is for its "PWM Wealth Management Services." This Form ADV, Part 2A, dated July 26, 2013, is accessible through the SEC's web site (via IAPD).

  1. Morgan Stanley's "Dual Registration" Status. 

Morgan Stanley Smith Barney LLC ("MSSB") is both a registered investment adviser (firm) and a registered broker-dealer (firm), among other registrations and memberships. It is likely that most of the "investment adviser representatives" of Morgan Stanley are "dual registrants." In other words, they are licensed both as registered representatives (sales representatives) of a broker-dealer firm and as investment adviser representatives (fiduciaries).  In some instances, the "Private Wealth Advisors" (also sometimes referred to as "Financial Advisors") of MSSB, as they are referred to, may also possess licensure as an insurance agent (thereby enabling the recommendation and sale of insurance products, such as variable annuities and variable life insurance products). The Form ADV, Part 2A makes no mention of this fact, but it would likely be found in each individual Private Wealth Advisers Form ADV, Part 2B (individual disclosure document).

   2. Client-Paid Advisory Fees to MSSB.

For its advisory services for its "Private Wealth Management Services" MSSB may charge a maximum advisory fee, paid directly by its clients (or deducted, with client consent, from the client's accounts, which is typical) of 2.0% annually. There is no doubt that many clients have negotiated annual advisory fees lower than 2.0%, however.

C. What About the Other Fees and Costs that Clients are Paying to MSSB, or In Connection with the Products Recommended? 

The main questions I seek to ascertain, through this analysis, are: (1) What other fees and costs the clients may be paying to MSSB, directly or indirectly, under this program? (2) Are such additional fees and costs adequately disclosed? (3) Are conflicts of interest, and their impact upon the clients, clearly and candidly disclosed?

Let's look through Form ADV, Part 2A, to see if we can determine these other fees and costs, how they are disclosed to clients of the firm in this disclosure document, and whether such disclosures are meaningful to clients.

   1. Payment for Shelf Space. There is a common practice in many broker-dealer firms, called "payment for shelf space." In essence, mutual fund companies pay the broker-dealer firms revenue-sharing payments, in order to secure preferred treatment. Here's how the Consumer Federation of America's Travis Plunkett, in testimony to Congress, described these arrangements:

  • "Payments for shelf space are another form of revenue sharing payment used to promote distribution. In this case, the fund’s investment adviser makes cash payments to the broker- dealer in return for “increased access to their sales staff, or for ‘shelf space.' The SEC, in its examination sweep, found that payments vary considerably, from 5 to 40 basis points on sales and from 0 to 25 basis points on assets that remain invested through the broker-dealer. Fourteen of 15 broker-dealers examined as part of the SEC sweep received such cash payments."
(Testimony of Travis Plunkett, Legislative Director, Consumer Federation of America, Before the Senate Governmental Affairs Subcommittee On Financial Management, the Budget, and International Security Regarding Mutual Funds: Hidden Fees, Misgovernance and Other Practices that Harm Investors; citing  “SEC Revenue Sharing Examination Findings” email provided to reporters by SEC Tuesday, January 13, 2004.)

The Consumer Federation of America notes that payments for shelf space do not come directly out of shareholder's (customer's) pockets, but rather are paid out of other fund company revenues. In many instances these costs are, in essence, paid indirectly by fund shareholders, as they are paid from the management fees paid to the fund's investment adviser. It might be reasonable to conclude, all things being equal, that if payments for shelf space were not made, it is likely that the management fees of such funds would be lower.

Let's now examine MSSB's core disclosures, in its Form ADV Part 2A, to its clients regarding such payments:

