Though It Pains Me To Say It, Obama’s Recommendations For The Brokerage Industry Are Surprisingly Sensible

Prepare yourself, for the end of days must be nigh: I actually agree with President Obama on something regarding financial regulation.

Now, I say this fully understanding that the President, if he had his way, would probably round up everyone in my line of work and lock us away in Guantanamo for the rest of time. Mr. Obama is no fan of Wall Street…or bankers…or brokers…or money managers…or for that matter, their high-income clientele. But for once, we find ourselves on the same side of an argument.

In a speech to the AARP this week, the President proposed that brokers who manage retirement savings account be required to disclose how they get paid…and by whom.

All I can say is, it’s about time.

In his speech, Obama said “These payments [that brokers receive for selling products], these inducements incentivize the brokers to make recommendations that generate the best returns for them but not necessarily the best return for you.”

Obama went on to suggest holding brokers to the same fidiciary standards currently required of investment advisers. Rather than just determine “suitability” based on age, income and wealth and risk tolerance, brokers would have to–gasp!–act in their clients’ best interests when managing their retirement accounts.

On both counts, I agree completely.

Most investors do not know the difference between a stockbroker and an investment advisor representative. Without bogging you down in industry jargon, I’ll spell it out for you as simply as possible: A broker sits across the table and sells to you; an advisor sits on your side of the table and buys for you.

In one arrangement, the client is a target for short-term gain. In the other, the client is more akin to a patient you’re trying to help. It’s not semantics; it’s a very different mindset.

The old stockbroker model is what gave Wall Street its (much deserved) bad name. You saw the movie The Wolf of Wall Street?

Yeah, Jordan Belfort was a stockbroker, not an investment adviser representative. He made millions by selling low quality stocks that generated the highest commissions. The “best interests of the client” was a concept that would have been completely foreign to him. It would have literally never crossed his mind.

Are all brokers the degenerate trash portrayed in Wolf? No, of course not. But the brokerage model does incentivize a wanton disregard for the client. And it’s not just stocks. In fact, the commission model for stocks went out of fashion years ago, but unfortunately, it is alive and well in products like variable annuities (see “Why I Hate Annuities”).

I can’t tell you how many clients have come to me with variable annuities they wanted to dump. Nearly every time, I’ve had to explain to them that doing so would result in surrender charges equal to 7%-10% of their investment. That 7%-10% represents the fat commission that went to the broker that sold them the annuity, something that probably wasn’t disclosed or was buried so far into the small print that no one ever sees it.

President Obama is absolutely right in proposing that investors be made aware of how their broker or advisor is compensated and by forcing a higher fiduciary standard on brokers.

In fact, I would argue that his proposals didn’t go far enough. If he wanted to be truly revolutionary—and really get under Wall Street’s skin—he would have proposed outlawing the commission-based model altogether.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.