Nicole Boyson has been a professor at Northeastern University since 2004 where she teaches and conducts research in areas such as investments and corporate finance. She joins us today to discuss her research on fiduciaries and brokers, particularly on financial advisors and potential conflicts of interest.
Listen now and learn:
- Common conflicts of interest in the investment space
- The evolution of various conflicts, including where we are today
- A simple method for determining if a financial advisor is dually registered
Watch, listen, or read the detailed show notes below.
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Show Notes
In this episode, I’m joined by Dr. Nicole Boyson who has been a professor at Northeastern University since 2004 where she teaches and conducts research in areas such as investments and corporate finance. In our conversation, we discuss her research on fiduciaries and brokers, particularly on financial advisors and potential conflicts of interest.
Here are my notes from our conversation.
1:07 – Nicole‘s Background
After completing graduate school Nicole went to work in the hedge fund space focusing on risk and return, eventually moving on towards hedge fund activism. During her journey, she gained experience in commercial banks in which she realized most investors lack experience and knowledge.
Eventually, Nicole worked for a smaller investment advisory broker that sold mutual funds and ran a pension business on the side. It was here that she began to realize how complicated mutual funds were in their pricing structure.
But as she began doing more research, she realized that it wasn’t just fund structures that were complicated, but also that different types of advisors were more complicated than she first realized. That’s when she began her foray into becoming an expert on what it means to be a fiduciary and thinking about whether investment advisors are acting in a way that serves their clients well.
4:50 – Different Types of Advisers and Conflicts of Interest
Nicole has an excellent summary of her paper on conflicts of interest here on Twitter that I encourage everyone to check out. If only all academic research were summarized this way!
While advisors have certain conflicts, they can be properly managed with honesty and transparency. But advisors known as dual registered advisors face some specific conflicts that are harder to manage. About 80% of fiduciary (aka registered investment adviser, aka RIA) assets are managed by these dually registered firms acting as both brokers and fiduciaries.
Here is a list of the top 10 dual registrants from Nicole’s research.
While acting as an advisor, you charge your client based on a percentage of assets under management but working as a broker you can earn a revenue from funds that you recommend through a process called revenue sharing. Revenue sharing is the split of profits to the broker from the fund for recommending their product, acting as a form of commission.
This creates a conflict of interest when acting in both roles because although a specific fund may not be the best option for your client, the firm will make profits by recommending it. A related issue is that brokers often have a “Preferred Funds” list for funds that participate in revenue sharing. This leads many advisors to favor these funds, rather than the multitude of other options out there.
Not only do these practices create opaqueness of how advisers and their firms are compensated, but these processes can also cause a “double dipped fee” meaning you will be charged a percentage for the advice, and a fee from the fund, which is often undisclosed.
As you can see in Nicole’s research, Dual RIAs charge higher fees than independent RIAs and the revenue sharing share classes they use underperform share classes that do not share revenue.
11:34 – The History of How Assets Shifted from Commission-Based to Fee-Based
Merrill Lynch started fee-based practice in 1990 as clients were wanting to trade more and more on their account, but didn’t want to pay the high commissions associated with frequent trading. They called it a wrap account and allowed clients to trade as much as they like for fixed fee rather than per trade fee.
Independent RIAs began to get annoyed with the dual registrants since there was not much regulatory language. This allowed these brokers to appear as fiduciaries based on their fee structures. Eventually the Financial Planning Association (FPA) sued the SEC in 2004 and won their case in 2007. The result was that brokers charging asset-based fees had to either start an RIA or shift those clients into RIA accounts.
This caused a huge shift in assets to RIAs, but also a huge spike in dually registered firms.
Interesting timing because of the Financial Crisis. People fired their broker for RIAs. There was also a growing amount of evidence, or at least awareness, that active management generally loses to passive management.
18:11 How to Figure Out If Someone Is Dually Registered
To determine if your advisor is dually registered, you can look to places online. The first is FINRA’s website called BrokerCheck, which allows you to find basic info on the advisor such as how long they’re been in business, disciplinary history, and other basic information.
The second place is the SEC’s website called Investment Advisor Public Disclosure (IAPD), which gives you access to Form ADV and Form CRS.
The Form CRS must clearly state whether the advisor is dually registered or not.
24:17 – Regulation Best Interest
Regulation Best Interest (Reg BI) was supposed to address some of the really bad practices in place on the brokerage side when brokers were able to adhere to the suitability standard, which is a bare-bones minimum of client care.
I’ve written in the past about the difference between the fiduciary and suitability standards, and I think the example I give makes the differences easily understandable.
Reg BI supplants the suitability standard in the brokerage side of the world, but it stops short of requiring brokers to act as fiduciaries. Making things more confusing is the definition of “fiduciary” includes the words “best interest,” so this new standard arguably adds to the confusion consumers face.
On the plus side, Reg Bi took away some unsavory practices in brokerages, such as a “sales contest” between employees to sell the most of a certain fund (usually a fund that was super expensive).
Another positive of the regulation is Form CRS, which stands for Customer Relationship Summary. The idea is to create a short form that helps potential clients make an informed decision. But the downside is that the form is so short that it doesn’t do much to clear up the difference between financial professionals.
Overall, Reg BI did not force brokers to adhere to a much different standard. It helped mitigate conflicts, but was far from eliminating many questionable practices.
29:28 – What Regulatory Changes Would Help?
Nicole talks about the SEC’s share class disclosure initiative, which forced dual registrants to more openly disclose their 12b-1 fees and how it worked particularly well. The thing about disclosures is that nobody really reads them and those that do are unlikely to fully untangle all the confusing language.
Nicole believes the SEC should go after revenue sharing in a systemic way as they did with the disclosure initiative.
36:59 – Nicole’s Book Recommendations
- The Geometry of Wealth by Brian Portnoy – Suited for beginners
- The Little Book of Common Sense by John C. Bogle – Suited for beginners
- Thinking Fast and Slow by Daniel Kahneman – Investor Behavior
- A Random Walk Down Wall Street by Burton Malkiel – More technical approach
- Just Keep Buying by Nick Maggiulli – Data and Research driven approach
39:30 – What Does It Mean to Be a Long-Term Investor?
Nicole thinks about your money and investments in a holistic way. It’s not just about buying one fund or another, it’s thinking about where she is right now and what she needs.
For example, she wants to make sure her kids are financially stable. She wants them to be able to go to college and maybe help them with the down payment on a house or maybe a wedding or something like that.
Another goal is to retire. You may not know all the exact details about when and what retirement looks like, but being a long-term investor means planning out so that you balance enjoying life while making sure you’re saving enough.
And because her house is such a big piece of her net worth, Nicole feels like that can’t be ignored even if it’s more of a consumption item than a true investment.
Connect with Nicole:
- Nicole’s Website
- Nicole is also very active on Twitter at @nikir1
- Here is her Twitter thread outlining many of the things we discussed in this episode.
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