A recent article noted that two powerful financial services lobbying groups are warning that if the SEC pushes for adopting a universal fiduciary standard will be very expensive for financial firms.
But since individual investors have few advocates in Washington, no one has bothered to ask how much money the existing, non-fiduciary system costs millions of naïve Americans annually.
The Securities Industry and Financial Marketing Association (SIFMA), a powerful lobbying groups claiming that real transparency and disclosing conflicts-of-interest will be expensive to implement, told the SEC that it will cost their member firms $5 million annually to upgrade their compliance, supervision and training systems.
Another lobbying group, the National Association of Insurance and Financial Advisors, said a uniform-fiduciary-duty rule would hurt middle-income investors. It then released a report showing that 84% of financial advisers said their business costs would increase if the SEC allowed the fiduciary standard. And to keep existing profit margins stable in the event a fiduciary standard was enacted, the same report said 44% of the advisors would pass on the higher costs to their clients by imposing or increasing fees.
What About Average Investors?
Of course, the job of Washington lobbying groups is to protect the status quo. That’s why the fundamental changes to the existing brokerage business model that would be significantly changed by the proposed fiduciary standard are clearly disruptive.
But what’s missing are some number showing the negative effect on millions of naïve American investors who unknowingly pay up to 17 separate fees when they buy a mutual fund. These lobbying groups also fail to note that 401(k) participants pay about $164 million a day in fees to the financial services industry.
Even worse, revenue sharing and 12b-1 fees, which would come into the light if a fiduciary standard, were enacted, cost investors about $9.5 billion annually.
These fees paid by unsuspecting investors—in revenue sharing, 12b-1, and in 401(k)s—dwarf anything SIFMA and other financial services lobbying groups have offered as a way to attract sympathy.
The Economic Cost of Transparency
But the fact is that the lack of transparency, and the lack of a fiduciary standard, is very profitable.
One academic study from 2007 found that when fund companies make it difficult for investors to choose between the 8,029 mutual funds and 21,631 different share classes that were available in 2007, fund companies stand to profit.
That’s why fund companies intentionally make the process more complicated, according to MIT Professor Gustavo Manso and fellow researcher Bruce Ian Carlin, who said “financial services firms over complicate their products to maximize profits; the more they confuse investors, the more money they make.”
Professor Manso and Carlin of UCLA’s Anderson School of Management, said in their paper, “Obfuscation, Learning, and the Evolution of Investor Sophistication,”
that there is a distinct financial motive behind the lack of transparency. Fund companies encourage the lack of transparency by creating new types of fees, share classes or changing managers. These unanticipated fund changes make it more difficult for the average investor to understand what is actually happening at the fund.
As a result, unsophisticated investors end up buying more expensive funds, while the more sophisticated investors buy lower-cost alternatives. The marketing is designed to obfuscate, not educate, the authors contend.
The paper address the costs of obfuscation to sophisticated, unsophisticated and fund companies, the optimal time to obfuscate, the extra rents available from unsophisticated investors, the baseline financial education that investors possess, the speed at which learning takes place, and the underlying mechanism in which sophistication evolves.
What makes the paper of interest to people advocating the adoption of a fiduciary standard is that it notes the lack of transparency is a profit motive, not a legal one.
Who Speaks for Individual Investors?
While industry lobbyists are paid to protect industry interests, only a handful of groups advocate for individual investors. The best known is the Consumer Federation whose director of investor protection, has diligently waived the flag for individuals. The problem is that the Consumer Federation is vastly out-gunned in this battle in terms of money and influence.
This void is filled by the financial services industry which ranks as the most powerful in Washington. That’s one reason why the SEC is a captive agency to the industry.
It’s also a reason why
Barbara Roper of the Consumer Federation wrote in a comment letter to the SEC that the agency has to “abandon its past propensity to protect the broker-dealer business model at the expense of protecting investors.” If not, Roper said the SEC “will be incapable of developing a fiduciary standard for brokers that truly puts the interests of investors first.”
But this is old news to the SEC.
Someone in Washington should point out that the existing system costs unsuspecting investors millions of dollars daily. This outweighs any costs that could be paid by brokers. So, it is simple math: transparency and a fiduciary standard benefits millions of investors.
Maybe it’s time the SEC did the math. Otherwise, they should just admit they work for the lobbyists.
