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A Rootin' Tootin' Separate Thread About [Financial Regulation]
DivideByZero
Social Justice BlackguardRegistered User regular
Social Justice BlackguardRegistered User regular
Spun off of everyone's favorite mid-season sitcom/clown show, the Election Thread, whose cliffhanger ending left us dangling with investment managers' jobs at the mercy of arch-nemesis, Regulation!
So let me get this straight:
Why is Bob's job entirely dependent on commissions from third party funds? Doesn't this structure cause a conflict of interest? Doesn't/Couldn't the IRA he works for pay him a salary to direct its investments in a responsible manner?
This would also be a good place to discuss any other current or pending regulation of the financial sector, why it's good or bad, and exactly how much money is in my investment account!
Crap.
spacekungfuman wrote: »Fencingsax wrote: »spacekungfuman wrote: »spacekungfuman wrote: »spacekungfuman wrote: »spacekungfuman wrote: »The flip side is that who you vote for probably won't impact a lot of social issues much. They tend to talk about them more than act on them. But who you vote for probably does have a direct and meaningful impact on your personal finances. In the IRA investment manager context I brought up, whether a Dem or Republican wins will literally determine if these people have a job or not. That is a much greater impact than almost anything else that someone may do in office.
I really don't see how making them act as fiduciaries eliminates their jobs unless they are currently acting in ways that are...questionable ethically. Which, given the reasons for the proposed rules change, is probably likely. I mean, fiduciary requirements are not new, and its not as though people currently acting in those capacities are all volunteers who help people with their finances in between the soup kitchen and tutoring.
What they are doing is taking people who currently recommended alternative investments to IRAs in a non fiduciary salesman capacity and turning those people into fiduciaries. They are also prohibiting fiduciaries to IRAs from getting paid in connection with recommending alternative investments, even if they are in the best interest of the IRA. It literally makes it impossible to be in the business of facilitating IRA investment in alternative investments. If that was your job, you won't have a job anymore.
No, it doesn't. It just makes it impossible for their job to be paid by commission. And you know what? Most other salespeople aren't paid on commission! They just earn a salary instead! For doing their job which continues to exist! Which typically works better from both a customer service standpoint, as far as businesses are concerned, as well as from an ethical/incentive standpoint. If the billable hour were suddenly made illegal would you be fired from your job, start bartering your services for chickens, or would you earn base pay + a set percentage of profit sharing rather than one based on billable time? I'm going to guess the last one.
It bans all compensation for the service of recommending alternative investments to IRAs. That means no companies will recommend alternative investments to IRAs, so they will fire the people who did that work.
No, it bans specific forms of compensation. Unless you are literally telling me that current fiduciaries earn $0 for their work. Because I'm pretty sure that isn't the case. Otherwise how would NAPFA pay its rent?
Current fiduciaries are paid for their work, including reccomendations of alternatives because there is no prohibition on paying them. This rule is prohibiting paying for that service, even if you can demonstrate that the investment is in the best interest of the plan. Under this rule, fiduciaries cannot be paid for anything related to alternatives (by the IRA or the investment). It is a major change and the industry is pushing back hard because it will literally cost a lot of people their jobs. Whole companies will shut down.
...Does the fee paid not cover such advice?
They don't pay a flat fee. It isn't like the IRA owner just hires JPM and the JPM manages all the investments, including alternatives. These are self directed IRAs and specific companies (that the IRA is not otherwise working with) let IRA owners know about new opportunities to invest in private funds. All they do is provide information and access to these private funds. Not letting them be paid for it means they can't be paid for anything.
So let me get this straight:
- Bob works for an IRA and manages its investments
- Bob also gets paid a kickback commission from a third party fund for directing his IRA to invest in that fund
- New regulation would ban those kickbacks commissions from third party funds
- Bob is now out of a job because ????
Why is Bob's job entirely dependent on commissions from third party funds? Doesn't this structure cause a conflict of interest? Doesn't/Couldn't the IRA he works for pay him a salary to direct its investments in a responsible manner?
This would also be a good place to discuss any other current or pending regulation of the financial sector, why it's good or bad, and exactly how much money is in my investment account!
