You Cannot Regulate What You Don’t Understand

Last week a comment on an article about financial regulation expressed the thought that regulators should have appropriate licenses and have experience in the industry.  Without that, they tend to miss important elements.

Regulation with no standard of comparison won’t work. Let’s look at three levels of behaviour either in force or proposed.

Suitability

The product or procedure recommended is suitable given the client’s situation, expectation, resources and knowledge. Suitability does not necessarily provide the greatest value to the client, it provides an answer that deals with their situation.

For example, term insurance is a poor product under some circumstances. If it is used to supply money to pay taxes at the end of life, whenever that may happen, it is weak. Ten year renewable term insurance becomes increasingly expensive as the client ages and it  is designed to expire, on average, before the policy owners.

At the other extreme is a young person with small children and many financial obligations being met out of a small income. Permanent insurance with high cash values and large payouts on death, whenever it occurs, won’t work because the premium is too high.

It doesn’t matter what the long run looks like if you cannot afford the short run.

Best Interest.

Best interest is clearly more stringent than suitability. The example with term insurance and suitability would be applicable here too, but you better have documentation and you better have attended to the client after the sale to discover when the term insurance stopped being suitable.

Best interest implies a more general condition. Something appropriate under either standard stays that way under suitability and does not under best interest.

The risk in best interest is the conditions change.

Best interest can be narrow or global. Term insurance for a young person is narrow. The regulations seem not make a distinction and global is the default. In a complex changing world, managing an interface for complex changing people is impossible, but the regulations are more rigid, or at least that is the fear.

How will a judge decide 15 years from now? Keep careful and complete records. Relate to the situation, the client’s assessment of it and how you might see it changing in future and what would you do then. Clients benefit from the 3Rs of record, review and revise and so will advisors.

If you do not do reviews, you cannot meet the best interest standard.

Fiduciary

According to investopedia, fiduciary means — Essentially, a fiduciary is a person or organization that owes to another the duties of good faith and trust. The highest legal duty of one party to another, it also involves being bound ethically to act in the other’s best interests.

That is too general to have meaning. Without the narrow vs. general idea of best interest, no chance of complying. Owing good faith and trust are nice sounding words, but what do they really add to a normal business relationship?

Good faith and trust should be a given and the relationship should demonstrate their presence. You cannot define them in a specific way.

For example, does good faith demand and include competence? An advisor can be trustworthy, operate to their idea of best client interest in the relationship, and be incompetent, all at the same time. Regulators generally expect licensing to guarantee competence, but that is worse than silly. All advisors are not equally competent. None are necessarily competent all the time and with any client.

Skilled clients operating with knowledge of their own best interests, products, and markets would solve the problem, without regulations. The egregious offenses are already dealt with under laws that have been in force for decades, even centuries.

So what does the layer of regulation add?

Probably nothing, except for:

  1. A huge cache of paper. The paperless society is now a nostalgic memory.
  2. Fewer advisors because we old guys will just go away
  3. Fewer clients with access to an advisor, because no smart advisor will put up with clients with unreasonable expectations, insufficient knowledge or shared loyalty.
  4. Clients must know more to recognize the level of service they receive now. Advisors will invoice clients for services not related to insurance and investment management. Only sophisticated clients will pay those. Advisors must begin to make their commissions transparent, but also what they do for them.

Regulation benefits regulators and hardly anyone else.

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.  don@moneyfyi.com  866-285-7772

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