Season Investments

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A Very Simple Principle

Posted on April 12, 2016

“It's a very simple principle: You want to give financial advice, you've got to put your client's interests first.” – President Barack Obama 

2016-04-12_salesman.jpgUnless you’re in the financial industry you probably haven’t heard much about the Department of Labor’s recent regulatory changes regarding the application of the “fiduciary” standard to brokers and advisers serving retirement clients. While this probably isn’t a topic that carries much intrigue for you, there are aspects of it that are incredibly important for consumers to be aware of so we wanted to provide a concise overview of the key points. 

Historically financial advice has been delivered via two separate and distinct models: we’ll call them the “adviser” model and the “broker” model. Advisers, governed by the watchful eye of the Securities and Exchange Commission (or similar state regulators), charge their clients an agreed upon fee, typically based on assets under management, for consultative advice and the discretionary management of their investment assets. Brokers, on the other hand, are governed by the Financial Industry Regulatory Authority (“FINRA”) and typically make their money by earning commissions tied to the sale of financial products such as front-load mutual funds, annuities and insurance policies. The first model could be seen as relational, while the second model is more transactional. 

An important distinction between the two models has always been the standard of care imposed by governing law. Advisers have always been held to a fiduciary standard, meaning they have a duty of loyalty and care that requires them to place their clients’ interests above their own and to always act in a way that is in the best interest of the client. This is a pretty straightforward standard, and anyone in their right mind would expect this from their professional adviser. 

The broker model, however, is subject to a suitability standard rather than a fiduciary one. An article on Investopedia highlights the difference well, 

Instead of having to place his or her interests below that of the client, the suitability standard only details that the broker-dealer has to reasonably believe that any recommendations made are suitable for clients, in terms of the client's financial needs, objectives and unique circumstances. A key distinction in terms of loyalty is also important, in that a broker's duty is to the broker-dealer he or she works for, not necessarily the client served.

There is a key difference between an investment being considered “suitable” and being considered “in the best interest” of the client. Another way to think of this is that a broker really just has to determine that the investment isn’t unsuitable for a particular investor…a highly subjective and incredibly low hurdle to clear, especially when there is a large commission to be earned. As the Department of Labor itself said, “…loopholes in the retirement advice rules have allowed some brokers and other advisers to recommend products that put their own profits ahead of their clients' best interest…”

In his article written for Fortune, Josh Brown (who we’re a huge fan of), put it this way: 

Under the current compensation regime, even the best intentioned brokers are continually put in a situation where what’s best for their own paycheck is not always what’s in their clients’ best interest. Brokers are routinely compensated the most heavily for selling the products that cost their clients the most in fees and lost performance. 

The notion that an investor needs to pay upfront fees in excess of 5% to buy an A-share mutual fund from a broker is laughable to anyone with even a passing familiarity with the modern-day options that exist. 

In short, the broker model creates tremendous financial conflict of interest that simply isn’t present in the adviser model. A great example of this can be found in the private REIT investments that have performed so well for our clients over the past five years. The vast majority of these REITs are actually sold through brokers who earn a whopping 7% up front commission. The client pays $10 per share, and $0.70 immediately goes into the broker’s pocket. When the exact same investment is offered by us to our clients, however, the 7% commission is simply waived and our clients get to buy in at $9.30 per share. We don’t have any financial incentive whatsoever to recommend the investment versus anything else our clients could invest in…our only aim is to do a good job for our client. 

This brings us back to the recent changes introduced by the Department of Labor. Among a sea of detail and nuance, the key point of the new regulation is to finally extend the same fiduciary standard known by advisers to the broker community as well. This new regulation has been years in the making, and not surprisingly has been met with strong opposition from a variety of fronts. There are many different aspects and angles to this issue that have to be considered, but most analysis at this point suggest the Department of Labor did a fantastic job of considering all sides and putting forth a balanced and rational law that moves things in the right direction without creating a new set of issues. 

This doesn’t mean everyone is happy about it. Not surprisingly, many in the brokerage community are wringing their hands over the necessary changes that will need to be made to their current business model and compliance practices. Surprisingly, the regulation is also facing severe criticism from Washington, and particularly from well-known Republican congressman Paul Ryan. Although we generally like Paul Ryan and agree with many of his positions, his main complaints are off base and misinformed on this issue in our opinion. Again, we would point to Josh Brown’s Fortune article as a great explanation of why. We specifically agree that the millions of Americans with modest retirement account values have far superior options available to them (via index funds, robo-advisors, etc) than getting sold any number of financial products laden with unnecessary fees and expenses. 

When we formed Season Investments in 2011 we decided from day one that we would work hard to avoid the plethora of financial conflicts of interest so pervasive across our industry. We get paid via an asset management fee beyond which we never receive any commission, trail, load, soft dollar or kickback of any sort whatsoever. In fact, we don’t even have the necessary licenses to receive such compensation. Additionally, as CFA charterholders we are held to a standard of ethical and professional conduct that is seen as the gold standard across the investment advisory industry. 

As advisers, our interests are in perfect alignment with our clients. It’s in our best interest to keep our clients’ best interest at the forefront. The more successful we are for you, the more successful our business will become. Those who know us personally will attest to the fact that we are in this to help people, not build our own personal kingdoms. We applaud the Department of Labor for the changes it’s implementing, as in our personal experience they are much needed. And while we agree with the DoL’s assertion that “Many advisers already put their customers' best interest first”, we only hope to see that number grow in the future.


david_headshot_bw.jpgAuthor David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.


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