New Financial Advisor Regulation will have little impact

Thesis: Obama’s regulations for the financial advisory industry will have little impact on advisor behavior.

President Obama last month said in a speech to members of the AARP (American Association of Retired Persons) that he has given the Department of Labor the permission to change its rule and the definition of fiduciary under the Employee Retirement Income Security Act. This simple change of one word’s definition has people in the financial advisory industry worried. The reasons behind this proposed change are obvious, to require the financial advisor to act in the best interest of their clients and disclose any and all fees associated with all potential investments ahead of time. Obama and his supporters argue here that the reasons for this this proposed rule changes are “that consumers are entitled to unbiased information, and that commission-based compensation structures generate inherent conflicts of interest.” The opposition argue that these changes will cause advice to “become more expensive or not available at all for small accounts or individual plan participants.” I am going to argue that these proposed changes will have almost no impact on advisor behavior.

I make my assertion that these changes will have little to no impact on advisor behavior because I am assuming that clients are going to be acting in the best interest of themselves and their own well being. If these clients are acting in their own best interests, then over time advisors who are charging higher fees for not acting in the best interest of the client will be weeded out. This is because if two advisors are identical and offer the same investment advice, but one, acting in the best interest of the client, invests their client’s money in a lower fee mutual fund, while the other advisor, not acting in the best interest of their client, invests the money into an equal mutual fund but one that charges higher fees for themselves, the returns for advisor #2 will be lower after all fees. This lower return will, over time, cause clients to switch advisors and go to the one who is acting in the best interest of their clients. They will do this whether or not they even realize if their current advisor is acting in their best interest because the returns will, on average, be lower for financial advisors not acting in their clients best interests. This process will act as a filter in and of itself to remove financial advisors who aren’t acting in the best interest of their clients. Over time, as people realize they are not getting the most out of this relationship, they will move their money to advisors with higher returns who already act in the best interest of their clients.

Even though as Jason Zweig writes in his article, “Mary Jo White, chairman of the SEC, voiced her view that stockbrokers, insurance agents, and other financial salespeople should have to put their clients’ interests ahead of their own” making any changes to the wording of the rules in place will not significantly impact on financial advisor behavior.

2 thoughts on “New Financial Advisor Regulation will have little impact

  1. Craig Friend

    I agree to a certain extent that competition will weed out advisers who dont act in the best interest of their clients but changing the wording could help the clients that are very interested in their portfolios. I assume there are numerous clients out there who hire advisers to manage portfolios and then forget about it. I dont see it hurting at all.

  2. Thomas Wen

    I definitely agree with your thesis. The most common way for FA’s to get more business is through referrals and that only occurs when there’s superior results. For those FA’s who don’t act in the best interest of their clients, they probably don’t have many clients given they don’t show results.

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