Financial Regulators Have An Impossible Task

It pains me to say this but I feel sorry for regulators in the financial services area. Their job is not doable in the real world.

Why Not?

Many people argue that suitability is an inadequate standard so regulators are looking for something more precise. The current front runners are the fiduciary standard and the best interest standard. They seem to have overlooked an obvious fact. Those standards are easy to talk about in the abstract, but there is no practical way to define them.

It is an old problem.

“In theory, there is no difference between theory and practice. But, in practice, there is.”

Computer scientist, Jan L.A. van de Snepscheut

What’s worse is that even theorists who recognize that there could be difference, invariably underestimate the magnitude of it.

The problem is driven by four factors:

  1. Few people know in detail what their own best interests look like and none know what the best interests of another person look like. Best interests rely on personal values. I had a client who refused to save for his retirement because, “No male in my family in three generations has ever lived past 55.” He died last year at 82. Good thing he had found some satisfaction in watching a portfolio grow.
  2. Interests change with time and not always for the better. Some people stop following recommendations.
  3. No one knows the future. What is good today may not be later. Which standard should apply? Retrospective assessment invariably includes information available to neither the client nor the advisor when the recommendation was made. Would it have been wrong to recommend the purchase of GM stock 10 years before it went bankrupt? Would it be wrong to recommend a particular tax strategy later denied by the government? How much inflation should we anticipate? Would it be wrong to save too much and have thus deprived someone’s children a trip to Disney World when they were seven?
  4. No one wants to be responsible for their decisions. All bad things are someone else’s fault. Lawyers like that idea and regulation makes it easier to find spurious examples.

Always notice “best interest” is context dependent. Where does it lead?

Advisors will (already do) refuse to associate themselves with clients who do not participate in decision making. Inability, as an excuse, will not be tolerated. People who are blame shirkers will be shown the door. People who cannot see value in the service will be cast out.

If you notice, exactly the ones who need the most guidance will be the ones who cannot get it.

Regulators are trying to design the entire process by looking at only one, even insignificant piece. They are partly right in assessing the problems with compensation. They are wrong in assuming that the actual transaction is the entire relationship.

I am pretty sure I have never fully satisfied a client based on my ability to fill out forms to purchase insurance. Even the design and product selection is uninspiring.

Most advisors derive their income from commissions arising from the sale and service of products. For what is involved, arranging a mutual fund is vastly more lucrative than an ETF. The regulators would be right if that were the only aspect.

Most advisors provide far more than the delivery of product.  They do so because they have found that clients both need and appreciate other services. New information and concepts. Tax planning, budgeting, long term financial planning, the counselor when things get tough, the conscience when a new bass boat looks attractive. The communicator with other professionals and family. These and more are thrown in.  Advisors can afford that because the commissions are large. Advisors who provide nothing but product acquisition are usually without clients. The other services are marketable. Clients don’t know they won’t have them without cost in the future. 

If sales and service based compensation falls, these services will be billed as a fee to those who want them. Experience teaches that clients faced with an invoice sometimes discontinue the service. Are they better off? That depends on what they did without. We won’t know for a long time, but probably not better off.

Good advisors ask and get answers to harder questions than people ask themselves. What is that worth. How much life insurance is appropriate? No one gets that right without help.

When exposed to an inadequate personally-designed insurance plan, a good advisor once said,

“Not planning to be dead long, are we.”

Good advisors sell common sense, experience, and the ability to deliver it. They just don’t get paid for that part. Is it in the best interest of people to be without it?

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.  In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you.  866-285-7772

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