Crap.
First they came for the Muslims, and we said NOT TODAY, MOTHERFUCKERS
DivideByZero on
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Here is the situation.
Fund A is privately offered. That means you can only invest if you are provided the materials describing th investment and you meet certain criteria. Fund A is willing to accept high net worth individuals as investors. For these purposes, this means people with at least $5 million. Fund A is willing to accept these investments through estate planning vehicles, including individual retirement accounts.
Person B has over $5 million and a self directed IRA (i.e., he chooses its investments himself).
Fund A tells Promoter C that it is open to high net worth individuals' IRAs investing in it. Fund A will give Promoter C part of its management fee for each IRA that Promoter C reccomends and which invests in Fund A.
Promoter C passes the Fund A offering documents on to Person B, and acts as a go between to get Person B's questions answered by Fund A and, if Person B chooses to invest, Promoter C helps Person B to complete the subscription materials for it to be admitted into Fund A. Promoter C does not offer reccomendations to Person B about whether Fund A is a good investment, and a Promoter C has no discretion over how Person B invests. Person B does not pay Promoter C for these services.
Under current law, Promoter C is not a fiduciary to Person B or Person B's IRA, and Promoter C may collect the fee from Fund A.
Under the proposed regulation, Promoter C is now a fiduciary to Person B's IRA. Further, Promoter C may not collect any fees in connection with Fund A, even if it is in the best interest of Person B's IRA to invest in Fund A. Demonstrating that the investment is in the best interest of the IRA would permit the fee to be paid if the investment was basically anything other than a private fund, but private funds are not eligible for the best interest exemption.
Hey, I tried to make GST a thing.
Let's make GST a thing.
the "no true scotch man" fallacy.
This just seems like a great example of why the US financial sector needs a massive, heavily regulated overhaul.
The problem is that, like a real estate agent on both sides of a deal, they set themselves up as providing a good deal for person b when their interest is the opposite.
Real estate agents fix this by enforcing fiduciary duties for person B on sales agent c so long as agent c brings them to the property of fund A.
In finances there is no such fiduciary duty, when their should be, and when it's likely assumed by person B.
The economic effects of such legislation are probably positive. Promoter C won't be out of a job, the management fees of private funds will decrease by the value they were paying in kickbacks and the investors will be able to pay for the services of promoter C directly.
What that leaves us with is simply fewer perverse incentives. And if that means fewer people in Promoter Cs class(or their income decreases) that is an impliciation that Person C was perpetrating harm on the economy.
Okay. So if I'm parsing this correctly:
1. Bill has an IRA and wants to invest it in Fund.
2. In order for Bill to learn about Fund, Fund hires Charlie, a Promoter, to pitch Fund to Bill and do the paperwork.
3. Charlie doesn't tell Bill whether or not it's a good investment because that's not his job. His job is to pitch funds and sign up people like Bill.
4. Bill pays Charlie nothing.
5. Instead, Charlie gets paid by Fund, on commission, for directing people like Bill into Fund.
New regulation states that Charlie now has additional legal/ethical obligations to Bill and as such, Charlie should not be getting paid by Fund because that's a conflict of interest.
Sounds good to me.
Bill should be paying Charlie directly, through fees for recommending good investments and signing him up. That way Bill is the customer, the Fund is the product, and Charlie is the salesman who gets paid on providing good service to Bill. The way you describe the status quo is: Bill is the product, Fund is the customer, and Charlie gets paid on providing good service to the Fund, which means signing up a lot of Bills regardless of Bill's interests.
All these Charlies who are supposedly going to lose their jobs should just group up and form their own IRA advisory firms and pitch their services to the Bills. If the market can't actually support the current number of Charlies, then it's pretty obvious that they weren't providing much service to the Bills.
Just for you, buddy
I agree in principle. In fact, the entire point of the new regulation is supposed to be to make it clear that Promoter C is actually interested getting Person B to invest in Fund A. The problem is that they way it is drafted, Person B's IRA cannot pay a fee to Promoter C for this service. No one can pay Promoter C for the service. The financial community is up in arms, but the DOL's response thus far has basically been "IRAs should just invest in index funds" which runs contrary to the SECs rules on who may invest in private funds.
