Solving The Biggest Problem w/ the DOL Fiduciary Rule

Hello everybody, this is David Trainer, CEO of New Constructs. Thanks for coming to our webinar today on DOL Fiduciary Rule solutions. I want to start just with a quick shout out to Michael Kitsis, who recently featured our op-ed on MarketWatch on this subject. supporting our perspective that the hardest part of the fiduciary rule is really about identifying or really defining what diligence means. And that's what we're going to spend time talking about today, because in my, you know, in my humble opinion, the hardest thing or the most difficult aspect of the fiduciary rule is understanding how to, how to implement it. And that's based on my, my discussions with individual advisors, very senior people at some of the largest wealth management firms in the world, consultants that work with wealth management firms, independent advisors, RIAs, as well as some of the key head of regulation type people at some of the largest information platform providers in the business. And so what we're going to talk about today is really focusing on what does it mean to be a fiduciary, what does that mean to the marketplace, and How in the heck are we going to do that as advisors? How does that— how do we make that happen? Because I don't think it's an easy answer, and a lot of it has to do with technology. But let's first kind of set the landscape here, because there are a lot of questions out there with respect to the fiduciary rule. The first one is, will the new rule stand? And the point that I've made, the point that Michael Kitces has made, the point that some of the top minds in the wealth management space have made over and again— Downtown Josh Brown, many others— is that no matter what the law says, you can't put the fiduciary level of service, the expectation for that, back in the bottle. Now that investors— now that the DOL has shined a light on sort of this corner of the market and more people understand that there's a difference between the suitability standard and the fiduciary standard, It's going to be very difficult for anyone to make a straight-faced argument that the suitability standard is acceptable. I don't think advisors want to be perceived as only offering that level of service, and I certainly don't believe any clients out there will accept the suitability standard only if they're paying for advice. The second question is, you know, what exactly does it take to fulfill fiduciary duties? You know, the deal has not been I think the things we do know for sure are that there is greater awareness in general about the level of and nature of service, and I think that that's never going to go backward, right? We live in a world where transparency tends to improve and only go in one direction. People don't tend to go back and say, oh, I want to go back to those days when I didn't really know what was going on. That's going to affect investors' expectations. But I think in general, the existence of the new rule implies that the existing practices or the current research behind recommendations is not adequate and will not suffice going forward. I think we know that for sure as well. So, you know, as I mentioned at the top, I think investors' expectations for the fiduciary standard are here to stay no matter what the official rules say. Nobody wants to be seen as not putting the client's interests first. Significant investment has already been made to fulfill the new rule, to meet the new rule. I mean, think about how much money Merrill Lynch and some other firms have spent to change their business to be 100% wrap. There are no trading fees or ability to even operate under that model. So a lot of big firms have already moved to that, which means there's really a new best practice out there. And you'd be darn straight that Merrill Lynch is going to market hard the fact that across the board that they have moved to an advice model or a wrap model only, which ensures that their interests, the interests of their advisors are more aligned with their clients than other firms. Everybody will want to tout the fact that they're meeting a fiduciary standard. The more it is unique, the more it is powerful as a marketing tool, right? If everybody's at the fiduciary standard, then saying you're meeting the fiduciary standard isn't a big deal. If you are one of few, or if you are in a minority, or if you are, you know, even if you're the majority, putting yourself out there as a fiduciary is going to be, I think, the new best practice and the competitive edge. And it's not just us saying this, and I've got in the slide deck links to op-eds and other articles that really make a really impressive argument as to why, even more impressive than what I'm giving you today, but more impressive argument as to why the expectations for the fiduciary service are likely to persist. Notice that I'm not saying the law, right? I can't control the law. I don't need to control the law. But I'm saying that the expectations for fiduciary level of service will persist no matter what the laws are. And by the way, we'll provide a copy to this presentation to everybody in a follow-up email, everybody who's attended, as well as the blog post on our website. We'll have a copy of the slides for you as well. So if expectation for the level for fiduciary service is going to be out there, then let's talk about exactly what being a fiduciary means. It's 2 things when you go right down to it, and Mr. Kitsis has written some excellent articles on this as well. But fiduciary is 2 things. Number one, There's the duty of loyalty. Do what is right for the client, not what is right for you or the advisor, right? This seems elementary. It seems almost silly that we even have to say this out loud. Is it not self-evident that your service provider should do