Wealth Management
(Washington)
Markets and polls are favoring Joe Biden to win the presidency, and markets think there are increasing odds that a blue sweep could occur. So if Democrats take over, what does the regulatory environment look like in wealth management? According to legal and policy experts there are a number of key changes. One big high-level difference between Trump and Biden is that Trump has always favored a principals-based approach to regulation in an effort to lower the compliance burden on companies. Biden would adopt a more rules-based approach with stricter enforcement. Here are five key items that would likely change under a new administration: restarting the debate on Reg BI (i.e. trying to get rid of it or modify it), move towards a rules-based approach in many areas, revive the CFPB, create a public credit reporting agency within the CFPB, and replace SEC commissioner Jay Clayton.
FINSUM: All of this makes perfect sense with what Democrats are signaling. We have another key item to add to the list—killing the new DOL proposal and replacing it with a more robust fiduciary standard either through the SEC or DOL.
(New York)
Well it took seemingly forever, but it finally just happened—the merger of Schwab and TD Ameritrade has just closed after a lengthy process. It will take 2-3 years for the operational end of the two custodians to become integrated, but in a corporate sense, they are united. The deal has made many RIAs, particularly those on the smaller end, nervous. TD Ameritrade was known for its excellent service of smaller RIAs, whereas Schwab was known for the opposite. Accordingly, many fear that under the new Schwab-led company, smaller RIAs might be forgotten. The combined entity now controls 51% of the RIA market with more than $2 tn in assets.
FINSUM: This is quite concerning for smaller RIAs, many of whom are thinking of switching to Fidelity or smaller rivals. Also of note, Schwab has not formally announced what they are going to do with TDA’s Veo One platform.
(Boston)
Anyone who sell variable annuities, or even has a passing familiarity with the business, know that the headline above is a controversial one. The reason why is that the first version of the DOL rule caused annuities sales to drop. Even though that rule was vacated, it had already changed the structure of the market. However, Harvard is now saying the rule actually helped the VA industry. It says fees were lower and returns higher, that the rule did not force smaller investors out of the market, and that captive brokers put more weight on client interests. However, those in the annuity industry say the report is completely biased and that the researchers went in with the intention of proving the exact points they already assumed were true. Critics cited a number of flaws with the study, such as the methodology for calculating expenses and commissions.
FINSUM: While it is clear that variable annuity product suites, including fees and commissions, came down because of the rule, it does not seem clear that it helped everybody in general because of differing market access based on investor size.
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(Washington)
There has been a lot of speculation that with Biden leading in the polls, Reg BI may be likely to get scrapped next year. Now obviously no one has great insight into how the election will go, but according to former regulators, even if Biden gets elected, it seems unlikely the rule would get scrapped. According to a former regulator at FINRA, the SEC has both cultural and structural barriers to overturning the rule. The SEC is run by a group of five commissioners, no more than three of whom are allowed to be from one party at any given time. Furthermore, while the White House does appoint a head of the commission, the group likes to set its own fresh agenda, and therefore largely sets its own objectives. According to Thomas Selman, a former vice president for regulatory policy at the Financial Industry Regulatory Authority, to “reverse it right away, it's just not something they have an appetite for”.
FINSUM: No one is certain how this will play out. However, in our view the most likely path is not getting rid of the rule, but rather much stricter enforcement of it. The rule itself leaves much to enforcement discretion, so that seems an easier avenue than scrapping and re-creating a new rule.
(New York)
Any advisor can tell you that while Modern Portfolio Theory (MPT) has a lot of strengths, it also has many shortcomings as it relates to investor psychology. For instance, Modern Portfolio Theory asserts that multiple aims can be achieved within the same portfolio, but this does not mesh well with how investors think about money—where each account has its own life purpose. Secondly, risk is an area of major disconnect. Portfolio Theory looks at risk in terms of historical standard deviations of volatility, whereas humans think of risk in more life-relevant terms: what I my portfolio does earn enough to pay for my child’s tuition? This is where goals-based investing comes in, as it focuses on how portfolios can be constructed—and reported on—in such a way as to match investor psychology about the life goals they are trying to achieve.
FINSUM: MPT has been revolutionary for quantifying risk and return profiles, but for many it simply does not resonate on the “human” level needed for some advisors to motivate and connect with their clients.
(Washington)
Reg BI was technically implemented three months ago, but it is still a little bit of an unknown quantity. More than just the shortness of its tenure, the fact that the SEC has explicitly said it is going to be light on enforcement during COVID means the pace of adaptation and understanding has been slower. Well one interesting aspect is emerging—the rule seems to give brokers a huge legal advantage when they get sued. According to a panel of top industry lawyers, the “informed consent” part of the rule means that Reg BI essentially creates a buyer-beware trap for clients. This will make it very hard to prevail over an advisor in a dispute. According to a law professor at Georgetown “If you take the recommendation, that becomes consent … The commission uses words that will live a long time on the defense side. When there has been full and fair disclosure, informed consent is present where the customer affirms by accepting the recommended action”. The language of the rule is claimed to be so obtuse that most clients will never read or understand it.
FINSUM: This was hinted at by those that opposed the real, but the scale of the advantage for brokers is only now being realized. That said, the effectiveness of Reg BI will largely come down to enforcement, which will likely shift over time.