  •  Payments from Mutual Funds. For Clients who chose to custody their assets at MSSB, MSSB receives payments from mutual fund companies whose open-end mutual funds are offered through the programs described in this brochure, of up to 0.16% of the assets of such Mutual Funds that are held by MSSB clients at MSSB (referred to as a “participation fee”). As described in greater detail below, the participation fee is paid by fund companies primarily to compensate us for providing services that the fund company would otherwise have to provide itself. However, a portion of the participation fee may be considered as “revenue sharing.” These payments are separate from, and do not impact, the fee that clients pay to us. They are paid directly from the mutual fund or its advisor or distributor to MSSB. Moreover, MSSB Private Wealth Advisors do not receive any additional compensation as a result of these payments.
  • A substantial portion of the participation fee compensates us for services that we perform on behalf of the fund sponsor or company. These services are generally sub-accounting and recordkeeping functions such as aggregating and processing purchases, redemptions and exchanges of fund shares; delivery of disclosure documents; processing of dividend distributions; tax reporting and other shareholder or administrative services.
  • MSSB considers the portion of the fee that exceeds the amount that the fund company would otherwise charge internally for such services to be revenue sharing. Revenue sharing payments are generally paid out of the fund’s investment advisor’s or other affiliate’s revenues or profits and are not made from fund assets. However, fund affiliate revenues or profits may be in part derived from fees earned for services provided to and paid for by the fund. No portion of these revenue-sharing payments are made by means of brokerage commissions generated by the fund.
  • As a general matter, MSSB requires mutual fund companies to pay the participation fee to enable the fund company’s funds to be made available through our advisory programs. There are limited exceptions in which fund companies pay us a participation fee of less than 0.16%. These exceptions create a potential conflict of interest in that MSSB could have an incentive to recommend a mutual fund from a family that pays the full participation fee. As noted above, Private Wealth Advisors do not share in this fee and these payments do not increase the fees that clients pay to us.
  • Mutual fund companies that do not agree to make these payments do not receive the same level of access to our firm.

So, related to the foregoing disclosures, let's ask some questions.

How Much of the "Participation fee" is "Revenue-Sharing"? Can't This Be Quantified and Should It Not Be Disclosed?

I simply don't have any clear information to determine how much of the "participation fee" is, indeed, "revenue-sharing."

Let's look at this issue - i.e., the cost of the services provided by MSSB which replace the services which would have been provided by the fund companies themselves - by comparing the fees charged by one mutual fund complex. The "administrative costs" of mutual funds, which are part of each fund's "annual expense ratio," can vary substantially from fund to fund. They can be just a few basis points (as in the case of Vanguard's ETFs and open-end mutual funds, where administrative costs of a fund can often be 0.02% to 0.03% a year. At mutual fund companies which do not enjoy such economies of scale, or who do not provide the services paid by such administrative costs "at cost," such "administrative costs" can be much higher.

Let's look at this issue from the standpoint of the costs of similar services provided by large discount brokerage firms. There are many discount brokerage firms which provide services to independent registered investment advisers. These brokerage firms are paid under a variety of methods, but one of the main methods is through transaction fees. Each purchase or sale of a mutual fund initiated by the independent investment adviser through the discount brokerage firm (custodian) might trigger the payment of a transaction fee, which might be in the range of $20 to $100 per transaction, depending upon the brokerage firm utilized. If trading is infrequent, then these fees become quite low, as a percentage of an investor's account. And, to my knowledge, no "participation fees" are paid by some of the mutual fund companies (such as Vanguard, Dimensional Funds Advisors) to these discount brokerage firms. Yet, these discount brokerage firms still provide the same services, as a custodian, to customers that MSSB does.

Hence, it might be fair to say that, given economies of scale present in a large broker-dealer firm, the costs of providing the services indicated by MSSB is likely only a few basis points (0.02% or higher). This is especially true given the aid of computerized record-keeping and reporting services today, including electronic and largely automated delivery of trade confirmations, tax reports, monthly statements, and prospectuses/annual reports and other fund information. If the cost is much greater than this, one would need to question why some large providers of such services are able to provide similar services at lower cost.

Why is the amount of the participation fee, which is in the nature of revenue sharing, not quantified for the advisory client?

We can only speculate as to what the "revenue sharing" payment is, for such data would have to be quantified by MSSB from its own data. But why is it not quantified - as an average for all of its clients? Is not such data reasonably available? Is it not material to the client? Would not a client desire to know how much the participation fees average, and what portion of the participation fees are (at least on average) paid to compensate for services, versus revenue sharing payments?

Does the participation fee really compensate primarily for services, and not primarily revenue sharing payments?

Regarding this aspect of MSSB's disclosure: "the participation fee is paid by fund companies primarily to compensate us for providing services that the fund company would otherwise have to provide itself. However, a portion of the participation fee may be considered as “'revenue sharing.'"  Is this disclosure accurate? Given that a large fund complex, such as Vanguard, can deliver the services listed to its customers for only a few basis points, or that large discount brokerage firms appear to also be able to deliver such services at seemingly very low costs, what amount of the "participation fee" is truly payment for such services, and which part is truly "revenue sharing"?

One would hope that the SEC is examining this issue, in order to verify the statement that the "participation fee" is paid primarily to pay for such services, and not primarily for "revenue-sharing" instead.

