Beware the Ides of March - A Lesson in Unintended Consequences

The Ides, or middle, of March holds a special historical significance for western civilization - one not enjoyed by the mid-point of any other month (except perhaps April 15th for those of us in the U.S., and for an equally sinister reason). March 15th, of course, is the commemoration of the assassination of Julius Caesar at the hands of Brutus, Cassius and other conspirators.

While this happened over 2000 years ago in 44 B.C. there are still lessons to be learned that we can apply to a multitude of different scenarios playing out in modern times. After all these years, the old adage still holds, that those who do not learn from history are doomed to repeat it.

The conspiracy against Julius Caesar was contrived to stave off a dictatorship and restore the Roman republic – while one could argue that the desired ends justified the means, the result was ultimately not at all what the conspirators expected nor wanted.

We see this same scenario playing out in the halls of Congress and the White House currently, specifically with respect to the Department of Labor’s Conflict of Interest Rule (AKA the Fiduciary Rule).

Some politicians are criticizing the rule because, they claim, it would limit competition, raise investing costs for consumers and cause many investors (particularly smaller investors) to be unable to obtain advice for their portfolios. Every one of these concerns sounds valid on the surface, but ignoring the DOL’s Fiduciary Rule will not only not address these concerns, but will leave investors (particularly small investors) worse off.  I’m not a politician, therefore I don’t expect you to take my word for it - I’ll prove it below.

Let’s address each issue, one by one. First, regarding the argument about limiting competition. I am very much in favor of the free market - allowing consumers the opportunity to choose lets them pick winners and losers based on their needs, rather than the government picking what they think (or are paid to think) is ‘best.’ But, for the free market to be able to operate effectively consumers need either basic minimum standards or the ability to differentiate one service provider from another.

Let’s look at this argument in greater detail via example. It’s likely you could describe the differences between a doctor, a nurse, a veterinarian, a phlebotomist and a dentist. Each serves a certain purpose in the medical field and different levels of training and expertise are required of each. Given that there are large differences, we, as a society, ascribed different titles to each of these roles. Calling them all by the same generic term, let’s say ‘doctor’ would lead to confusion and no doubt more than one awkward encounter with a veterinarian for decidedly human problems.  

This is true in every industry. A car salesman is not the same as a car mechanic, nor are either race car drivers despite all three being in the automotive field. Why then are both brokers and Registered Investment Advisors called ‘advisors?’ This leads to nothing but confusion for the consumer, leading to the incorrect assumption that they are the same. You wouldn’t want a car salesman working on your transmission, why would you want a financial product salesman working on your portfolio? It would be one thing if you knew which was which, it’s another issue entirely when this major difference is obfuscated – the major difference of course being whether they must work in your best interest or not!

The second argument against the DOL Fiduciary Rule is that it would cause costs to rise for consumers. The free market dictates that better run companies adapt and thrive and poorly run companies eventually fail and close. If an advisor (or more specifically in these cases, brokers) cannot adjust to the regulation without maintaining cost competitiveness then they will eventually fail. This is simply the survival of the fittest on a corporate scale – it is not the governments job to prop these firms up by passing (or not passing) preferential legislation. That being said, brokers historically have charged more than RIA’s, in many cases significantly more, therefore if they can’t afford to eat the cost of this, in my opinion, minor regulatory hurdle, perhaps they are not as good at managing money as you might desire from an advisor. For comparison’s sake, my firm is certainly not the size and scope of a Merrill Lynch yet we manage to be many times less expensive while still providing a higher legal standard of service to our clients.

The third argument often cited as a case against the Fiduciary Rule is the inability of small investors to get advice should the rule be put into effect. This is false on the surface and should require no explanation, but nevertheless I’ll entertain the notion. Robo-advisors pride themselves on their ability to serve small investors and for a cost significantly less than brokers charge. Traditional investment managers such as Scale Investment Group and many others, also do not have minimums and will work with small accounts as well as large ones for a fraction of the cost of a traditional broker.

One thing that is rarely mentioned is that the ‘advice’ usually given to small accounts by the broker community is a 5% up-front load (commission) on a generic mutual fund portfolio. What is not mentioned is that many small investors would be better off investing their own money and making their own mistakes rather than paying 5% of their portfolio up front to a broker. In other words saving on a 5% commission allows the investor the luxury of making a lot of mistakes before even coming close to the cost a broker will hit you with right out of the gate.

Lastly, I would be perfectly fine with the DOL rule never being implemented, if, and only if, consumers had transparency into who they were working with. In other words, brokers would have to call themselves brokers, no longer would they be allowed to repackage themselves as advisors and pretend to be something they aren’t. This simple piece of legislation, essentially requiring a spade to be called a spade, would eliminate the need for the conflict of interest rule all by itself. Consumers are not stupid, they can, and will, make good choices on their own, but that is made increasingly difficult when they are purposefully deceived and not given the facts they need to make such decisions.  

Failure to implement the Fiduciary Rule, or alternately to call brokers what they are rather than painting brokers and RIA’s with the same broad brush and calling them all advisors, will not be a benefit for consumers. It would not increase competition, but rather prop up those that cannot stand on their own merits in a changing market. It will not increase costs for consumers because consumers will move to more cost-effective alternatives if they find the price of advice objectionable, of which there is no shortage of options. It will not leave small investors to fend for themselves, as there are already plenty of firms that would be happy to help them. However, many investors would be better off managing their investments themselves rather than turning them over to expensive brokers due to the already astronomical up-front costs.

The arguments against the DOL rule are cloaked in the auspices of being free market driven, but they cannot truly be free market without transparency into who the investor is dealing with, an advisor or a salesperson masquerading as an advisor. Don’t be fooled by the rhetoric, and the expectations. Those of us in the know, recognize full well that the end results will not be what is promised or expected. Let the lessons of history be our guide. Beware the Ides of March.