what's best for you, not for them? They should focus on building your wealth, not theirs. Well, I'm sorry to say that unfortunately that is not the case in the marketplace. Those folks only meeting a suitability standard. It's a red flag. The suitability standard is a longstanding loophole for advisors to put clients in products that are better for the advisor than they are for the client. Hard to believe that we're even having a conversation about the fact that this should be scourged from the earth forever, right? It's true. It's still happening. That's part of why, again, the deal is having to do what they're having to do. Right, that goes back to my point. There's no new— there's no reason for the DOL to raise awareness around this new fiduciary duty and rule if not for the fact that there was a need for it. Duty of care is the second part, right? Not only do you need to be focused on doing what's right for your client, not what's right for you, right? Not only do you need to be focused on putting the best interests of your client above your own, You need to do well by them. This is also sort of like a duty of competency. If you don't have the tools, the capability to do the right job, then you need to take yourself out, tap out, or refer them to someone who can. Ignorance is not an excuse, should never be an excuse. If this, you know, it's, it's certainly not an excuse, and the way we make it not an excuse in the legal and medical fields is that you have to take oaths and you have to be certified. Similar oaths and certifications are not required in this field. So really, the DOL is only doing what it should do to catch the financial services sector up to all other key sectors, which is make it against the law to be incompetent. I couldn't help it because I wasn't good enough at my job is not an excuse. And, you know, look, I don't think it should ever be excused between us here, but— so, duty of care. And what does that care mean? Care, skill, prudence, and diligence. That's law. And this is a link in the slide deck that we'll share with you that will take you to the law, as you can see right here on a Cornell website, that speaks specifically to the law of what being a fiduciary means— acting with care, skill, prudence, and diligence. Duty of loyalty, sort of like the duty of care, right? Skill. If you can't do the job, don't take the fees, don't be in the business. If you're not going to be prudent, I don't— do I even need to explain that? And diligence. What is diligence? So what does that mean tactically? What does that mean when we're getting down to the nitty-gritty of providing diligence? I think it means that the research you use, the justifications you use for investment recommendations need to be inarguably in the best interest of the client. I think that's self-evident, right? And what does that mean? I think that means the research needs to be comprehensive. It needs to be objective. It needs to be transparent. It needs to be relevant. Comprehensive, taking into account all relevant information. Objective, 100% conflicted, right? Unconflicted, sorry. Transparent. Should good research not want to show the consumer, the client, how much work went into it? You know, it blows my mind, black box research. If you've done the work, you should be more than happy to show what you've done. So anytime it's a black box, I think that's a red flag. And it needs to be relevant, right? You know, I'm not always sure that technical research is relevant. I'm not always sure that sentiment research is relevant. And there's certainly lots of research out there. I'm not always sure that Cramer is relevant. It may be entertaining. It may be indicative in the short term. Is it truly relative? Yeah. To the long-term competitive advantage cash flows of the company? Is it truly relevant to an investment decision? And again, we're talking about investment advice, not speculator advice, right? Speculating, that's a different activity. That's a different activity. Speculating is in theory, you know, defined as trying to predict the day-to-day direction of stock prices, the near-term direction of prices. Right. I don't believe in that game. That's not what we're about. That's another thing altogether. That to me is not investing. That's not what advisors should be doing for clients. This is about investing, and this is how you go about doing research the right way in order to provide investment advice. So more detail on what it means to be Comprehensive, objective, transparent, and relevant. Well, first of all, comprehensive, I think, starts with, at a minimum, you're going through all publicly available information— annual reports and quarterly reports. All that information has been diligently reviewed, including the footnotes in the MD&A. Can anyone make a straight-faced argument As to why you wouldn't do that kind of work? Why would I make an investment recommendation without that diligence? Can I make a straight-faced argument to my client? Can your advisor make a straight-faced argument to you as to why they shouldn't do that? I think that would be tough. Objective. There must be empirical analysis that supports the recommendation. Right. It needs to be focused on information that's really relevant to the business, like cash flow. And how about valuation? And for those of you that aren't familiar about what we— you know, about our valuation, please take a look at the education section of our site and take a look at the work we do, the diligence we do, because, you know, we believe that valuation need not be a purely speculative activity or piece of analysis. It can be purely very much objective. Right. Right? It's called reverse DCF. It's called expectations investing because valuation need not be about a bunch of ratios or different ways or different ratios to make