Here's a related question. Should the average costs of shareholder servicing, by all funds, be disclosed? One would assume this information is available from the SEC's database of fund information, if it is not already compiled by some other firm or organization (such as the Investment Company Institute, Morningstar, etc.). And, if the average costs incurred by MSSB to provide such services exceed the average, should disclosure be made of this fact?

Is the conflict of interest disclosure relating to the participation fee adequate?

Certainly the receipt of other compensation, in the form of revenue-sharing payments, is a material fact that must be disclosed to the client of a fiduciary. Another question I possess relates to the adequacy of disclosure of these payments as creating a conflict of interest for MSSB and its "Private Wealth Managers."

In the fourth paragraph above, MSSB does state that, when firms pay less than the full 0.16% participation fee, this may create a conflict of interest for MSSB to recommend firms that pay the full participation fee. But this is not a disclosure of the conflict of interest itself.

To find the main disclosure of the conflict of interest requires looking to at prior paragraphs in the same section of Form ADV, Part 2A, where is contained a more general statement of the conflict of interest disclosure:

  • "MSSB and its affiliates provide investment advisory, prime brokerage, trading, execution and other services to each other, to managers, pooled investment vehicles, and other clients, and receive compensation for such services."
  • "MSSB may choose to recommend managers or investment products for which MSSB or one or more of its affiliates serve as broker, prime broker, counterparty, administrator or other service provider, including investment banking, placement agent or secured lender and with respect to which MSSB and/or its affiliates receives fees, interest and/or other compensation. MSSB, in the course of these activities, including its prime broker and secured or margin lending activities, may take actions that are adverse to the interest of its advisory client, such as foreclosing upon collateral comprised of assets of an investment product pledged with respect to a loan."

Digging deep here, this main conflict of interest disclosure states, in pertinent part: "MSSB may choose to recommend ... investment products for which MSSB ... serve[s] as ... service provider ... and with respect to which MSB ... receives fees, interest and/or other compensation. MSSB ... may take actions that are adverse to the interests of its advisory client ..."

Do you think clients understand the conflict of interest that is inherent in recommending only funds that pay revenue-sharing payments?

Is the use of the language "may take actions that are adverse" appropriate? Should the disclosure instead state: "often takes actions that are adverse" to the best interests of the client?

Should it be disclosed that fund companies which provide extremely low-cost funds (such as Vanguard, as one example) typically don't pay "participation fees" or any form of "revenue sharing" payments?

Should the impact of payment of revenue-sharing payments, and the non-use of many lower-cost funds on this MSSB investment advisory platform, be disclosed? For example, where is it disclosed that lower-cost mutual funds typically have higher returns, over the long run, all other things being equal (which conclusion results from the substantial amount of academic research in this area)?

Is the disclosure candid? Or does it seek, via the language utilized, to disguise the conflict? For example, examine the last sentence of the general disclosure set forth above. MSSB provides the example of "foreclosing upon collateral comprised of assets of an investment product pledged with respect to a loan." How often does this occur? For which clients? Is not the greater conflict of interest, applicable to all clients, the receipt of revenue-sharing payments, and why is that not provided as an example? In other words, by using an example which is rare and not applicable to all clients, is the client's attention directed away from the more severe (in my view conflicts of interest. Is this an example of "Plain English" writing? (I often point out to my students that long sentences, as exist in the disclosure above, are difficult for readers to understand.) It appears to this reader, in my opinion, that the general disclosure set forth above obfuscates the message which it otherwise should seek to convey.

   2. Disclosure of Possible Receipt of 12b-1 Fees.

MSSB also discloses that it may receive additional compensation from mutual funds in the form of 12b-1 fees. This disclosure states:

  •  Morgan Stanley Distributors Inc. serves as distributor for these open-end investment companies, and has entered into selected dealer agreements with MSSB and affiliates. Morgan Stanley Distributors Inc. also may enter into selected dealer agreements with other dealers. Under these agreements, MSSB and affiliates, and other selected dealers, are compensated for sale of fund shares to clients on a brokerage basis, and for shareholder servicing (including pursuant to plans of distribution adopted by the investment companies pursuant to Rule 12b-l under the Investment Company Act of 1940).

Are 12b-1 fees actually paid by mutual funds to MSSB under the PWM Private Wealth Services program? If so, can't those payments be at least estimated, on average, for all clients of in the program? What are those payments, if they are made, utilized for - the same "shareholder servicing" which the "participation fees" are paid for, or are they just additional revenue to the brokerage firm?

