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Reg BI continues the main differentiation between traditional Wall Street brokers and Registered Investment Advisory (RIA) firms, which is good for my business. But the SEC offered little help for consumers. It affirmed their commitment to Wall Street over Main Street.
Brokers versus RIAs
The simple difference is compensation. Brokerage firms get money for recommending products. That may sound harmless, but a strong sales culture impairs investors. At the very least, it limits the product offerings into two broad categories: those that pay commissions and those that don’t. Just try to buy an inexpensive Vanguard index fund through your local broker.
Complexities arise from other practices. How does an investor decide when his broker offers a bond for his portfolio? The rate and issuer sound nice, and there’s no sales commission. The broker’s firm serves as agent for some transactions and principal in others; what does that even mean?
Some brokerage firms buy and sell stocks and bonds for their own profit. How would you feel to learn that a stock you bought came from the broker’s own portfolio? Essentially, their “expert” traders may be selling at the same time you are buying.
RIAs have fiduciary responsibility for the portfolios they manage. The relationship isn’t a “one and done” sales transaction. It’s a level of service beyond the brokerage model … it’s not that everything brokers do is bad, but more that many potential conflicts aren’t even allowed to RIA firms.
Why are bad practices allowed?
The fact that they have historically been allowed is one reason they are still allowed. Wall Street argues that brokerage firms have served millions of clients for dozens of years. If its behavior is so awful, why do customers keep coming back? How have firms survived all these years?
Those seem valid points. But I see two large groups who choose the brokerage model. One group is highly-informed, and they deliberately seek trading platforms and services offered through a brokerage model. They understand what they are buying.
The second group – far larger– doesn’t see or fully understand conflicts, recommendations, charges, or alternatives. If they truly understood, they’d be concerned.
Do some customers not know any better?
Yes. What if your doctor received kickbacks from certain medicines or treatments? What if an inferior hospital paid something to send patients there? What if he or she earned a commission on X-rays or blood tests? Would anyone be comfortable with that? I don’t think so and, yet, it’s OK for investments?
Whose side is the SEC on?
Well, the SEC acknowledges that conflicts are important; their required solution is disclosure. They demand various conflicts be spelled out in customer agreements. That’s like suggesting that I should read an entire insurance policy. Chances of me reading and understanding that entire document is slim. Let the buyer beware, I guess.
Our president is a New Yorker, enormously wealthy, and friendly with many Wall Streeters. His perspective is understandingly influenced by those personal relationships. He also hates government regulation and prefers that free markets impose any necessary changes (an opinion I tend to share).
Massive amount of Wall Street money flows to lobbyists and political campaigns. The traditional brokerage industry is a huge player in national politics. That’s not by accident.
SEC decision-makers usually come from the brokerage community. They understand the conflicts, but they also know how much revenue is tied to those practices. Elimination of sales commissions or proprietary trading or mutual fund 12b1 fees could amount to millions in profits each year. Old colleagues won’t be inviting you to the annual picnic if you mess with their profits!
Why don’t RIA firms have similar influence?
It’s partly a function of size. The firm I started has been very good to me and my colleagues. For our local marketplace we’ve grown very nicely and provide exceptional services to a great group of clients. We manage some $300 million for them. That is nothing – less than nothing – compared to any single Wall Street firm.
We aren’t aligned with others, either. Most RIAs are completely independent and relatively small. Although there are some trade groups and vendors who serve thousands of us, there is nothing on our side comparable to Wall Street. It seems unlikely that we can ever amass enough scale to outspend them.
Complexity helps them, too. It’s hard to illuminate problems because products are so complicated. Many fees were disguised or hidden. There’s an old industry adage that people would rather pay a high fee they can’t see than a low one they do. People don’t get too worked up over things they don’t see. That includes regulators and legislators, too.
How will Regulation BI affect advisors?
I don’t see immediate changes. There is an impact, though. Through the regulatory processes for this and the Department of Labor’s (DOL) now-delayed fiduciary rule, consumers have learned. Any good marketing class will discuss Early Adopters and how innovations typically move through a marketplace.
The RIA segment is seeing momentum as Early Adopter investors spread the word. We see more queries where investors ask about fiduciary services and explicit fees.
Surprisingly, the number of brokers leaving brokerage firms and moving into the RIA space is growing, too. That probably signals that the best and brightest sense a sea change faster than the brokerage bureaucracy can respond.
I wouldn’t count brokers out, though … Wall Street has brilliant marketers and money by the bucket. They won’t give up easily.
Dan Danford, CFP® is an advisor in St. Joseph and Kansas City, Missouri. He learned about money from his late father Thad Danford who charged rent on the family lawn mower while Dan cut neighborhood lawns. Danford is also author of Stuck in the Middle: The Mistakes That Jeopardize Your Financial Success and How to Fix Them.
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