a deal look good. Like, I remember when I was first on Wall Street, I realized, hey, you know, they can make any deal look good. They can find a ratio to make any deal look good. Objective, quantifying the expectations baked into the stock price. You know, that also means 100% conflicted. I'm sorry, 100% unconflicted. You know, I almost get a little bit tired of saying that. Do we even need to have that discussion anymore? Do we need to make it clear that research for recommend— for investment recommendations needs to be certifiably, incontrovertibly, 100% unconflicted? Do we need to talk about that anymore? Does it even make sense? Right? So, unconflicted just kind of goes without saying. And I'm not saying that all research out there today is conflicted. I'm not saying that all sell-side research is conflicted. No, it's not. But can you tell me for sure, for sure, which sell-side reports are not or are conflicted? I don't think anybody can know. I'm certain Wall Street's not going to come out and say, hey, this is the bad one, this is the good one. How do I know that? How do you know that? Take a look at a Wall Street report. Take a look at 2 or 3. The common trait among all of them is a very lengthy disclaimer at the end of every one of those reports, and all of them are exactly the same. All of them are exactly the same. All of them effectively warning the client that the bank, the underwriter, the issuer of the research may be currently, in the past, or in the future engaging activities that are contrary to the best interests of the client. And they go into a fairly gory amount of detail that if you've ever read one of those disclaimers, You're never quite the same again. I'm not kidding. If you haven't read one before, I highly recommend you get your hands on one because you will be more than a little surprised as to how many ways they could be acting contrary to your best interest. It's dumbfounding. It's kind of ridiculous. So number 3, transparent. Advisors should be able to show how the analysis was was performed and the data behind it. Research providers should show how the analysis was performed and the data behind it. Why not? It's a secret? Or maybe because you don't want people to know because it's really not that diligent? That's my guess. And that's because I was on Wall Street. I was there during the tech bubble. I've seen how the sausage was made. Trust me, you know, if you're doing real work, you want to show it off. Why not? If you've done your diligence, show it. If you haven't, well, maybe then you don't want to show that. It needs to be relevant. There must be, um, You know, better research, diligent research, it needs to be relevant. There must be a tangible, quantifiable correlation and connection to stock, ETF, or mutual fund performance. No, right? I mean, so this is what it takes to be a fiduciary. This is what it takes to fulfill fiduciary duties. This is what it takes to make an investment recommendation that's prudent, that meets a fiduciary level of service. And if you don't want to just take our word for it, the same thing has been printed on MarketWatch. Defining diligent research: comprehensive, objective, transparent, and relevant. Michael Kitces tweeted about this same article. He also put it into his weekend reading. where he features our article, The Labor Department Still Has to Define the Hardest Part of the Fiduciary Rule. And he says even better than I do, right? The fiduciary must act with care, skill, prudence, and diligence, including due diligence on potential investments. He notes that Hal, Sam McBride, and I, the co-author, note that the deal has done little to clarify its expectations for what Constitutes the necessary level of diligence, especially in the context of advisors. Advisors who don't necessarily have time to conduct the comprehensive due diligence. And it's— look, it's not just advisors. You know, we've got some of the biggest hedge fund managers, biggest wealth managers in the world. They struggle with it too. All right, and, and, and it's— it requires special technology to do this kind of work, and it's rare, but it's what needs to be done. Kitsis also points out, as we point out in our article, the history of fiduciary law also makes it clear that trying to manage risk through diversification is not sufficient to meet the diligence standards. It's not enough to go light on diligence and hope that the client is diversified enough to mitigate the damage if an investment goes awry, right? You know, diligence— I mean, diversification is not a substitute for diligence, right? You don't just put your money— just putting your money in a bunch of bad ideas is better than putting it in one idea for sure, but putting it in any bad ideas, right? And that kind of speaks to our ETF and mutual fund research. When we provide a rating on a mutual fund or an ETF, we're covering and looking at all of the holdings in the ETF and mutual fund to come up with a rating and due diligence on all of those holdings. and let you know whether or not there's risk of one particular stock or a group of stocks blowing that fund up. And then he also points out it's feasible to outsource due diligence to third— to third parties, but in a world of financial media with a low signal-to-noise ratio and a lot of conflicted sell-side research, there aren't many sources of third-party due diligence. Which comes back to the question, how's the DOL going to do this? So, again, don't just take our word for it. Some of the greatest media outlets and thought leaders in the business have featured our approach to this. And the takeaway, again, is it's got to be research that's comprehensive, objective, transparent, and relevant. With that, I'll take questions. Before finishing up. So the first question is, if the fiduciary rule gets passed, will