Fiduciary Corner

Blaine F. Aikin

Fiduciary standard doesn't raise costs: Study

Brokerage industry's claims of more expensive products fail to take "agency rents' into account

Apr 1, 2012 @ 12:01 am

A new study out of Texas Tech University casts significant doubt on brokerage industry claims that the fiduciary standard leads to higher costs and fewer product choices for investors.

Ever since the 2010 Dodd-Frank Act empowered the Securities and Exchange Commission to extend the fiduciary standard to all investment advisers who provide personalized advice to retail investors, the formidable brokerage industry lobbying machine has been working overtime to delay, dilute or defeat imposition of the fiduciary standard. The higher-cost-and-reduced-choice argument stands at the heart of these efforts even though opponents of such a standard have not offered any evidence to back these claims.

Now the issue has been examined in an independent academic study entitled “The Impact of the Broker-Dealer Fiduciary Standard on Financial Advice.” In the interest of full disclosure, this study was funded in part by fi360 Inc. and the Committee for the Fiduciary Standard, of which I serve as chief executive and a member of the steering committee, respectively.

Professors Michael Finke and Thomas Langdon designed the study to “take advantage of differences in state broker-dealer common-law standards of care to test whether a relatively stricter fiduciary standard of care impacts the ability to provide services to consumers.” In other words, they observed that several states unambiguously impose a fiduciary standard on brokers, and several others unambiguously do not impose a fiduciary standard, while the majority of states fall somewhere in between.

"NO STATISTICAL DIFFERENCES'

By comparing the fiduciary and nonfiduciary states, the researchers were able to test the hypothesis that the fiduciary standard leads to higher costs and fewer choices, among other things.

The study results contradict brokerage industry contentions on all counts.

“We find no statistical differences between the two groups in the percentage of lower-income and high-wealth clients; the ability to provide a broad range of products, including those that provide commission compensation; the ability to provide tailored advice; and the cost of compliance,” the study concludes.

In effect, the fiduciary standard is not more expensive for investors; it is more efficient. They can acquire advice that is subject to higher accountability without higher costs or reduced choices.

Why doesn't the fiduciary standard lead to higher costs to investors? After all, it is a higher standard under the law than the suitability standard, with stronger investor protections. Moreover, all other things being equal, investors who know the difference between the fiduciary and suitability standards would prefer that their adviser be held to higher obligations for objectivity and competence, so fiduciary advice is inherently worth more.

The study offers a clear explanation for why there is no apparent cost differential.

It has to do with the ability of firms that adhere to a nonfiduciary standard to take advantage of the information imbalance between advisers who know a great deal about investments and the products they offer, and their clients, who typically know much less. In the absence of fiduciary obligation, broker-dealers and their representatives are able to exploit the information imbalance by extracting extra “agency rents” from clients.

Agency rents, the authors of the study explain, “occur when the broker recommends products that benefit the broker to the disadvantage of the customer. Examples of agency rents include recommending products that have higher commissions or not taking the time to consider alternative financial strategies for a customer.”

The results of the study suggest that when obligated to place investors' best interests first, broker-dealer firms should accept lower profits rather than raise prices or cut services.

Fiduciary principles embody the high ideals attendant to professional advice. The higher-cost, fewer-alternatives argument against the fiduciary standard seeks to put a price on the cost (or value) of professional principles.

Even if one were to accept the dubious theoretical idea that we should compromise professional principles based upon cost considerations, the study from Texas Tech helps make clear that this a false choice based upon practical observations in the real world.

Blaine F. Aikin is chief executive of fi360 Inc. and a member of the steering committee for the Committee for the Fiduciary Standard.

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