If 12b-1 fees are paid:

  1. Is the recommendation of funds influenced by the payment of such 12b-1 fees? If so, the general disclosure found for this section, discussed previously, seems to be the main disclosure of the conflict of interest which would result. But, again, is that disclosure adequate?
  2. Does the disclosure mention that there are share classes, and entire mutual funds, that don't provide 12b-1 fees?
  3. Does the disclosure indicate that payment of 12b-1 fees, if paid, result in higher fund costs for investors, which in turn lead to (on average) lower returns?
   3. Disclosure of Possible Use of Affiliated Products.

MSSB'S Form ADV, Part 2A states:

  • "MSSB has related persons that are registered investment advisers in various investment advisory programs (including Morgan Stanley Investment Management Inc., Morgan Stanley Investment Advisors Inc. and Morgan Stanley Investment Management Limited). If you invest your assets and use an affiliated firm to manage your account, MSSB and its affiliates earn more money than if you use an unaffiliated firm. Generally, for ERISA or other retirement accounts, MSSB rebates or offsets fees so that MSSB complies with IRS and Department of Labor rules and regulations ..."
  • "Where clients select to invest in mutual funds where the investment adviser is a MSSB affiliate, in addition to the program fee paid by clients, MSSB and its affiliates may also receive investment management fees and related administrative fees. Since the affiliated sponsor or manager receives additional investment management fees and other fees, MSSB has a conflict to recommend MSSB affiliated Funds."

Again, the receipt of additional compensation, by recommending "affiliated" funds, creates an inherent conflict of interest. While the conflict of interest is clearly disclosed, is the impact of the conflict of interest, upon the client, clearly disclosed?

Additionally, one must ask why such additional compensation, if it occurs, is not quantified in some manner. Perhaps as a range of fees. Isn't this information readily available, and material, and hence should form part of a candid and forthright disclosure?

   4. Disclosure of MSSB's Proprietary Trading Activities.

Like many large Wall Street firms, MSSB trades on its own account, using its own cash. Trading also occurs between the firm and its client, particular for "principal trades" when individual stocks, bonds or certain other securities are sold to the client directly from MSSB's accounts. Here is MSSB's conflict of interest disclosure relating thereto, as found in its Form ADV, Part 2A:

  • "Trading or Issuing Securities in, or Linked to Securities in, Client Accounts. MSSB, MS&Co., and their affiliates may provide bids and offers, and may act as principal market maker, in respect of the same securities held in client accounts. MSSB, the investment managers in its programs, MS&Co., and their affiliates and employees may hold a position (long or short) in the same securities held in client accounts. MS&Co., MSSB, and/or their affiliates are regular issuers of traded financial instruments linked to securities that may be purchased in client accounts. From time to time,  MSSB(or an affiliate’s) trading – both for its proprietary account and for client accounts – may be detrimental to securities held by a client and thus create a conflict of interest. We address this conflict by disclosing it to you."

The last sentence is the key. Disclosure is made of the conflict of interest. But nothing is said about otherwise managing the conflict of interest.

Is any disclosure made of the impact of such conflict of interest upon the client? What additional fees and costs might the client incur as a result? Could lower-cost investments be secured on an agency (broker) basis, rather than by MSSB engaging as a principal (dealer) in a transaction with its client? Can such fees and costs be quantified?

Should disclosure also be made of the fact that the principal trading of activities of the major Wall Street firms, in using their own cash, usually are profitable nearly every day of every quarter, regardless of whether the market moves up or down? Isn't this information the client would want to know? And why are not the same trading strategies made available to every client of the firm?

   5. Disclosure of Fees and Costs of Funds.

In a different section of MSSB's Form ADV, Part 2A for this program, it states:

  • "Investing in Funds is more expensive than other investment options. In addition to our fees, you pay the fees and expenses of the Funds in which your accounts are invested. Fund fees and expenses are charged directly to the pool of assets the Fund invests in and are reflected in each Fund’s share price or NAV. These fees and expenses are an additional cost to you and are not included in the fee amount in your account statements. Each Mutual Fund and ETF expense ratio (the total amount of fees and expenses charged by the Fund) is stated in its prospectus. The expense ratio generally reflects the costs incurred by shareholders during the Mutual Fund’s or ETF’s most recent fiscal reporting period. Current and future expenses may differ from those stated in the prospectus. You do not pay any sales charges for Mutual Funds in the programs described on this brochure. However, some Mutual Funds may charge, and not waive, a redemption fee on certain transaction activity in accordance with their prospectuses."

