This is an updates version with more detailed discussion today.
I will be writing securities and investment related topics from now on, as I believe there are issues or topics I can contribute to what is available out there.
I finished designing and publishing the first blog using the plugin Smart Slider 3 on my home care organization website www.actikareofwalnutcreek.com. In the middle of doing it, it came to me that all
the businesses I want to be in, the business that interests me or turns me on, require one thing in common: Someone with a fiduciary mission in mind and carries it out in action.
Take in-home care for an example, the biggest and the ultimate duty for all caregivers is to be clients’ judiciary worker, meaning to put clients’ well-being before their own. Similarly, the role of an investment advisory firm (IA), including all its investment advisor representatives (IARs), is to do a good fiduciary job, essentially acting as clients’ fiduciary investment managers.
But do we really understand what fiduciary duty is about and what it calls for?
My Real Life Fiduciary Duty Experiences
I do feel qualified to speak on this topic as I have the first hand real life experience on being a fiduciary agent for someone else, with no strings attached.
Of the four siblings of my generation in the family, only my sister and I live in the Bay Area of the US. The problem is that my sister and her husband barely speak any English. Once in a while when they need to interact with anybody outside the family, I would be the interpreter as my niece, who speaks better English than me, is often too busy to take care of that.
What I have learned from being an interpreter is that it is more demanding than one thinks. Here is a good example. I set up the appointment for both of them to do a blood test ordered by their PCP at a Quest Lab in Antioch. The original appointment was on the 18th, but they went to LA on that date, so I had to switch it to the 19th at 9:00 and 9:15 for the two.
Given that they cannot read and speak English, I offered my phone for all the communications with the lab. At around 9AM the lab sent me a link for mobile phone check-in. Since Berkeley is roughly 45 miles away from Antioch, I called my sister first to make sure they did arrive at the lab. Once they did, I clicked the one button to check them in. I then told sister to call me as soon as she saw someone coming out to receive them from the lab. That way I can speak to the lab staff on their behalf to explain that they fasted since last night and have three vaccine shots and no symptom of Covid-19.
During the whole time around 9am I normally would run to the hill as my morning exercise routine and normally I don’t take my phone with me. But since I have the judiciary duty I must take it to the run and must answer the phone anytime it is ringing. It did make a difference because in the middle of my uphill running I received a phone call from my sister and performed my interpretation job. I cannot turn off my phone after that because the lab assistant asked my sisters to wait outside for her turn, as there were several people ahead of her. This should not have happened because I made two appointments so that my sister should get her blood sample taken at 9:00, while my brother-in-law at 9:15. The lab staff mishandled the appointments and their system showed no sign for my brother-in-law, only my sister. But what can you say? Shit happens and happens all the time.
Anyway, I must say I have never been so attentive to my phone before in my life. One reason is that my sister and I were communicating through the Chinese app WeChat, which does not have a ring tone like the normal phone has. It only silently shows someone is calling on the screen. I literally had to look at the screen every 30 second or so.
Anyway, on that day I first helped my sister and then waited and waited until my brother-in-law was getting in the line. Long story short, my entire morning routine was changed completely.
But that is what fiduciary duty all about! You must put other people’s interests ahead of yours, you often must sacrifice but remain considerate, and do not complain about all the inconveniences you may encounter. In short, you must get the job done regardless of what.
Fiduciary Duties Require Something in Return
My personal case is not typical because I got nothing in return other than helping family members. Normal fiduciary duty usually requires something back to the fiduciary agent for doing the demanding job. This holds for both senior home care and financial planner. That “something” is most frequently money.
That said, not all agents were born equal even with the same financial return. I tend to believe that you cannot teach someone to be a good fiduciary, just like you can’t teach a pig to sing. Strong fiduciary sense came to us in early ages and tends to stay with us for the rest of the life. It is a part of who we are.
Psychological Award to Fiduciary Agents
I also want to point out that there are other ways for a fiduciary agent to be paid, sometimes these rewards are even more important than the financial return. One way standing out is the psychological award.
Here is a good example. A financial advisor will routinely recommend stocks, funds, bonds, Real Estate Investment Trust (REITs), ETFs (Exchange Traded Funds) and options to fulfill the duty of a financial planner or financial consultant. However, once the recommendations are made, in public or private, they become a common knowledge and investors will be wanting to see if they are good or bad. When the market or the firm went with the recommendation, the investment advisor will feel happy and earn the bragging right. For a financial advisor this matters even more than the onetime fee charged, because more investors hearing the news will come to do business with the agent, with (or without) the understanding that nobody gets everything right all the time, even for Warren Buffett, thus the warning that past performance does not guarantee the future.
But even when the recommendations are entirely private, meaning nobody else other than the beneficiary investors knew them, a fiduciary agent can still appreciate the success he or she has made in predicting the market or firms. Money simply can’t buy this sense of self-satisfaction.
It Is Easy to Forget the Fiduciary Duty
That said, there is a dangerous side with psychological awards: Agents who crave too much of it sometimes may go too far. Essentially they turn it into a personal game and believe winning or getting the market right is everything that matters. Driven by such a desire, they will debate anyone disagree with them, and worse, they only talk about the good things about a stock, a bond, an option, a REIT, an ETF, or anything they happen to recommend.
