Best Interest Root Canals

“If you went to the dentist and they told you they worked for you, in your best interest, and for a flat fee per procedure performed, would you be upset to know the reason you paid for and got so many root canals is because the crown companies paid the dentist per crown they installed?”

Let me just be super clear up front: This is going to be long, it is going to be over-explained, there’s going to be a call to action at the end, and it is going to be the most important thing I’ve written about to date. If ever you’re on the fence about reading something I write and you’re not sure whether you want to take the time, today I’m cashing in whatever chips I have with you: Read this, share this, and understand this. This is important and it will affect you and everyone you know.

Effective today, the SEC’s “Regulation Best Interest” or “Reg BI” comes into effect, intended to replace the Department of Labor’s defunct “Fiduciary Rule” from 2018, which was overturned on grounds that the Department of Labor had overstepped its bounds in crafting what was otherwise an excellent regulatory framework for enhancing the quality of services provided to the general public.  So now we are faced with Reg BI, which is a franken-monster of special interests and implied truths without substance behind them. Let me summarize it right here: It is not only legal, but required, that people who act as investment brokers lie to you at the outset of their relationship with you.

I’m not exaggerating: If you hire a broker for any investment purpose, they will hand you a lie in writing, and they are required to do so by regulation. So what is the lie? Well, this is the exact form it’s required to take (no changes, omissions, or deviations from this script): “When we provide you with a recommendation, we have to act in your best interest and not put our interest ahead of yours. ” Followed by examples. Now that all sounds pretty straight forward, except there are a few fundamental holes in what’s being presented to you.

First

“We have to act in your best interest and not put our interest ahead of yours.” That sounds all well and good, but the regulation has some critical holes in it. You see, in several hundred pages of detail around the rule making of Reg BI, the SEC never bothered to define “best interest”. In spite of using the phrase hundreds of times in the regulation and being the cornerstone of the regulation, they never once give a framework for that standard. In fact, a common critique of the standard has been that the language they use here is more or less identical to the old regulatory language, “That recommendations must be suitable”, simply meaning “appropriate for this kind of investor” without any other regard for the characteristics, costs, or conflicts of interest involved in the transaction. That is a huge problem, because by contrast, Registered Investment Advisers are required to provide recommendations in your best interest under a fiduciary requirement, which includes a duty of loyalty, a duty of care, and a duty to execute client instructions. Not only does the Fiduciary requirement carry these duties, but it also caries stiff penalties for failure to do so, including treble damages (3x the harm caused), whereas a “best interest” standard carries no such duties or penalties for failure to follow.

Second

Conflicts of interest are a big deal. We all have them about all sorts of things, but let me explain how deep a conflict of interest can go. If you work with a brokerage firm that accepts revenue sharing agreements from their product providers (a process known as “buying shelf space”), that brokerage firm will likely only offer you a limited selection of investments based on which vendors have paid for shelf space. So while you might see many well known names on the shelf, others might be missing; Vanguard famously is unavailable at many firms because it refuses to increase the cost to consumers by splitting revenue with distributing brokers, and therefore they’re missing from the shelf, in spite of Vanguard funds being objectively some of the best priced and consistently performing funds in the passive index space. This would be normal at a store; for example, I don’t go to a best buy expecting them to sell shoes. But at a brokerage firm, this limitation of the “catalog” is not going to be readily apparent from the outside, and while this limitation may be disclosed to you, it often is done so in an incredibly long legal document that, let’s be honest, no one is going to read. As a result, by talking to a broker at a brokerage firm with a limited catalog, you may only be offered one of their limited product options, and that broker can meet their duty to make “Recommendations in your best interest and without putting his or her interest first” simply because they only have the options their firm allows; you can’t be mad if you want to buy shoes at the best-buy, after all, this is your fault for not knowing that you weren’t in a store with the selection you wanted.

Third

There is a famous problem called the “Two Hats” problem within the financial advisory space. Now let me be super clear about this: I have worn two hats. The first four years of my time as a financial advisor, I affiliated with a firm that offered products as a broker and services as a Registered Investment Adviser. The challenge to any consumer that worked with me is that upon deciding to work with me, they were fundamentally trusting me (which was well placed trust, but trust nonetheless). It would be more or less impossible for a consumer to know if at any given time whether I was wearing the Investment Adviser Representative hat, and therefore be bound by Fiduciary obligations, or if I was wearing the broker hat and only bound by the flimsy Best Interest standard. This was a major reason that I shifted to being a Fee-Only financial planner, so that clients would know I was always providing fiduciary advice, but that problem still pervades today. With the majority of financial services professionals offering advice being “dual registered”, meaning that they wear two hats, the public has to rely on their trust of the adviser to hope they’re not being taken advantage of. Why such a big loophole? Because the SEC in its infinite wisdom has decided that brokers only give advice “solely incidental to transactions”; so while you might pay a dual registrant a fee for a financial plan, thus receiving that plan as a fiduciary and being given guidance as a fiduciary, you may find yourself then being advised by a broker (same person, different hat, different standard of conduct) about how to implement that plan. The great challenge is this: It is literally impossible to tell when the person across the table from you is wearing a broker hat or an investment adviser representative hat, and therefore which standard they’re being held to at any given time. That isn’t to say there are no dual registrants who are doing good work, acting as fiduciaries in behavior if not in legal standard at all times, and who are trustworthy. The issue is that trust can blind us to danger when it’s present, and Regulation Best Interest enshrines that danger behind trustworthy words.

So why does this matter to me?

I get it, it’s a fair question. You’re already a client or you’re an acquaintance and you figure if you ever need help, you’ll just ask me and I’ll point you in the right direction; and I will. The problem is this: Here in Longmont, CO, there are 150 brokers and investment advisers, and there’s one fee only financial planner. The bulk of those 150 brokers are dual registered; they can wear the best interest hat, sell people things from an expensive limited catalog with back-end revenue sharing, baked in extra costs, and their customers will never be the wiser, because they’ll also talk to them wearing the Investment Adviser Representative hat from time to time. They will use the phrase “I’m legally required to make recommendations in your best interest” over and over again, except as you now know, they might as well be saying “All I sell is apples, so if you buy apples then I’m meeting my legal requirements.” In spite of the fact that the sign above the door might say “All Groceries”. In spite of that long winded example, the simple fact is that if someone was just going to randomly pick a financial advisor out of the 150, there is a 99.33% chance they will be working with someone who doesn’t have to act as a fiduciary at all times to their clients, and thus the door to the client being taken advantage of is left open.

So let’s just be clear about this: You need to raise your voice about this problem. You need to have conversations with your friends, family, co-workers, neighbors, and acquaintances about this “Regulation Best Interest” and how it’s a legally mandated lie that will cost them money via expensive products, conflicts of interest, and undisclosed revenue sharing agreements. When doing so, just remember the analogy at the start:

“If you went to the dentist and they told you they worked for you, in your best interest, and for a flat fee per procedure performed, would you be upset to know the reason you paid for and got so many root canals is because the crown companies paid the dentist per crown they installed?”