This is the typical form of disclosure all investment advisory firms make, when they recommend mutual funds to their clients. And yet I wonder if this form of disclosure is adequate.

There is a heavy emphasis on the "annual expense ratio" of mutual funds. Yet, many costs incurred by fund shareholders are not included in the annual expense ratio. These include commissions and other transaction costs incurred as a result of trading within the fund. Soft dollar payments by fund complexes to the brokerage firms they utilize (in return for "research") can result in higher commission costs than would normally be paid by the fund. Also of note are other costs incurred indirectly by fund shareholders, such as bid-ask spreads, market impact costs, opportunity costs due to canceled or delayed trades, opportunity costs due to cash holdings, returns lost due to arbitrage (by other firms predicting which stocks might be added to an index) or resulting from pre-announcement of index changes (often resulting in price changes ahead of the periodic reconstitution of index funds). I wonder why such fees and costs, which are often quite large (and in some cases can exceed the annual expense ratio of a fund) are not at least mentioned in Form ADV, Part 2A.

    6. Summary, MSSB's Disclosure Practices.

I have not set forth all of the conflicts of interest disclosed in MSSB's Form ADV, Part 2A. I would encourage all of the readers of this blog post to download it (via the web site, by checking out investment advisers under the "Education" tab) and review it in its entirety.

Again, it is not my intent to single out Morgan Stanley. If one looks at the Form ADV, Part 2A of other dual registrant firms, similar disclosures (or lack thereof) occur.

But I do question whether the Form ADV, Part 2A are adequate, in several instances. I note, as well, that certain business practices (receipt of additional compensation, in many cases) appears to me to be contrary to the requirements of a bona fide fiduciary standard.

D. Do Clients Understand Disclosures?

If, as many in financial services now seem to think, disclosures are all that is required when a conflict of interest takes place for the client of a fiduciary, one must ask if disclosures are understood by clients?

While this singular topic could fill an entire volume, let me summarize by stating that academic researchers have long known that emotional biases limit consumers’ ability to close the knowledge gap between advisors and their clients. And recent insights from behavioral science further call into substantial doubt some cherished pro-regulatory strategies, including the view that if regulators force delivery of better disclosures and transparency to investors that this information can be used effectively. This is in large part due to many behavioral biases which

Note as well that “instead of leading investors away from their behavioral biases, financial professionals may prey upon investors’ behavioral quirks … Having placed their trust in their brokers, investors may give them substantial leeway, opening the door to opportunistic behavior by brokers, who may steer investors toward poor or inappropriate investments.”  [Robert Prentice, “Contract-Based Defenses In Securities Fraud Litigation: A Behavioral Analysis,” 2003 U.Ill.L.Rev. 337, 343-4 (2003), citing Jon D. Hanson & Douglas A. Kysar, “Taking Behavioralism Seriously: The Problem of Market Manipulation,” 74 N.Y.U.L.REV. 630 (1999) and citing Jon D. Hanson & Douglas A. Kysar, “Taking Behavioralism Seriously: Some Evidence of Market Manipulation,” 112 Harv.L.Rev. 1420 (1999).]

Moreover, as observed by Professors Stephen J. Choi and A.C. Pritchard, “not only can marketers who are familiar with behavioral research manipulate consumers by taking advantage of weaknesses in human cognition, but … competitive pressures almost guarantee that they will do so.” [Stephen J. Choi and A.C. Pritchard, “Behavioral Economics and the SEC” (2003), at p.18.]

As a result, much of the training of registered representatives involves how to establish a relationship of trust and confidence with the client. Once a relationship of trust is formed, customers will generally accede to the recommendations made by the registered representative, even when that recommendation is adverse to the customers’ best interests.

E. Because Disclosures are Ineffective, the Fiduciary Standard of Conduct is Imposed. Conflicts of Interest Must be Properly Managed - Not Just via Disclosure Alone.

There are substantial public policy reasons, including those stated above, for imposition of the fiduciary standard upon all who provide investment advice.

I must emphasize, however, that a bona fide fiduciary standard requires disclosure of all material facts to the client. And fees and costs incurred by clients, and conflicts of interest between the investment adviser and the client, are all material facts. In essence, these are the types of facts that matter to the client.

