The first two months of the year saw the release of a pair of independent studies — the first from the National Bureau of Economic Research and the second from Boston College’s Center for Retirement Research —that might have flipped the debate on the cost of a uniform fiduciary standard.
Indeed, the issue of the fiduciary standard never should have centered on fees. Fiduciaries can charge any range of fees, as long as they’re “fair.” The real issue should have been, and always will be, conflicts of interest. Remember, the singular motto of the fiduciary duty isn’t “charge the lowest fee,” it’s “always act in the best interest of the client.”
It’s always in the best interest of an investor to invest in securities that have the best chance to maximize returns. The NBER paper (“It Pays to Set the Menu: Mutual Fund Investment Options in 401(k) Plans”) concludes brokers are more likely to keep and recommend affiliated funds even if they appear in the worst decile of investment performance. The study found these poorer-performing affiliated funds went on to underperform by an average of 3.6 percent. This equates to a cost of more than $1 billion a month—or about $30 billion in total since the SEC first proposed the uniform fiduciary standard.
Before the dust even settled on the NBER study, another study came out in February. The CRR research focused exclusively on IRAs. It echoed the conclusions of earlier studies that show broker-sold funds—regardless of their performance decile—underperform direct-buy funds from as low as 23 basis points to as high as 2.55 percent. The CRR paper looked at 2009 data and concluded (not considering performance at all) 12b-1 fees alone cost IRA investors $2 billion.
The common thread in both these studies is the ongoing conflict of interest to which investors are being exposed. By using affiliated mutual funds, brokers are not acting in the client’s best interest. This is the focal point of the fiduciary standard. Eliminate the conflicts of interest in terms of giving advice, and investors will immediately benefit. It doesn’t mean eliminating brokers, it just means eliminating the claim that brokers are giving advice. They are not. Advice requires a fiduciary duty. Brokers don’t (and shouldn’t) have to operate under the regimen of a fiduciary duty. Brokers don’t give advice. They trade.
By eliminating the opportunity for brokers to give advice, the SEC will eliminate the conflict of interest. From then on, it’s caveat emptor for investors. They’ll have to understand that dealing with a broker involves greater due diligence than when hiring an investment advisor. It is the very assumption of this fiduciary duty that sets the investor’s mind at ease and justifies the fees charged by the advisor.