Skip to content

Middlemen vs. Fiduciaries

I don't think the financial planning profession could have gotten better publicity than when U.S. Senator Olympia Snowe (R-Maine) repeatedly asked Goldman Sachs executives, on TV and in full view of the world, whether they had a fiduciary obligation to their customers, whether they have a duty to act in the best interests of their clients. The Goldman people, who satisfyingly came across as arrogant jerks, responded as if somebody had thrown a cobra in their midst, suddenly turning cautious, parsing their words carefully, and repeatedly denied that they were required to meet a fiduciary standard or act as fiduciaries when they packaged shoddy loans into disastrous investments and then shorted them for maximum profit. "I believe we have a duty to serve our clients well," one said cautiously. "I believe we have a duty to serve our clients to show prices and provide liquidity," said another.

Meanwhile, the Senate hearing produced a wonderful set of e-mails sent by Fabrice "Fabulous Fab" Tourre, the Goldman trader who sold billions of dollars of hybrid securities, included a boast that he could sell shoddy subprime products, some of them to people he described as "widows and orphans." He later commented about one of the products he unloaded: "Boy that Timberwolf was one shitty deal." One has to wonder: what standard of care did this NOT violate?

But I think it's important that we, the profession, don't get too giddy about this unexpected window into the brokerage world, and don't overreach in our lobbying efforts. The brokerage world operates on two levels. On one, the companies bring buyer and seller together in (primarily institutional) transactions where there should be no obvious advantage to either party. In these transactions, the institutional buyer on one side wants to offload a certain type of risk, and is willing to pay somebody else to assume it. The middleman–the brokerage firm–has no role in telling either party that taking on or offloading the risk is a good or bad idea; it provides the environment where buyers and sellers can find each other. Personally, I think the Internet or an electronic exchange would be a more efficient, fairer (and MUCH cheaper) way for these buyers and sellers of risk to find each other, but until that day comes, we should not lobby that the fiduciary standard applies to a middleman role. It's an important part of our economy, and by the very logic of fiduciary, no firm could possibly put the interests of both parties, on both sides of the transaction, first.

Then where should we apply the fiduciary standard? When the company is selling securities to individual investors who are relying on the expertise of the brokerage firm to find investment opportunities or choose among them. We can argue that Fabulous Fab's customers–which seem mostly to have been large banks–were actively misled about the securities they bought. In that case, the regulators should handle this under fraud or nondisclosure guidelines, rather than fiduciary ones. If the people on the other side of the transaction were actual widows and orphans, and Tourre had recommended these complex instruments for their retirement portfolios, then he should be held to a fiduciary obligation.

The problem, which became obvious to the world during the Senate testimony, is that the brokerage/wirehouse world seems not to understand this distinction between acting as a middleman and serving as an advisor. Customers buy from a broker at their own risk. They are doing business with a company that will recommend stocks it no longer wants to own in its own portfolio, or IPO shares that it is paid to sell to the public even when (as showed up in the internal e-mails of several investment banks some years back) the company's analysts think the public offering is a load of crap. Rather than serving as a middleman, the brokerage firm benefits every time it dumps these "investment opportunities" on its customers. The only visible signs of caring for those customers show up in the wirehouse advertisements, which do everything they can to portray the broker as a trusted advisor–a tactic designed to make the customers less suspicious of the company's self-serving recommendations.

It is this disparity between what they say and what they do with the consuming public–with retail investors–that Congress and the SEC should explore. The current SEC chairperson seems unconcerned with enforcing the standards that the wirehouses set for themselves with their implied or explicit promises, allowing them to call themselves advisors while functioning as if they were salespeople or middlemen. I think it's time to ask her whether any advertisement which suggests that the firm's brokers are "trusted advisors" who help people "fulfill their life's goals" isn't strongly implying a fiduciary obligation, which should then become the standard for regulatory enforcement.

The Economist recently quoted from the Goldman Sachs prospectus when the company went public in 1999. The company painted itself as a white knight of the marketplace, the sort of organization that would never earn billions by shorting the shitty securities it dumped on its customers. "Our clients' interests always come first," the prospectus proclaimed. "Our experience shows that if we serve our clients well, our own success will follow. Our assets are our people, capital and reputation. If any of these is ever diminished, the last is the most difficult to restore."

Good stuff–powerful, even. I hope the SEC attorneys hold Goldman to every letter of this noble promise in the pending civil lawsuit–but under fraud statutes rather than fiduciary. And I hope consumer investors will remember the fear in the eyes of the world's most profitable brokerage firm when these masters of the universe confronted their revenue model's most dreaded enemy. Sticking their clients with billions of dollars in losses apparently didn't faze them at all. The word "fiduciary" had them running for cover.