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Pragmatic Capitalism

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Being a Fiduciary, Part Deux

Here’s Matt Levine on the Morgan Stanley decision that I wrote about yesterday:

This is exactly right. Matt is just describing the world as it is today. Which is really the crux of the whole debate about the fiduciary rule. But that world is changing in large part because the salesman are forcing the stores to change. So, to elaborate on Matt’s analogy – the brokerage firms are like malls. Malls earn a profit by charging companies to sell their products in the mall. Brokers and financial advisors are consultants who roam the mall giving people advice on what they should buy.  Some of these consultants work for the mall and others just enter the mall to give advice where they think appropriate.

In the financial mall the brokerage firm makes the most money by recommending that people shop at the stores in the mall that they own. That is, they earn a fee by charging you to shop at any store AND they earn a fee when you buy their products from a store they own. It’s doubly good for them when you shop in their stores in their mall. But there isn’t just one mall out there. There are lots of malls. And more malls are offering access to more stores. This is very attractive to the shopping consultants who can become independent and advise their clients in whatever mall they want. More importantly, this allows them to advise their clients where to shop without having the pressure and conflict of recommending the stores owned only by the mall operator.

So, that’s the current financial landscape in a nutshell. In my opinion, financial advisors should operate more like doctors in this space. That is, they should seek out the best products in the stores/malls that best meet their client needs.  Of course, there are always conflicts in this process.  Doctors have tons of conflicts in their business and so do financial advisors. This doesn’t mean they can’t try to do what’s in the best interest of the client. But some of these conflicts are just too obvious to even argue about. For instance, when we know that 95% of active mutual funds are little more than closet index funds it becomes an obvious conflict of interest when you recommend a 1% fee closet index fund over something like a similar Vanguard fund.

Don’t get me wrong. This is a complex debate. Morgan Stanley made a decision that is in their best interest. But I also think they made a decision that makes it more difficult for their advisors to claim a fiduciary status.  And in my opinion, this highlights the conflict of interest that is most urgent in the financial space – the fact that too many of the shopping consultants feel pressured to recommend the stores and products owned by the mall instead of the products that can best meet their client needs.

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