The arguments against the Department of Labor’s fiduciary rule grow ever stranger.
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By John Rekenthaler | 02-15-17 | 06:00 AM | Email Article

Investment Calories
Technically, Gary Cohn was no longer president and chief operating officer of Goldman Sachs when he made his statement, having resigned his duties in January to become director of the National Economic Council. Thus, despite my fervent desire, I couldn't entitle this column: "Goldman Sachs: We Sell Junk."

John Rekenthaler is Vice President of Research for Morningstar.

Ah, well. It's still a doozy of a quote. Arguing against the Department of Labor's fiduciary rule, which was passed in 2016 and scheduled to be enacted in 2017, Cohn said, "This is like putting only healthy food on the menu, because unhealthy food tastes good but you still shouldn't eat it because you might die younger."

In other words, brokerage firms like Goldman Sachs that must change their practices to conform to the new rule, are doing the financial equivalent of dropping junk food from the menu. Which implies, of course, that they now sell such fare.

Well, that's a remarkable admission.

Indexing, Indexing Everywhere
Exactly what Cohn was confessing to, I do not know, because the department's rule does not directly address investment policies. Rather, the rule covers pricing: the possibility that because different investments carry different commissions, that brokers may be tempted to consider what benefits them when recommending investments. Under the fiduciary rule, that is not permitted; all sales must be in the clients' best interests.

Most likely, what Cohn means is that the rule will encourage the greater use of index funds, for two reasons. First, more financial advisors will switch from selling load funds to charging asset-based fees. As investors are much more willing to hold index funds in asset-based accounts than they are to pay a load charge when buying an index fund, the change in payment structure will likely lead to more indexing. Second, the fiduciary rule creates additional legal concerns, and indexing tends to be a safe approach for avoiding lawsuits.

Nothing new there. Indexing is already eating active management's lunch. Now perhaps, aided by the fiduciary rule, indexes will also gobble down dinner. That's good for those who manage index funds, bad for those who do not. But that shift doesn't eliminate items from the investment menu, as Cohn implies. It affects the mix of orders placed by the customers, but not the choices that are available.

Against Best Interests?
Cohn's exact meaning eludes. What is crystal clear, however, is the statement's spirit: that brokerage firms shouldn't be required to do the right thing for their clients.

To use Cohn's own words, the changes forced by the fiduciary rule will improve their customers' financial health. The shift is akin to giving up double bacon cheeseburgers with jumbo fries, in exchange for grilled fish with quinoa. Perhaps that dietary swap won't prove to be a benefit; one can eat badly, overcome the odds, and die at an old age of other causes. But the action will not harm. Nobody was ever hurt by better nutrition.

In which case, one would think, brokerage firms would automatically recommend investments that meet the fiduciary standards, even if such a rule did not exist. After all, such funds per Cohn's own words are the best for their customers' financial health, and surely that's what the brokerage firm seeks. (Right, Goldman?) The better the client fares, the happier the client, and the better for the brokerage firm's business.

Or so one would think. Cohn, however, has a rejoinder: The clients won't take what's good for them. Many people prefer the taste of double bacon cheeseburgers to grilled fish, and more prefer french fries to quinoa. (French fries, as Eleanor Belmont once said of private railway cars, are not an acquired taste.) Similarly, many if not most investors prefer exciting if less-profitable investments to bland ones.

The Analogy Fails
I don't buy that. True, some investors do like to play the market, gorging on the junk food of high-cost, high-concept funds. It's not the brokerage firms' job to prevent them from doing so, any more than it is a doctor's job to control patients' diets. The professional's duties are to inform and advise, not to police.

But such investors are few and far between. Most who eat investment junk food do so unknowingly, and without pleasure. People who order the double bacon cheeseburgers generally have a very good idea of how their purchase will taste. In contrast, those who buy bad, expensive funds typically have little idea of what they are getting. And they don't much care about savoring the experience. Most investors want nothing more than to become wealthier. Aesthetics are beside the point.

I appreciate that brokerage firms wish to meet the needs of all clients, including the ones who choose unhealthy paths. If discount brokers are permitted to execute such trades, then full-service brokers should be allotted the same freedom. Fair enough. Just have the client sign a statement acknowledging that he has been fully informed of the facts, and that according to best investment practices his trade is unwise. If customers wish to proceed from there, fine. Let them, indeed, eat junk.

A Losing Battle
The vast majority of investors, though, want only what's best for their financial health. Why would brokerage firms not wish to provide that? Why would they continue to recommend "unhealthy food" that might cause their clients to "die younger?" (Once again, these are the words of the director of the National Economic Council, not mine.)

You got me. That anybody would attempt to refight the fiduciary issue is baffling. It is the business equivalent of erecting Jurassic Park. Possibly the dinosaur will be revived, but it won't survive. The investment world is moving forward, with or without the fiduciary rule, and with or without the dissenters' permission. Because the arguments in favor of doing what's best for investors are powerful, and those against are … well, you just read about one of them. "Weak" would be putting it kindly.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

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