The Investment Scientist

Who Should You Trust

Posted on: September 8, 2010

[Guest post by Tom Warburton] Almost every single day a buddy calls us to discuss the “Investment Pornography” coming from the brokerage houses or from the mouths of the talking heads on CNBC.  Last week was different – almost all of our buddies only wanted to talk about Goldman-Sachs and the Senate Hearings.
The crux of the issue was proffered by Knut A. Rostad, Chairman, Committee for the Fiduciary Standard.  His quote from Wealth Manager “Goldman Sachs, Suitability and the Fiduciary Standard”, April 21, 2010
“The Case Highlights The Wide Gap And Opposing Roles Of A Broker Who Is Permitted In Law To Further His And His Firm’s Interests At The Expense Of Customers, And A Fiduciary Who Is Required In Law To Put His Clients’ Interests First. This Is At The Core Of Why The Fiduciary Standard Is Important.”
To hear Lloyd Blankfein, Goldman Sachs CEO, tell it, the financial markets did their job.  Absent the unfortunate downturn in the housing market, everything would have been just fine.

In the heated Senate Subcommittee hearing held on April 27th, the Goldman CEO argued that Goldman sold people the risk exposures they wanted and were never obligated to disclose that the collateralized debt obligations (CDOs) they were packaging and selling to their clients were the very same investments they were betting against (selling short) in their own accounts.
So – we get to the heart of the matter:

  • Did Goldman have the obligation to disclose their view to their clients?
  • Was Goldman wrong to sell investment vehicles they secretly and frequently cited in emails as being garbage (expletive deleted and replaced)?
  • Did Goldman break the law by not disclosing a conflict of interest – their negative view of products they were selling?

It’s difficult to justify the corporate behavior that played into the downturn.  Blankfein’s $9 million bonus, in part the result of the garbage (expletive deleted and replaced) assets Goldman sold and shorted, is uniquely difficult to rationalize since it occurred in the same year when millions were losing their jobs and their homes.
Again, at the heart of this matter is ‘what are Goldman Sachs, JP Morgan, Merrill Lynch, Wells Fargo, Smith Barney, Edward D. Jones, AG Edwards, Charles Schwab, eTrade and the dozens of other brokerage firms permitted to do under the standard of suitability’?
The SEC asserts that Goldman’s conduct was not permissible.  Blankfein vociferously disagrees. The outcome may rely on answering this question:

Is Selling A Garbage (Expletive Deleted And Replaced) Investment Illegal Or Just Immoral?
If the SEC determines it’s illegal, Goldman and the other Brokerage Houses have a big problem.  If it’s immoral, investors have a big problem.
There is a solution:
Seek The Advice Of A Fiduciary
Fiduciaries are required to act with undivided loyalty to their clients. They are required to disclose how they get paid and reveal any corresponding conflicts of interest.

Knut Rostad’s Committee for the Fiduciary Standard states the five principles of fiduciary standard, as follows:

  1. Put the client’s best interest first.
  2. Act with prudence; that is, with the skill, care, diligence and good judgment of a professional.
  3. Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts.
  4. Avoid conflicts of interest.
  5. Fully disclose and fairly manage, in the client’s favor, unavoidable conflicts. 

These are noble aspirations which many brokerage houses would like you to believe they adhere to until they are pressed on the issue as Blankfein was in his January, 2010 SEC hearing in which he stated, “We are not a fiduciary.”  He added that Goldman must “fully disclose what an instrument is and be honest in our dealings, but, we are not managing somebody else’s money.

Unlike a brokerage firm, Warburton Capital is a fiduciary.  We manage our clients’ assets.  We willingly accept the responsibility to put our clients’ best interests above our own.  We make investment recommendations that are in the best interests of our clients and their ability to take on bond or stock market risk.

At Warburton Capital we accept this fiduciary obligation.  We receive no revenue sharing and no incentives to recommend one mutual fund or investment over another.

If there is one fundamental lesson that investors can learn from the recent Senate Subcommittee meeting, it is this:
Work With A Fiduciary Who Accepts The Fiduciary Responsibility
And Puts Your Best Interests Above Their Own.

Always enjoying chats with our buddies, we remain

2 Responses to "Who Should You Trust"

100% agree but hardly any investors are aware, or even have the knowledge to ask, whether or not their advisor is operating under a fiduciary standard of care.

Fortunately, content like this will help with this battle.

More and more content like this needs to get out to the investors. They need to be educated. So many of them don’t even want to take the time unfortunately. What do you think about a certificate or designate for financial due diligence?

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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