Trust But Clarify

Trust But Clarify

By Bill Kelly, CAIA Association CEO

What’s going on here? Wasn’t it just a few short weeks ago that the SEC came out with a self-reporting initiative aimed at advisors who essentially fail to disclose lower fee share classes to their client? This amnesty program was put into place to combat what the regulator described as a “widespread problem.” Perhaps this is not a huge surprise given the fact that most funds have between four and seven share classes, and some are even replicated in well over a dozen different fee structures. Assuming there is a method to this madness, it is quite easy to see why investors might at least wonder if their best interests are being served.

The Fiduciary Rule (circa 2016) was supposed to have changed all of this, at least when it came to retirement savings where a prior “suitability” test yielded to a higher degree of what is known as a best interest standard. The former is centered mostly around the risk of an investment, and only required that the recommendation be suitable for a client’s portfolio but did not necessarily have to be in her best interests. Although neither standard dictated that the lowest cost option must be used, especially when it comes to share classes, the best interest standard moves real or perceived conflicts of interests right to center stage. As simple as this may sound, it perhaps has the unintended consequences of limiting choice, and perhaps even limiting paid advice, out of fear that the hindsight of enforcement and litigation is 20/20 regardless of intent. The impact and interpretation of the Fiduciary Rule becomes especially acute at a time where investors will need to be looking at investment alternatives that perhaps fall outside of the very basic equity and fixed income fund offerings that are available for a small handful of basis points.

One new input came this week courtesy of the Fifth US Circuit Court that was an appeal of an earlier case which challenged the basic premise of the Fiduciary Rule. This time, the court came down on the side of the industry that brought this appeal by declaring that the Department of Labor had overreached in the initial broadening of this standard. If that’s not enough, another circuit court went in the opposite direction on this same issue, and a show-down in the Supreme Court might be inevitable. To further confuse matters, state regulators will continue to define and dispense their own views on rules regarding proper conduct around financial advice on their home turf.

Ultimately, this is less about which side is right. Investing is a very complex business and the current equity and fixed income markets have never been more correlated and perhaps more prone to loss. Increased investment options accompanied by greater emphasis on education and advice are critically important at this phase of the cycle. This is not about a simple Hobson’s Choice, and we must recognize that investor trust must be clarified via actions and intent, and only then can it be verified through a codified set of rules.

Seek diversification, education and know your risk tolerance. Investing is for the long term.

Bill Kelly has been CEO of the CAIA Association since 2014.

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