Under the new rule, if you provide any advice or reccomendations about investments to a retirement plan or IRA, you cannot collect a fee unless an exemption applies. The main exemptions are where the plan (but not an IRA) is managed by someone who is knowledgable about investments or where the advice is in the best interest of the plan or IRA (and the contract between the fiduciary and the plan/IRA must recite that it can only act in the best interest of the plan/IRA). The simplest fix IMO is to just expand the best interest exemption to apply to alternative investments, but it is unclear what the DOL will do.
People should be paid by those they provide services to. Being paid directly by funds indicates these guys are acting in the interests of the funds and not the investors.
Remember, they were not fiduciaries previously. The contracts would always say very explicitly that the promoter is not making an investment recommendation, and the IRA would have to acknowledge that it was not relying on the advice of the promoter in choosing to make the investment.
This just seems like a very winking work-around.
Right, which is why this whole thing sounds so sketchy to begin with. Like they ring up a dude with an IRA and are all, "Yo dawg I heard you like private funds, well have I got a private fund that's just dying to get its hands on your money!"
And the dude is all, "Sounds cool, will it turn out good for me?"
"Well I can't really say either way. But they really want your money! They paid me to tell you so!"
And dude is like, "Well shit sign me up then!"
These guys sound like the Doctor Nick Riviera of finance.
What do you mean? The regulatory intent would be given effect (the Promoter is now bound by the hugest fiduciary duties under law as an ERISA fiduciary to the IRA) and the nature of the Promoter's compensation would be disclosed to the IRA. Further, if the fund does poorly, the IRA could bring a claim against the promoter alleging the investment advice was not in the best interest of the IRA, which could force the Promoter to give up its fee.
That is arguably a fair description.
In practice, these promoters have a group of IRAs they send opportunities to and depending on the promoter, they may be curating the opportunities these send (for example, a bank that invests money it manages in Fund A may tell a select group of IRA owners about Fund A, and there is the implicit reccomendation from the bank that it chose to invest). I don't take issue with making them fiduciaries, especially in the latter context. I just think there our to be a way for them to be paid.
I may not have properly expressed the relationship between the promoters and the funds. Large institutional investors inquire with funds directly or have investment managers they pay that seek out funds that are the best fit for their clients (as a practical matter, the manager tends to bring most of the investors it advises into the same funds because there aren't many differences in the needs of institutional investors). With a few exceptions, high net worth individuals (including IRAs) don't have the ability to contact funds directly and don't hire managers. Instead, they rely on connections with the entities I have been calling "promoters" to find out about and get access to private funds. Some funds strike deals with one or more promoters where they are effectively asking them to market the fund to their investor contacts. More commonly, the promoter is independent and approaches a fund saying it has investors that might be interested. Either way, the fund pays them though and this has historically been hidden from the investors because they are just told that the management fee is 2%, but aren't told that 1.5% of that 2% is going to the promoter with respect to their investment.
I am fully on board with requiring disclosure of who is getting the fees and in what amount. I just don't think the promoters should be precluded from getting the fees, once adequately disclosed.
The current setup is like a perfect storm of perverse incentives and obfuscation.
I was wrong before; they're not Nick Riviera, they're Lionel Hutz.
If the promoter discloses that they are paid by the fund, acknowledges that they are a fiduciary of the investor, and is required to act in their best interest, what is the issue? It is very similar to a buyer's realtor, like others said earlier.
Because seller and buyer realtor on the same side of the deal is still sketchy regardless of the situation and there are even problems with seller/buyer having separate realtors (since realtors get paid out of the sellers commission).
I should have put "solve" in quotation marks because it's still not near ideal.
Because all of their compensation is still coming from the fund? So no matter if they claim to be working in the investor's interests, they're still working for the fund and not the investor. Hence they still have the incentive to get as many people as possible invested in the funds that pay them the biggest kickbacks commissions. The promoter's and fund's interests align, and who watches out for the investor? The promoter might claim to but can you really be sure?
