[sgmb id=”2″]Being a political outsider has captured the attention of the American electorate in the last decade or so and is now been credited with generating a fundamental re-assessment of the national political establishment. Now, it’s time for outsiders to emerge in the financial services industry.
Simply because the “financial services industry,” a term I have used thousands of times over the years, is no longer the monolithic, all-potent source of industry leadership that represented its various constituencies and sought to promote their best interests, often at the expense of the industry’s own
This industry also is at a crossroads in terms of competing business models: the robo-model vs. the traditional sales model.
The robo-model elevates the interests of customers by seeking to deliver high-quality analysis at a low cost, while the traditional sales model (commonly used by large global banks, insurance companies, old-line investment management companies) preserve obsolete wholesaler networks, an army of active managers and other high-overhead sales-research facilities that only detract from an investors’ net returns.
To worsen this problem, financial services corporations have spent millions on lobbying at the state and federal levels to promote rules and regulations that work against their own customers and employees. If these lobbying efforts were more transparent, they would be contested by customers and some employees, except executives at the highest corporate levels. This is why a new group of independent, outside tech-based invest firms have emerged that offer great promise for individual investors.
Yet as new firms have emerged, old ones have failed. Here are a few examples of where established corporations in investment management, banking and insurance have failed to acknowledge that their own employees and customers have different interests than corporations rooted in the traditional sales business model.
The New Fiduciary Regulation: Much Ado About Nothing
The recent DOL fiduciary regulations that require financial salespeople to suggest products that are in their client’s best interests. The regulation states that advisors explain the differences and costs between similar products and present any conflicts-of-interest that the salesperson may have with the suggested products.
Sounds simple enough, but the financial industry has spent hundreds of millions of dollars on lobbying over the past decade to prevent this regulation from being enacted. Like the Affordable Care Act, Benghazi and Hillary Clinton’s e-mails, the financial services industry continues to work against this regulation, and has even paid House Speaker Paul Ryan (R-Wisc.) to lobby against the regulation.
Yet at the same time financial services executives and their lobbyists continue to spend money and expend energy to defeat the regulation, a recent survey by Pioneer Investments of 861 financial advisers in all 50 states who work for wire houses, broker-dealers, independent advisory firms and companies with an insurance-based business model, found that over half said the fiduciary regulations would “be good for business as it will level the playing field for retirement account advice.”
In more detail, the survey showed that 61% of advisers already use a “level compensation” model based on fixed fees, so they would not have to need to rely on the rule’s “best interest contract exemption” for revenue. In addition, the survey found that 49% of advisers expected little to no impact on their business and only 23% indicated a moderate to high negative impact on their rollover and IRA business.
So what this survey indicates to me is that if the rank-and-file advisors said the regulation is favorable overall, why did the corporate headquarters spend millions over the last decade to kill the regulation and why are they continuing that effort today when their own people think it is harmless?
Support for the Keep Our Pension Promises Act?
In another example, Sen. Bernie Sanders (D-Vt.) has introduced Senate Bill 1631: Keep Our Pension Promises Act, which would repeal the Multiemployer Pension Reform Act. That Act allows certain troubled pension plans to ask regulators for significant cuts to retiree benefits. Since the late-Fifties, companies have been allowed to go bankrupt and thus cancel or significantly reduce their pension obligations to their own employees.
Pension were eliminated or reduced, while other creditors, consultants, lawyers, fund administrators were paid off, while workers received less than their contracted pension payouts. The Sanders bill has broad support from unions, including the Teamsters and the Machinists union, along with retiree advocates AARP Inc. The measure additionally protects workers by setting up a $29 billion fund paid for with the elimination of certain loopholes on estate and expensive-art-sales taxes,” according to the Wall Street Journal.
Now, at first glance, this would seem like a no-brainer for the financial services industry to whole-heartedly support. After all, it would restore pensions to the disenfranchised and expand the retirement industry.
But so far, I have not seen any public support from the financial services mega-corporations to support this bill to keep their contractually-obligated benefits. My bet is that the largest investment advisors, insurance companies and consultants who have preyed on the corporate and union pensions plan sponsors for decades will sit this one out on the sidelines, even though it would benefit their own employees and pensioners. Plus, the bill benefits union members, who are anathema to Republicans.
The Big Schism Between the Corporate Suite and Advisors
These two examples show how the schism between many financial advisors who want to do the right thing for their clients and top corporate management that has its own agenda. That agenda is largely based on preserving their own compensation structure.
If that sounds naïve and to self-serving, this same argument was used by the heads of the nation’s largest banks who insisted the banks could not be broken up simply because it would result in a salary and perk decrease for the top executives. One executive compensation study found that “Bank executive compensation is closely and positively related to the size of the institution, but not generally related to profitability.” And what does this mean in dollars? Bank of America CEO Brian Moynihan and Michael Corbat of Citigroup revealed they got salary boosts of 23% to $16 million and 27%, to $3.5 million respectively in 2015, even as shares in their own banks fell.
In essence, ethical financial advisors, pensioners and average Americans who need objective financial advice are being held hostage by a small group of top executives, their corporate attorneys and lobbyists who want to do what is right for a small, elitist group rather than the vast majority of their own employees and customers.