Too bad they fail to recognize that they are doing exactly the opposite what a fiduciary agent should be doing: Putting clients’ interest first. The highest duty for a fiduciary agent is not to prove how good you are, but what is good for the client. In other words, it’s never about you, or you alone, but always about your clients. In order to work for the best interest of the investor to prevail, advisors should always take every recommendation not as a personal bet but as objective as possible, meaning to present investors with both sides of the material facts.
The Regulators May Have Forgotten Fiduciary as Well
Here is another side of the story: Even the regulators (the SEC or Securities and Exchange Commission at the federal level, and the state securities administrators, per the Uniform Securities Act, at the state level) can fail to put the interests of private or non-institutional investors before everything else, even when their number one job is to protect them.
The current rules and regulations are very heavy on monitoring brokerage agents and investment advisor representatives (IARs), even to the extent that ties up their hands for client services.
To be sure, the current laws and regulation do exempt fiduciary transactions (e.g., those carried out by guardians, conservatorship, insurance companies, employment benefit plans or trustees) from state and federal registration, saving them big trouble and cost involved in registration. But the rules also try to separate brokerage agents from investment adviser representative (IAR) as much as possible, even prohibiting the same individual from playing the roles of agent and an IAR at the same time.
According to this SEC rule, “A broker or dealer that is registered with the SEC under the Securities and Exchange Act of 1934 (“Exchange Act”) is excluded from the Act if the advice given is: (i) solely incidental to the conduct of its business as broker or dealer, and (ii) it does not receive any ‘special compensation’ for providing investment advice.”
In plain English, this says if someone working for the brokerage house and making commissions from transacting securities is not allowed to give securities advice to any investors, unless their advice is “incidental,” meaning they are not paid separate fees other than commissions.
This rule goes too far and is interfering market — at the cost of hurting fiduciaries. For a mature market to function efficiently, it must allow competition to work its way out. This means more capable and nicer agents can get more clients solely because more investors would prefer to work with them. Limiting investors’ pool of choices to the people with an official title of Investment Advisor Representative (IAR) does not help investors achieve higher efficiency from their investment portfolio. This is why I say investors’ fiduciary benefit will be artificially reduced.
We see this all the time: Someone with an official title knows less than someone else without the title. In the case of brokerage agents versus IAR, it is quite possible that an agent has seen more facts and truths from facilitating stock trade and is thus capable of offering more insight than an IAR does. The right approach is to let competition play its role.
Of course, the concern is with conflict of interest: A brokerage agent is likely to encourage every investor to buy or sell stocks, because the more the investors transact, meaning to buy or to sell securities, the more commission the agent can make. This is a real risk but disclosure, not categorically rejection or prohibition, is the right way out. We require all agents or all IARs to disclose the fact that they may have personal interest from recommending — or not recommending — something, and we let investors make an informed decision whether to follow the recommendation. Competition comes into play because investors will have a chance to hear the reasoning of both agents and advisors, and whoever with convincing reasons wins out. That is a win for investors, because they were able to let different voices come to their ears, not one sided opinion that often spells risks.
Let’s consider a hypothetic example. One investor was talking to her advisor who objects buying more Tesla shares because one driver was recently killed in a crush involving the auto-pilot function. The investor did nothing following her advisor. Little did she know there was a better informed agent who learned from the buyers of Tesla that the accident did little on the enthusiasm of Tesla and people are still buying like crazy. In this case, neither the advisor nor the agent was lying: The advisor was right to worry about the impact of the accident, while the agent was also right that people are still buying Tesla, pushing the stock price up. The investor would be better off if she heard from both, which would allow her to make more informed decision.
I remember reading an opinion piece arguing that the SEC should prohibit all the “hybrid agents” from calling themselves investment advisors, because only full-blown investment advisors hold themselves up to the fiduciary duty, not brokerage agents. But this is just America, where everyone tries to defend his/her turf. The right question to ask is what is best for investors? Just because the regulation says IARs have a fiduciary duty does not necessarily mean they all do.
I like what Ronald Reagan famously said before, we should trust both agents and IARs but certainly verify all of them. Good and thoughtful regulations are full of exemptions and contingencies, avoiding sweeping, categorical or preemptive rejections and prohibitions.
In addition, investors still have the right to sue agents or IARs if they lied or omitted material facts. In fact, the anti-fraud provision sets such a high standard that the agents or advisors will be prosecuted as long as they made fraudulent statements whether the investors gain or lose in their investments, and whether there is conflict of interest or not.
My point is that we should not let fraud concern overtake the efficiency concern, meaning to worry too much about fraud and too little about investment efficiency. We should also not equate conflict of interest with fraud. The former is a liability, while the latter a felony. Nobody can guarantee a conflict of interest will turn into a fraud, nor an IAR will never lie about something to the investors, even if he has received fees for making the best recommendations. Preemptive prohibition throws the baby out with the bathwater.
One thing is always true: good agents or advisors are always in short supply, and investors are always on the lookout for them. If they found one, they most likely would use him or her in more than one way, simply because that is in their best interest. Regulators should help, not block, them for doing that.