THE BULL SESSION: Investors should expect, deserve transparency

I think it was Warren Buffett who said,“When the tide goes out, you get to see who still has their pants on.”
Well, there is no doubt that the tide has gone out on the equity markets and there have been quite a few major figures that have lost their pants – Madoff and Stanford as of late, Ebbers and Enron just a few years back.
These were people and companies that we were supposed to be able to trust, but they let us down. It’s not hard to earn trust in an up market. When investors are making money they don’t tend to sweat the details.
Trust is important, but it is over-shadowed by the reality of a profitable market. When investors count on the trust of their adviser is when things aren’t going so well. When their financial life is on the block they need to know that we advisers are looking out for their best interest. That is where we are having a problem.

Who can you trust?
Investors have a hard time knowing that they can trust us. It’s confusing.
Back when I started in the business, my business card said stock broker. I traded securities for my clients, and I made money either from the commissions on the trade or from the product I sold. That’s what stock brokers do. Insurance salesmen sold insurance, CPAs worked on your tax issues for a fee, and bankers managed your deposits and loaned you money.
Now every one of those industries can have someone working for them who has a business card that says they are a financial adviser or a consultant.
Unfortunately, for the most part, many of the roles haven’t changed. Stock brokers still trade for commissions, insurance salesmen still get paid by the product, and now almost everyone else can sell products to the investing world.
The investing public isn’t used to having accounting firms sell investment products, and it is confused by the role of the banks. Many readers I have talked with are confused about what is covered by FDIC insurance at the bank.
What has made the situation worse is that different groups have different standards of care when working with a client.
The standard of care for Series 7 registered advisers is that they must know their client and cannot sell anything to a client unless the client has the financial wherewithal to handle it.
But the standard doesn’t say anything about the appropriateness of the product. The problem isn’t that we have a bunch of financial representatives that are out there trying to sell inappropriate investments to their clients.
I was in that part of the business for years and most of the representatives I know try very hard to put their clients in appropriate investments. Sometimes it is difficult to know what the appropriate investment is, and if your firm is not required to live up to a standard of care that requires appropriateness, then the water can get a little murky.
Don’t get me wrong, we need the major wire houses and brokerage firms. They are the place where new securities and investments are created. They have been responsible for a lot of good as well as some bad ideas over the years. But once they create something, they have to get out there and sell it to the investing public.
They do that by paying their sales force to promote their product. That product promotion is different from consulting and advising. Yet the investment world has a hard time understanding the difference. It is very difficult to figure out expense ratios, front end loads, back end loads, no loads and level loads.
It’s even more difficult for clients to know if that new emerging market bond fund is a good addition to their bond portfolio because of the low correlation to U.S. bonds even though the standard deviation looks pretty high.
The least we can do is let clients know where our allegiance lies. If we are getting paid by the product, let’s make sure they know how and how much. If our company has brought a new product to market, let’s make sure they know.
We build trust by being transparent and that is something we are having a bit of a hard time with these days. Clients should demand to know what their “advisers” get paid and how they get paid.
They should be familiar with the standard of care to which their advisors are held. And we, as an industry, should do a better job of making that distinction apparent at the beginning of a relationship.
No secrets, no surprises. It’s what you deserve.

Scott Reed is CEO of Hardy Reed Capital Advisors in Tupelo.

Scott Reed

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