it protect everybody from bad advisors? No. You know, I mean, it doesn't protect necessarily, but it does give you recourse. That's the big rule. That's the big thing. You could still get robbed, you could still get bad advice, but, you know, at least you've got recourse. You can go back and sue and get your money back or put that person out of business. Right now, you can get robbed and there is no recourse because they can claim they met the suitability standard. As awful as that sounds, it's true. I think the other point to point out here is that Diligence doesn't guarantee you'll always make money, right? You can do a lot of diligence and things can go against you. I've run a hedge fund. We did diligence, trust me, and we weren't always right. Now, most of that was on the short side. We were rarely ever wrong on the long side. But on the short side, stocks sometimes went up a whole lot before they crashed. We were right, but we were right too late. And unfortunately, in the business of shorting, Timing is just about everything. But yeah, diligent research will not guarantee that you won't get duped. It does give you recourse if you do. You know, how can you tell if the advisor is doing his job? How can you tell the advice is in the best— Ask. Ask if the advisor is holding himself to a fiduciary standard. Make them prove it, right? I mean, they shouldn't be— they shouldn't be coy about this when they want to be proud. All right, if they're not going to be forthright about it, That's a red flag. Will the fiduciary rule have an impact on the financial markets? You know, I don't think so. I mean, in terms of, like, hitting the stock market. Do I think it makes the capital markets more efficient? Do I think it— does it help the capital markets? Absolutely. Right? And that's part of our message to the DOL. And we believe that if the deal could provide some guidance here, it's going to improve the integrity of the capital markets. Absolutely. I think holding everyone— you know, it's, it's— who can make a straight-faced argument that providing anything less than a fiduciary level of service is what advisors should do? Do doctors ever get away with saying, you know, I don't really have to give you my, my best? In fact, you know, I'm going to put my interest ahead of yours. I'm a little tired today. I'm just going to botch this operation, right? I mean, who are we kidding here? It's kind of silly. So, uh, yeah, I think it's going to change the capital markets long term. I think it's going to make the capital markets have high— operate with greater integrity. And I think greater integrity means that they'll be more efficient. And a more efficient capital market long term means a higher standard of living for our country and eventually other countries. I think the U.S. exports quality of life and improvements in standard of living in a big way. I think we'll be able to do even more of that. And I think we'll also, to the extent that other countries aren't at a similar level of regulatory support for the integrity of the capital markets, you know, setting a standard for that, raising awareness of that, will help those countries as well. But I'm a big believer, huge believer, in the importance of the integrity of capital markets. And how that affects standards of living. I'm not a believer in regulation. I don't believe in regulation. I usually hate regulation. I love the idea of, of, um, getting rid of 2 rules for every new rule added. I think that we kind of— we need to do that. We need to be more careful. We need to be more deliberate. We need to be more judicious in the rules and regulations we put in place. And this is one that I think makes sense. It absolutely makes sense. Another question, would it be advisable to inform clients of our association with New Constructs who provides us with diligence? I think so, absolutely. You know, we're, you know, New Constructs is now on about a million desktops through our partnerships with Thomson, ScottTrade, Interactive Brokers. I've got, um, 4 or 5 new partnerships I think that are coming online that are going to put us on another potentially 10 million desktops here in the next few months. I, I honestly believe that those clients that— or those advisors and investors that are on the front end of providing diligence to clients are going to do better than those that are on the back end. Those that wait, those that hope that the suitability rule remains, those that hope to hide behind the suitability rule and not provide investors with their best service, those that don't put the best interests of clients ahead of their own, I think risk major reputational damage. How do you justify that? I'm a financial services firm that puts My best interests above yours. That's not going to be good for business. So, yes, I think it's a good idea. I think it's a good idea for you to build your business around integrity and build your business around making sure you do what's right for clients and that they know that you're going out of your way to do that and to let them know you're doing that because that sets a new standard because the folks that aren't doing it, they're going to be left behind. They're not going to be loud about it. So just by comparison, being loud about doing the right thing, it's going to hopefully, I think, be a good thing for you. Yes, you know, we have a public website, right? So your clients could access our website as well. And, you know, I think that that kind of transparency is probably a good thing. If you are giving advice that goes contrary to what New Constructs is doing, and if those of you aren't familiar with our website, right, we have ratings on portfolios. You can track multiple portfolios in our system, right? And we'll, you know, red is bad, green is good. That's the way it works, and