Mr. James Green
Editor in Chief
Investment Advisor Magazine
1161 Broad Street, Suite 200
Shrewsbury, NJ 07702
RE: Fiduciary Duty, Thomas Giachetti, November 2006
Dear Mr. Green,
I deal with complex financial issues and provide reports and testimony covering some unique areas- including investments and fiduciary duty. I have also taught all the courses for CFPs, brokers, insurance agents, etc. The entire resume is at my site for validation of background. I read the article by Mr. Giachetti. While the theory is applicable, the real life application is not only suspect but effectively useless.
Giachetti notes, "the SEC maintains that advisors have a fiduciary duty to reasonably determine that the investment advice and/or services that they provide to their clients are suitable, taking into consideration the client's financial situation, investment experience, and investment objectives. Accordingly, each firm should be prepared to demonstrate that it has a policy to obtain (and maintain) sufficient information regarding the client's circumstances to enable the firm to determine whether particular advice or services are suitable, initially and thereafter. Examples of the type of corresponding documents that advisors may determine to implement include client questionnaires, fact sheets, investment objective(s) confirmation letters, and investment policy statements (IPSs)."
I have enclosed a recent letter to NASD CEO Schapiro regarding the various elements or diversification, risk and suitability. The point being that the NASD has never required any of its licensees to know the fundamentals of investing. While Giachetti addresses suitability, how is an adviser going to do the remaining analysis? On what basis is investment experience going to be analyzed? Investment objectives? Not without a formal budget. As far as the firm is concerned, what supervisor has been taught any requirements relating to risk or reward? Series 4, 8, 24? No. There are no fundamentals in any of the licensing courses nor has ever been. It's an specious comment to suggest that the maintenance of incomprehensible forms and incompetent staff can validate what the firm has done. A standard (suitability) cannot be upheld when the standard that cannot be identified (no knowledge nor identity of practical application).
Giachetti continues, "Therefore, the advisor, as a "fiduciary," should not begin the investment management process until the client's objectives and risk parameters are clarified and consistent, and written confirmation thereof has been obtained.
Our general recommendation is to keep the client "intake" process simple. Have a new client information document that requires the client to indicate, in his own handwriting, his risk parameters and investment objectives, and, most importantly, any reasonable restrictions that the client desires to impose on your investment management services."
Somebody has got to be kidding. A client understanding risk? Diversification has not been taught to brokers- even to CFPs. Asset Allocation? Not for brokers and only 3.25 pages out of 800 in an exam manual for CFPs. And a client will possess these requisite skills? Standard deviation (not taught to brokers and inadequately presented to CFPs but used all the time) is universally been relegated to "risk" ipso facto (categorically wrong). Literally every investment plan shows risk going down over time. No. The risk of loss goes up over time. Does someone even remotely believe that the client understands this as part of the risk parameters? Given the fact that advisors are clueless as well? (An initial portfolio with a standard deviation of 15% has a lower SD in 10 years of 4.75- over 20 years, 3.35. That's what is presented- lower risk'. But in 10 years, the final value could be just 61% of anticipated- a 40% loss from that anticipated. In 20 years, the value is just 50%- and that is just for one standard deviation. Professor Mandlebrot in his book, (Mis)Behavior of Markets, states that the risk is much, much larger.)
As regards investment objectives, how does correlation impact their decision? After all, it is impossible to get a handle on what might happen with investments if this is remiss. Is correlation in any securities licensing manual? No. Has it been presented in CFP material? About a couple of words. And no practical numbers or application at all. Dollar cost average- a wasted amount of three sentences and no proper application whatsoever. It is used by the bulk of brokers and planners- but it has not worked before, does not work now nor, univerally, will never work in the future. In other words, we have limited and incomplete information abounding with no real life applications to anything.
In a highly idealized world, clients could extemporaneously, logically and with knowledge aforethought present a detailed description of what they wanted and why.......and the risks associated therewith. Not even close. Save for a skeleton of a few advisors, they cannot do it either. Nor can attorneys hope to provide the insight necessary since they are clueless as well. (Outside of my course in 1995 to the California Bar, Practical Investment Theory and Application", I do not know of any other similar presentation anyplace.)
I do not dismiss Mr. Giachetti positions in an faultless world where the agents had requisite skills. But since none of the skills addressed above are offered to brokers and effectively nothing more to planners, the idea that consumers can be responsible to themselves is 99 44/100% absurd. That supervisors and firms are responsible for their agents is mandatory. But if they haven't been taught any of the fundamentals of investing nor none of the true applications, the overview is inherently flawed.
Fiduciary duty is not only taking on the responsibility but having the requisite skills to do so. Such skills have never been evidenced by training and licensing- and all anyone has to do is read the manuals to see the fallacy of the bulk of Mr. Giachetti's posits.
Errold F. Moody Jr.