In mid-2017 the US Department of Labor finally, after several clunky attempts beginning in 2010, implemented a “Fiduciary Rule” or “Conflict of Interest Rule”, governing financial advisors’ behavior when dealing with a client’s retirement accounts. In broad terms, this rule required advisers to act in their client’s best interests while putting their clients’ interests above their own; requiring transparency on how advisors received payments for services. By March of 2018, this rule had been vacated by The Fifth Circuit Court of Appeals, deemed to have overreached in its provisions to protect the average investor. Thankfully, this is not a discussion of the appropriateness, validity, or history of that rule. Instead, I would like to discuss something a bit more in our control: Trust.
Why was the “Fiduciary Rule” deemed necessary by some in the first place? Because there are bad actors in every industry – every walk of life, and regulators work to protect those they feel will be most at risk to those elements. The capital markets involve money, and perhaps by definition, attract many a bad actor – but they certainly don’t have a monopoly.
One hot summer night in Austin long ago, I was approached by a young, desperate-seeming, but well-groomed couple asking for $20 for gas money, as they’d somehow run out of both gas and money on their way to Corpus Christi. Having just fallen off the turnip truck, I happily contributed and wished them the very best of luck on their journey as I trundled off into a restaurant. As it happened, some three months later when meeting friends at a restaurant not too far from the previous, I encountered this wildly unlucky couple again, having suffered the same unfortunate, yet similar, chain of events.
We at Altus are also no strangers to those with ill intent, and despite our experience with such, have fallen victim to them on occasion. One such individual went so far as to proudly display a new shipment of windows received to our construction supervisor, only to return them to the store in which he’d gotten them, pocket the funds, and vanish. These examples are pretty straightforward and easy to understand, but sometimes it’s not so obvious. The investment arena can yield a cornucopia of such examples. One such example, relayed via Bloomberg columnist Matt Levine:
The Kuwait Investment Authority, a $700 Billion sovereign wealth fund, hired State Street, a giant bank and financial services company, to transition (exchange) its entire bond portfolio. State Street agreed to perform this service for no fee. Do you think State Street was going to make zero dollars on this set of transactions? Did the sovereign wealth fund think that? If they did, they shouldn’t have. As State Street processed trades in the portfolio valued in foreign currency, they thought it best to route those FX transactions through State Street’s own desk, which unsurprisingly resulted in massive spreads on those transactions (i.e. profits for State Street), landing the heads of this activity in prison some years later.
Even the most sophisticated investors can be duped by bad actors – this isn’t simply a problem solved by intelligence, education, and sophistication. Instead, as Malcolm Gladwell puts it in his book “Talking with Strangers”, what we’re really wrestling with is our predisposition to “default to truth”. When faced with a conflict/conundrum not quickly resolved by available fact, we assume the person relaying information to us is telling us the truth. Bernie Madoff’s massive Ponzi scheme raised red flags with a number of brilliant and educated investment industry professionals – but when faced with the possibility that someone with the cachet and influence of Madoff could really be running a giant fraudulent empire, they all assumed something other than the worst. They “defaulted to truth”.
But how could we do otherwise? This is Gladwell’s point. We are social animals that thrive off cooperation with our fellow man to accomplish incredible things. The cost of sacrificing our ability to function socially, just to protect ourselves from the possibility of being duped occasionally, is too great a cost to bear. We know bad actors exist and we know we can’t protect ourselves from every violation of trust (and can’t expect regulation to do it for us), so what do we do? More specifically to this medium, what do we do when investing our hard-earned capital?
Here are a couple of suggestions:
1. If someone is performing a professional service for you and not charging you for it, then they are most likely making money somewhere else. You should figure out where that is, and make sure you’re ok with it.
We all need to make money, and we want those we work with to be properly compensated for the work they do, the risk they take, and the effort they put in. If no fees are being charged, red flags should go up. I could use the recent trend of zero commission on stock trades as an example. But I won’t.
2. Considering what a lack of transparency and bad actors can cost you, trust is an invaluable currency. Put in the effort to build it, keep it, and use it for the greater good.
Here at Altus, we are constantly at work broadening our networks of brokers, lenders, investors, experts, etc. But despite this, or because of it, we continually circle back to those we’ve worked with in the past. We place special emphasis on those we’ve had great experiences with, those whose expertise have been honest, straightforward, and easily shared. Many have saved us certain heartache by a word of wisdom or caution. We simply wouldn’t be where we are today without those we trust. We all get entranced by the “shiny things” every now and again, but please don’t let it be at the expense of deep, meaningful, relationships – even when investing.
A “Fiduciary Rule” or something similar might give some recourse against those who acted with ill intent or provide an avenue for appropriate punishment for the one who acted against your interests. But it’s a poor substitute for working with those you trust, who have “skin in the game”, and act transparently about their intentions with everyone’s interest in mind. In Nassim Nicholas Taleb’s book of that same name (Skin in the Game), he writes “No friendship without trust, no opinion without consequence, no wealth without exposure. Nothing without skin in the game”. No legal precedent nor safeguard can legislate away risk, nor can it take the place of mutually beneficial relationships between those whose success and long-term goals are linked. Now, as much as ever, it behooves us to invest – invest the time, effort, and energy – to build time-honored, trusting relationships in our communities, families, support networks, work-lives, relationships, and yes, even investments. There is no substitute. Trust is paramount.
About the Author: Andrew Eicher is the Director of Acquisitions of Altus Equity Group Inc., responsible for sourcing new investment opportunities, as well as performing a multitude of supporting functions to bring each investment to fruition. In his previous life, he served as Director of Operations for a securities broker-dealer, giving him a broad view of securities, investors, regulations, and markets. Andrew has spent the last two decades in the investment world, researching, transacting, and supporting a broad array of investment vehicles, approaching each from perspective of financial responsibility. He can be reached at firstname.lastname@example.org.