there's details here. And if you have— look, I'm not here to say that New Constructs is the beginning and ending of what research is. Look, we only focus on risk-reward. Our overall rating is a function of risk-reward. And we focus on fundamentals. And there are other aspects of research and making investment recommendations, absolutely. Is what we do an important aspect? I think so. Is it critical? Probably. Should it be part of every investment decision process? Yes, it should. You should focus on fundamentals. Might there be things that drive the stock price in the short term other than fundamentals? Absolutely. When that ends or not, who knows? But the main takeaway is fundamentals are important, and you owe it to your clients to do that kind of work. And if you have an opinion that's different from ours, well, you should be prepared to justify that. I'm not saying you can't have a different opinion. I'm saying you should have different opinions probably a lot of times. That's why you add value. And so, yeah, I think, yeah, if you have an opinion different from ours and one of your clients points that out to you, feel free to— Be prepared to justify that difference. It's no different than sell-side research, right? If Merrill's got a buy and Morgan Stanley's got a sell, you know, same thing. Um, people are entitled to differences of opinion and, uh, and, and their opinion in general. So yeah, I, I think that, you know, look, new constructs should be available to everybody, or deep information, deep dive information. The question here, how does new constructs help advisors meet the fiduciary rule? We do comprehensive— if you haven't been on a webinar before, you haven't seen the education section of our website, you know, I recommend you check it out because we do that work that's required to fulfill diligence. We've been doing it for 15 years. We've designed technology around doing that with scale, diligence with scale. That's what we specialize in. All right, last question. If you see a rating in our system that hasn't been updated in a long time, send us an email. Either there's something wrong with the filings on the SEC's website or something got clogged in our system, but if it's suspended and you haven't seen an explanation, Or an update as to why it's suspended, or that hasn't changed in a while, let us know. You know, for example, this one's been suspended for almost a year. We're waiting on the new 10-K to come out before we speak to— now, suspended rating doesn't mean that the rating is no good. It just means we don't feel really good about what the existing financials that we have access to say about what the business is like in the future. A lot of the model really still works. The quality of earnings, the returns on invested capital of the business could change a lot. The valuation, it all really still works because what it's doing is quantifying what kind of future cash flows are required to justify the stock price. So understanding how different cash flows in the future have to be from what they've been in the past, that's valuable. If they have to be way larger than what they've been in the past, that's still valuable. They're, you know, it's not that the suspended rating doesn't mean that you— it's not like a Wall Street suspended rating, which means they're like, oh, we don't say that. We don't— we're still giving you a lot of information here. That's why we leave all this detail here. That's why the model's still available, right? You can go in, look at the model, click through the underlying data, get all the key data. You know, for example, marked-up filings, right? That'll show you exactly Where we have parsed information, right? There's the income statement parsed, right? Here are write-downs pulled out of the footnotes, page F-27, right? Here's where we found that buried in operating costs and expenses, you know, transition costs, non-recurring costs buried in there, right? Other operating expenses. Right, other unusual charges buried in there, merger and acquisition costs, special charges, loss on sale, right? Page F27, that could be page 927, right? Because they don't number them sequentially anymore. It's F, F27. F stands for 4,000. Just kidding, right? But you get the idea. So there's a ton of work that's going on here. Don't think that just because we say the remaining suspended, It's no good. It's still good, it's just not as good as we'd like it to be. And we want to be clear that, you know, something major has happened that's not recorded in the financials, and until we see the updated financials, we can't really be as confident about our rating system as we would be otherwise. Okay. Thanks very much. Feel free to send us emails with questions. We'd love to follow up. If you have any questions, typically on our site, like, everything is defined. Like, so for analyst notes, suspended rating, cause, large acquisition, you want to know what that means? Click on analyst notes. Large acquisition. There it is explained. Also notice that on all these pages up at the top, there's a tour button. Walk you through how to do everything. If you want more information on how to, how to deal with new constructs, you can always go to the Get Access page, take a tour. Whoops. That's how you buy a Platinum membership. This is how you get the tour, right? And the tour will go through step by step how everything works, even show you how to log in. So there's tons of education here. And keep in mind, when you have stocks in our portfolio, right, we get alerts. So We're proactive about getting in touch with you whenever there are changes with the model, so you can be sure that you're up to speed on all new filings coming in. Okay, thanks very much. I appreciate everyone being with us today, and we look forward to working with you in the future.