July 2019 Newsletter

“All commissioned salesman have a tendency to serve the transaction instead of the truth.”
Charlie Munger

“I think it is inhumane to put people in a strong conflict of interest situation and expect them to behave well.”
Dan Ariely

“Edward Jones as a firm does not act as a fiduciary,” an [Edward Jones] advisor wrote to the CFP board, according to a person who shared details of this and other letters. “Can you provide light on my situation? Will I be forced to choose between my designation or the firm where I have worked for more than 20 years?”
https://onwallstreet.financial-planning.com/news/will-edward-jones-stop-advisors-from-using-the-cfp-designation

Market Review

Below are the indices we follow.

Stock markets around the globe posted positive returns for the quarter. Looking at broad market indices, US equities outperformed non-US developed and emerging markets during the quarter.

Value stocks outperformed growth stocks in emerging markets but underperformed in developed markets, including the US.  Small cap stocks underperformed large caps in all regions. REIT indices underperformed stock market indices in both the US and non-US developed markets.  Below are some visuals of performance.

Fiduciary Duties and Reg BI – Why Hire a Registered Investment Adviser Instead of a Broker?

As a Registered Investment Adviser, McCartney Wealth Management takes its fiduciary duties very seriously and has always looked suspiciously at the conflicts of interests of brokers.

The Securities and Exchange Commission, our regulator, issued new rules known as Reg BI (for “best interest”)  in June that go into effect next year. They are intended to provide investors with peace of mind in dealing with brokers, whose duty to investors has historically been lower than the duties of registered investment advisers such as McCartney Wealth.  The regulation unfortunately does not eliminate conflicts of interest of brokers, which occur when an individual’s personal interests diverge from their professional or moral responsibility to others. The new regulation does strengthen “disclosures” of conflicts, but as you will see below, research has shown that can be worse than no disclosure at all.

The Washington Post’s April 30, 2019, article on political spending shows what the broker world is trying to protect as they compete with Registered Investment Advisers, as the “financial sector spent close to $2 billion on lobbying and campaign contributions in the 2018 election cycle, a 36 percent jump from the last non-presidential campaign year, according to a new report released Tuesday.” There are some steep profits in commissions and revenue sharing.

It is important to note the distinction between brokers and investment advisers. Broker-dealers, or “brokers,” are usually commission salespeople who sell securities and investments. Common brokers are Edward Jones, Stifel, Wells Fargo Advisors, Merrill Lynch, JP Morgan, Morgan Stanley, etc.  They do not have a fiduciary duty to their clients, meaning they do not have to do what is “best” for their clients, but only what is “suitable”.  You will never hear a broker tell a client that they “don’t have to do what is best for them.”  When we review portfolios of new prospects who are coming from brokers, we almost always see high-cost mutual funds with revenue sharing going to the broker selling the mutual fund, along with 12b-1 marketing fees.

The primary job of brokers is to sell products, either manufactured and managed in-house mutual funds, or mutual funds or other products that pay shelf-space fees disguised as “revenue sharing” arrangements, or “shared asset” management fees (separate account management programs), or investments the company has purchased for its own account that it no longer wants to own (proprietary trading activities).

A Registered Investment Adviser such as McCartney Wealth Management by law has a fiduciary duty towards its clients and sells advice, not products.  It has to do what is best for its clients, and must put its clients’ interests ahead of its own. The distinction is very clear.  Supreme Court Justice Harlan Fiske Stone wrote in 1934:

“I venture to assert that when the history of the financial era which has just drawn to a close comes to be written, most of its mistakes and its major faults will be ascribed to the failure to observe the fiduciary principle, the precept as old as holy writ, that “a man cannot serve two masters.””

The late John Bogle of Vanguard wrote:

“The fiduciary acts at all times for the sole benefit and interests of another, with loyalty to those interests.”

In fact, our United States Supreme Court has itself opined on Registered Investment Advisers’ fiduciary duties to clients in the 1963 case, Securities and Exchange Commission v. Capital Gains Research Bureau, Inc.  In the case, the court referred to a report issued by the Securities and Exchange Commission that led to the Investment Advisers Act of 1940:

“that investment advisers could not “completely perform their basic function — furnishing to clients on a personal basis competent, unbiased, and continuous advice regarding the sound management of their investments — unless all conflicts of interest between the investment counsel and the client were removed.”

The Supreme Court continued:

“And the Committee Reports indicate a desire to preserve “the personalized character of the services of investment advisers,” and to eliminate conflicts of interest between the investment adviser and the clients as safeguards both to “unsophisticated investors” and to “bona fide investment counsel.”

Reg BI falls short in a number of ways:

1. It does not define what “best interest” means, so a broker cannot know what his or her duty really is.
2. The SEC believes more disclosure is the answer, although as anyone can see from the Supreme Court case above, eliminating conflicts is the real answer, and not more disclosure.

In fact, Professor Daylian Cain from Yale found in his research that when disclosure of conflicts of interests are provided at the outset of a relationship, brokers “will actually feel more emboldened to provide conflicted advice.”  This alone should mandate avoiding conflicts versus disclosing conflicts.

Charlie Munger advises “never, ever, think about something else when you should be thinking about the power of incentives.”  Incentives drive behavior, and commissions and hidden revenue sharing arrangements of brokers put investors in high cost, sub-optimal products. Professor Cain states “Conflicts of interest are a cancer on objectivity. Even well-meaning advisers often cannot overcome a conflict and give objective advice. More worrisome, perhaps, investors usually do not sufficiently heed even the briefest, bluntest and clearest disclosure warnings of conflicts of interest.”

What is the answer for someone seeking investment advice?

Avoid brokers and hire a “fee only” (no commission) Registered Investment Adviser. If you ever have any concerns whether your adviser is a fiduciary, ask that they confirm their fiduciary duty to you in writing.

Until next time,

Mike and Emily