Wall Street’s lobbyists often suggest that court precedent exists for the proposition that disclosure alone is all that is required to meet the fiduciary standard when a conflict of interest is present. These lobbyists are either engaged in wishful thinking or mistaken. This argument often relies upon language found in the U.S. Supreme Court’s seminal 1963 decision applying the Advisers Act, SEC vs. Capital Gains Research Bureau. However, a correct construction of this case reveals that investment advisers are required to do much more than merely disclose conflicts.  This follows centuries of common law applying the fiduciary standard, including application of the time-honored phrase, “no man can serve two masters.” Indeed, acting under the fiduciary duty of loyalty requires active avoidance of conflicts of interest. Conflicts of interest which cannot be reasonably be avoided are then subject to the multi-step process to ensure that the conflict of interest does not harm the client in any manner.

Unfortunately, the SEC has, likely due to regulatory capture by the Wall Street firms it regulates, apparently acceded to this incorrect notion that conflicts of interest between fiduciaries and their clients are somehow "properly managed" by mere disclosure of the conflict of interest, alone. This is a dangerous notion.

F. In Conclusion.

I post a number of questions above, for which I don't possess clear answers. It is possible that disclosures are found in other documents (such as fund prospectuses, SAIs, and annual reports), or are made by other means by dual registrant firms. But, in my experience, clients don't read all of these additional disclosure documents. (Indeed, the duty to read is circumscribed when the client has a fiduciary advisor.)

I question the non-disclosure of many material facts in Form ADV, Part 2A, which I believe should be disclosed.

Of greater import, I challenge the ill-advised notion that disclosure alone can negate the fiduciary duty of loyalty. It appears to me that clients, due to conflicted practices, are paying much higher fees and costs than they would otherwise pay. And, from my own experience in meetings with hundreds of clients and potential clients, I would observe that 95% or more of these clients don't understand the fees and costs they are paying, nor their impact upon the client's investment returns.

However, I must state that it is my belief that fiduciaries deserve to be well-paid. Fiduciaries possess a duty of care, required of an expert, and must possess the skill and knowledge to discharge that obligation. Good advisors can add a great deal of value in dealing with individual clients. Hence, fiduciary expert advisors deserve professional-level compensation. Yet, they should not be permitted to extract excessive rents, as I believe is now occurring as to the portfolios of many clients of dual registrant firms, when such firms "double-dip," "triple-dip," and "quadruple-dip" through the receipt of additional compensation from the providers of investment products they recommend, and through other means. A true fiduciary seeks to establish a fixed amount (either as a flat or hourly fee, or percentage of assets under management) with a client, and eschews arrangements which would later increase the compensation of the fiduciary. In other words, bona fide fiduciaries seek to avoid, whenever possible, variable compensation arrangements.

In essence, we have the situation where many firms are advertising and promoting their services as "fiduciary" - yet, they then seek to merely disclose aways conflicts of interest in order to receive additional compensation. Through disclosures, and conflict of interest waivers signed by clients (which are ineffective in most instances - the subject of a future blog post), the fiduciary relationship is transformed back into a sales-customer relationship. The relationship becomes an "arms-length relationship" again, and the principle of "caveat emptor" applies. This is not a fiduciary relationship at all!

In essence, through registration as an investment adviser, but through non-adherence to bona fide fiduciary principles, the essential protections afforded to clients by the status of their advisor as a fiduciary are eroded, and often negated. The client is often, due to behavioral biases and other factors, unable to discern this transformation from trusted advisor to salesperson, especially since fiduciary status still exists under the law. As a result, the illusion of protection occurs for the client of firms which operate in this basis.

Pull up the Form ADV, Part 2A of your investment adviser. Does it say ...

    "I am your fiduciary. I act in your best interests. I am your trusted advisor.
            BUT ...
            BUT ...
            BUT ...
            BUT ...
            BUT ...
            BUT ..."

Too many "buts" (or "butts") makes for a stinky mess!

In essence, with each conflict of interest which is permitted, and with each receipt of additional compensation, and with each disclaimer of fiduciary obligations, the relationship of trust between the client and the advisor is slowly and irrevocably dissolved. In essence ...

         which then becomes
         when then becomes
         which then becomes
         which then becomes
          ... nothing.

Clients of all financial services providers - whether they are fiduciaries or non-fiduciaries - will need to ask tough questions. And they should get the answers to those questions in writing. See my previous blog post about this, found at

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