This is why it is long overdue for an outsider to emerge in the financial services industry?
Time for Outsider Financial Services Firms to Emerge
So who would these outsider services firms be?
My suggestion is that they come from a robo-advisory firm that does not have a legacy of employing a national salesforce of mutual fund wholesalers, or any other sales organization with an expensive, outdated sales force that sells conflicted products via the Old Boy’s network. Firms that spent millions with Washington lobbying firms to support anti-customer legislation should also be excluded.
Robo-advisors are online financial advisory firms that use automation and algorithms to help manage client portfolios. This technology allows robo-advisors to offer cheaper investment than a human financial advisor.
While this may be bad news for human advisors at old-line full service firms that lobby against their own customers, this change in the financial services industry should not be unexpected. After all, how long can any industry disrespect its own customers and expect to get away with it?
Ethical advisors at old-line firms should understand that they probably are in conflict with their own senior management. That poses a real career dilemma.
To fill that void, here is a list of good outsider robo-financial services firms could include fi360, Betterment, Wealthfront, Charles Schwab, FutureAdvisor, Blooom, Vanguard, or Personal Capital. Socially conscious fund companies, such as Domini, Aquinas Funds, American Century, and Thrivent would also be good outsider candidates.
While it is less visible, what we are seeing in the financial services industry parallels what’s happening in national politics. In a political column, Robert Reich said the national anti-politic movement is based on “a growing number of people who think the game is rigged against them. There’s no center, only hostility and suspicion.”
While it is more extreme in politics, there are many average investors who know the underlying message of the 2007 recession, mortgage crisis, price-fixing scandals, excessive CEO compensation, the retirement crisis, wage disparities, stagnant incomes and a low-return stock market, can be traced to various degrees to Wall Street’s unregulated behavior.
So who can benefit from this sentiment? Being a financial industry outsider, akin to the anti-establishment politic movement, has great marketing potential, especially as the robo-firms and ethical funds make their differences better known against the global Wall Street banks and old line investment management companies that want to do business-as-usual and work against their own customers.
But as we are seeing in the political arena, that old-line, anti-customer model is teetering and will never be the same. The same should be true for the old-line financial firms that routinely work against their own customers and employees.
It also gives the robo-model a new message to reach investors who are tired of global banking scandals, high fees, limited transparency and paying for active management that does not deliver.
People resist the new regulations because of the potential for new theories of recovery and a whole new set of litigation. Every arbitrary, less than pristine definition of a term may ultimately be litigated. In those situation, no one wins – everyone loses other than the plaintiff’s bar. A common response is to become ultra conservative. It’s like MyRA and its fixed income investment. Under the new DOL rules, could any fiduciary survive the plaintiffs bar’s challenge where they recommend such an investment to a 30 year old in their Individual Retirement Account? Everyone, even those who might benefit from such regulations, should resist the massive regulatory overreach we see everyday.
You mention that the multiemployer pension participants are somehow “disenfranchised”, that the repeal would “restore” pensions, and that it would “expand the retirement industry.” I see your point when it comes to the financial services industry. However, this is simply another ploy by politicians to use taxpayer dollars to buy votes. Weren’t the trustees fiduciaries? If so, how the heck did they allow the fund to get so underfunded? Let’s see them prosecute a few of these folks first, a few perp walks and some jail time (as well as paying a few fines) before you start asking taxpayers to bail them out. Similarly, it is not as if the union and the employer weren’t aware of the underfunding. So, they deliberately over committed and the deliberately under funded the plans. Obviously, management and the unions both had to be quite aware of this scheme. So, time to take major haircuts. And, of course, remember that they will be dumping these liabilities onto the PBGC – where the deficit/debt is now estimated to be $76B (9/30/15), up from $11B for FY 2008 – that’s a 590% increase in 7 years!!! My comparison to 9/30/08 is very important because, remember, PPA 2006 included all sorts of provisions designed to solve, once and for all, those pension funding deficits. I mean, come on, it is more than 40 years since ERISA and almost 10 years since PPA 2006!!!
You state: “… In essence, ethical financial advisors, pensioners and average Americans who need objective financial advice are being held hostage by a small group of top executives, their corporate attorneys and lobbyists who want to do what is right for a small, elitist group rather than the vast majority of their own employees and customers. …” You cite Citigroup as an example. As far as my DB plan and 401(k) plan, I say, Citigroup Who? Just not accurate, Chuck. The service provider/record-keeping fee is $3/month for my 401(k). My S&P 500 index fund has a charge of 2 basis points and almost no tracking error over the past year, five years and ten years.
Robo-firms? Maybe someday – once they have a track record and have shown an ability to succeed in terms of alpha in excess of their costs in all kinds of market and economic conditions. For the time being, I will probably stick with my 2 basis point S&P 500 index fund that comes with an annual account fee of $36 – and let others test the robo-firms’ capabilities.
If you want to see how high fees damage your 401k and retirement, buy the book, How 401k Fees Destroy Wealth and What Investors Can Do To Protect Themselves.