“If we can’t rip off small investors, then to hell with them!”(1)

Bureaucrats have a bad name, and rightly so if you ask me. All too often they are at best a necessary evil. But every so often a remarkable exception arises, a bureaucrat so principled, so courageous, so morally determined to rescue hapless citizens from (whatever) that our faith in government bureaucracies is restored. At the US Department of Labor, that person is Phyllis C. Borzi.

Ms. Borzi took one look at the regulatory regime I outlined in my last post and said to herself, “By gad, if the SEC won’t do anything about this abomination [hello, the SEC created it], then I, Phyllis C. Borzi, will!” And damned if she didn’t, despite being hounded to within an inch of her life by the likes of Goldman, Morgan-Stanley, Merrill, the entire Republican Party, etc., etc. As my loyal readers know, I’ve offered to marry Ms. Borzi, even though I’ve never met her, but she isn’t responding. (Hello PB, did you lose my number?)

Unfortunately, Ms. Borzi is only one of 17,449 bureaucrats at DOL and the others are…, well, see below.(2) Let’s just say that between the time the new stockbroker fiduciary rule left Ms. Borzi’s happy desk and the time it was promulgated by Arch Bureaucrat Tom Perez (who is also DOL Secretary), very bad things had happened to that rule. For example:

1) If it’s true that brokers are ripping off the public to the tune of $17 billion/year, as President Obama says, then you might naturally suppose the new fiduciary rule would go into effect toot sweet, as the French say. You might even suppose that the damn rule would be made retroactive to 1934, when the Securities Exchange Act was passed. But the brokerage firms howled to the high heavens. “For God’s sakes!” they cried, “Our guys (and gals) have been ripping off the public for generations! You can’t expect them to stop on a dime!” The rule will become effective in 2018.

2) It’s not DOL’s fault that they only have jurisdiction over retirement plans, but that means that brokers can keep ripping people off on their personal assets. In case you’re wondering why the SEC doesn’t do something about this, I can answer the question in two words: regulatory capture.(3)

3) The new fiduciary rule is completely unenforceable. The redoubtable Ms. Borzi didn’t just fall off the hay wagon, so she knew that your typical IRA owner is no match in litigation or arbitration with multi-billion dollar brokerage firms. She therefore required that the rule be incorporated into the engagement agreement with the client. That way the aggrieved investor would have a simple breach of contract action, something even the dumbest plaintiff’s lawyer in Missouri could figure out. But when AB Perez promulgated the rule, this provision had mysteriously gone AWOL.

4) Investor rip-offs don’t materialize out of thin air, they result from particular practices that skew brokers’ incentives in the rip-off direction. I refer to practices like charging commissions, accepting sales loads on investment funds, pushing proprietary products, fee-sharing arrangements – the sort of activities that are anathema to true fiduciaries, like RIAs. But AB Perez’s rule as promulgated specifically authorizes all these practices! (I’m not making this up, folks.)

5) Maybe worst of all, the DOL has done the dual-registered monsters one better: now all the brokers in the country can walk into prospect meetings shouting, “Before you even ask, the answer is, ‘Yes! I’m a fiduciary!’” Hapless investors, who formerly had trouble differentiating brokers from RIAs, are now being asked to tell a true fiduciary from an ersatz fiduciary. No wonder that, as soon as AB Perez started promulgating the rule, stock prices of brokerage firms went up.

As I wrote in a related post two years ago, “prepare to be ripped off.”

(1) This is, believe it or not, the brokerage industry’s objection to the fiduciary rule. Put in nicer words, they argue that the rule would raise costs so much (presumably through increased compliance costs(!)) that brokers wouldn’t be able to work with smaller investors on a profitable basis and so would dump them as clients.

(2) As Caltech astronomer Fritz Zwicky would put it, they are all spherical bastards. The good professor meant that they were bastards any way you looked at them. See Brian Greene’s The Fabric of the Cosmos, p. 294.

(3) That is, two words not counting this footnote. “Regulatory capture” refers to a situation in which the regulator has been captured by the industry it’s supposed to be regulating and therefore the regulated are actually regulating the regulators.

Next up: It’s Inflation, Stupid

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Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.