If they're really working for the investor, the investor should pay them directly to manage their investments. Then the investor's and promoter's interests align.
And yeah, if realtors only represented sellers, then you'd probably see a whole lot of buyers getting screwed over in the real estate market. Who's watching out for their interests really? No one, even if the seller's realtor claims to be.
Parties that actually make investment decisions have always been prohibited from receiving fees from the funds they invest in, when representing pensions plans or IRAs.
They sound like utterly superfluous middlemen who perform nothing of real value.
But there is still a conflict of interest though and especially when the buyers agent "just happens" to also be the agent for the sellers.
This is the same type of problematic structure
If we eliminated utterly superfluous middlemen who perform nothing of real value, we'd have an unemployment crisis as we put the majority of financial services out of work.
the "no true scotch man" fallacy.
We could always put them to work digging ditches.
At least then we'd have a whole shitload of ditches.
But we allow people to consent to the conflict, and for agents to be paid. I agree the conflict exists, but refusing to allow any dealings at all because the conflict exists, even when disclosed, seems very paternalistic to me, particularly when dealing with an IRA of a person with at least $5 million in assets (the same person could enter into the exact same arrangement with less protections if they used their non-IRA assets to invest).
Because there is a limit on how widely privately traded funds can advertise the fund. They can't just announce it and tell every qualified purchaser that they can invest. Logistically, a fund is also not going to be willing to deal with tons of small investors. They will only deal with the promoter, who is responsible for making sure the subscription materials are prepared correctly and for aggregating questions from investors. When your fund is taking $25 and $100 million investments, they don't have the resources or desire to hold the hand of a $100 thousand investor.
All I hear is "blah, blah, blah. Rich people problems. The plebes wouldn't understand."
Not trying to be a dick here, but seriously. We can't advertise because we can't be bothered to deal with six figure transactions?
Fuck those guys and the horses they rode in on.
There are limits placed on how widely funds can advertise/offer to investors and still remain exempt from registering as a public company.
Whoop de shit?
So register as a public company if it means that much to you. All you have provided are excuses for why this thing that totally appears to be reasonable, and ultimately beneficial for the investor, can't be done due to its inconvenience.
There are countless reasons that an investment fund would not become public, including adverse tax consequences, the loss of the ability to call additional capital from investors to make investments (this is a fundamental aspect of how private equity funds operate), and a desire to avoid the scrutiny from competitors that would happen if they had to make public filings. Only a handful of private equity funds have ever gone public. I don't think there are any public hedge funds in the US. I worked on a public PE fund once and it was a nightmare dealing with the regulatory issues.
*wonders what would happen if it was mandatory for private investors to go public with their funds*
Funds charge two types of fees. The management fee is a percentage of committed (or called) capital. Normally 1.5 or 2%. The performance fee (or incentive fee or carry) is normally 15 or 20% of the gains made by the fund after the investors receive a full return of investment plus a preferred return (usually 8% of their invested amount, compounded annually). Because these promoters are not being retained by the investors, there is no investment management fee charged by the promoter. Instead, the fund agrees to give 75-100% of the management fee it collects with respect to the investors the promoter brings in (because it wouldn't have the investments otherwise) to the promoter, and the fund just benefits by having more investment capital to commit into more investments. There is no additional charge to the investor, because they would pay the management fee no matter what. The only alternatives would be to require the investors to retain the promoters directly (which would cost the investors more money) or to require the fund to pay the promoter a flat fee.
Private funds really aren't meant to be publicly offered and the mechanics don't work well. For example, when you subscribe to a private equity fund you pledge to invest $x, but you don't actually fund money until the fund is going to make an investment and it tells you how much you need per investment. For a PE fund to go public, what it essentially needs to do is start private, raise investment capital, call 100% of the capital then go public. (Capital calls are not possible after it goes public). It changes the economics of the fund significantly and means people end up with a lot of money invested by not being out to productive use for years.
If the investment does badly, does the promoter suffer at all?
Is there a reason to deter them from taking a riskier investment option that gives commissions rather than a safer investment that does not?
http://forums.penny-arcade.com/discussion/164450/private-equity-in-the-public-eye/p1