If Politicians Were Investment Advisors

Alexandra F. Baldwin

I had a conversation with someone the other day about the growing regulatory burden on financial institutions, specifically those instituted by the Securities and Exchange Commission in their oversight of Registered Investment Advisors (RIA’s). These rules range include many that are logical and obviously beneficial (a regulated custodian bank has to deliver a statement of holdings and activity to clients every quarter) and some that are extremely cloudy (try to find the exact piece of statute, rule or guidance that tells you whether or not you can provide a client with performance data on their own accounts that is gross-of-fees.) My guess is that the industry will tell you that they are over-regulated, and some in Congress (like Elizabeth Warren) will tell you that they are under-regulated.

I’m not going to touch that at all, because it isn’t my point here. My point here is that politicians have a nasty habit of demanding that others are held to a higher standard than those to which those same politicians are held. To do so, we are going to take a little spin through an imaginary world that I am going to call “The land in which politicians hold themselves to the same standards that they insist Investment Advisors meet."

{Side note: work on a snappier name for this fantasy land. Other side note: you can’t be advisors and advisers, people, pick one and go with it.}

First of all, let’s talk about why this is a reasonable exercise. RIA’s are regulated because they are in the business of providing advice and guidance to investors, and because such a service is of extreme importance to a massive number of Americans. Clearly, our elected officials do work that is of at least equivalent importance, and in fact, they administer an even larger portion of the wealth created by most people than do Investment Advisors. Between Federal and State income and payroll taxes, property taxes and miscellaneous sales and other taxes, the average American probably pays something like 20% of their gross income in taxes every year. With our current National Savings rate of only 5.7%, RIA’s handles barely a quarter of the assets that elected officials do.

All of which is my way of saying that it is not outrageous to suggest that we hold our elected officials to the same standards that we hold our investment advisors.

Now, then, let us walk through some of the major pieces of RIA regulation and see how that might stack up in a political world.

Conflicts of Interest
This is a big one, and sort of encompasses a bunch of other rules. Basically, the rule acknowledges that Advisers will always have circumstances in which their interests conflict with those of their clients, and they are required to a) disclose those conflicts, and b) describe in detail what steps they have taken to ensure that the interests of their clients are always put ahead of their own. There is a specific format, and a required disclosure document called an ADV form that must outline these conflicts. Some common examples include:

• "Frontrunning”, which is the practice of placing your own trades before you place your clients’ trades so that you are not using your clients’ assets to increase the market price of a security you just bought.
  
• Allocation of investments – if you, as an adviser, have been given access to an IPO or some other objectively valuable investment, you have to offer it to clients before you take it for yourself.
  
• Fee transparency – if you get paid to recommend a fund or some other product, you have to tell the client that you are paid to do so. If you are paid to refer business, you need to tell a client before you refer them.
  

In politics, there are certainly some requirements to disclose conflicts of interest, most notably in contribution filings. Candidates must disclose the names of anyone who directly gives them more than a certain amount of money. Those disclosures include the donor’s employer, which creates at least some industry-level conflict data. That is certainly helpful, but the requirements are nowhere near those placed on advisors.

For example, if a Senator were forced to file an ADV, it might include a sentence like “The Senator accepts contributions from Political Action Committees controlled by lobbyists. In some instances, the Senator may take action up to and including the introduction of legislation, specifically designed to promote the interests of those people represented by those lobbyists.” And if that sentence doesn’t appear in the politician’s ADV and he then (like, for example, Harry Reid did) takes $68,000 from Jack Abramoff in exchange for asking the Department of the Interior to reject casino applications that would compete with Abramoff’s Native American clients, why the Political-SEC would fine him. Or, if it were egregious enough, they might bar him from public office.

Pay to Play
The SEC has some new and pretty strict rules on employees of RIA’s moving back and forth between the public sector and the private sector. If, for example, an RIA hires an employee who worked for any municipality, the firm cannot bid on business from that municipality (which applies to the management of pension assets of that city or state, for example) for a period of at least two years. {There may or may not be rules related to political contributions as well, but I am not clear on that}. There is no rule that works the other way, and politicians are free to hire friends and family or donors or other benefactors at will. Heck, while we are on the subject, it’s probably worth noting that companies can hire the friends and family of politically-connected people without disclosure or repercussion. I mean, you didn’t really think McKinsey was going to hire Chelsea Clinton on her own merits, did you?

Performance and Marketing
Oh, this one is a doozy! The rules around advertising are incredibly strict, and violation of those rules comes with big and nasty consequences. In the simplest terms, an Advisor that advertises its investment performance (“We have earned 8% per year over the last ten years!”) has to calculate that performance according to established rules of calculation. They also must disclose, in detail, exactly how they calculated that performance, including the policies for including or excluding accounts from the calculations, what assets are counted, how they are counted, how you measure the impact of advisory fees, etc. What’s more, they have to provide an objective benchmark of that performance to measure their own results against. And, they need to maintain detailed records so they can re-create that performance record for as long as they use that record in any advertising.

You’re already laughing at the idea of Politicians having to report their performance under objective, measurable and auditable standards. Heck, they created any entirely phony kind of accounting that no one else would ever be allowed to use just so that Social Security masked the annual deficits for about 25 years. “I once ran a marathon in about 3 hours.”

Donald Trump says he created thousands of jobs and paid hundreds of millions of dollars in taxes. He definitely can’t say the first because it isn’t a verifiable claim, and he can only say the second one if he has used some accepted method to specifically calculate exactly what he has paid and can reproduce the calculation. Hillary Clinton says she “won health care for 8 million children” and “Every piece of legislation that I introduced in the Senate, just about, had a Republican co-sponsor.” Well, the first one is a no-go because it is misleading – she lobbied for it as first lady, but only Congress could actually pass that law. The second one is just straight wrong (Politifact calculated 30%).

So, again, both of you are going to get a findings letter from the Political-SEC, and frankly, you both lie enough that you’re going to get fined and I don’t see much hope for either of you being allowed to participate in the industry any time soon.

Forward-Looking Statements
RIA’s are not allowed to make any speculative forward-looking statements that promise any specific results to any clients under any circumstances. You can’t promise to earn someone 5% per year, and you can’t guarantee anyone’s investment, and you’re almost certainly going to get shut down if you try.

Politicians, though, are encumbered by no such rules! “Your premiums will go down by $2,500” turned out to be as preposterously stupid as it seemed at the time, but that doesn’t even matter…even if it was true, if we treated politicians like Investment Advisor’s, he simply wouldn’t be allowed to say it. Trump is promising 25 million jobs and 4% growth. Clinton is promising 10 million and says Trump will lose 3.4 million. Sorry guys, you are going to have to clam up about that…or else you’re gonna be banned!

Insider Trading
60 Minutes did a piece on this a couple of years ago, which caused outrage for a day and promises from Congress to enact immediate change. They, of course, did nothing. And why would they? After all, while RIA’s (and really everyone else) are strictly forbidden, under penalty of jail, from trading on material, non-public information, Congress is welcome to invest based on their own knowledge of upcoming law changes without oversight.

Are you a Senator on the Energy Committee who thinks that a sweeping new solar subsidy is going to get passed? Feel free to buy all the solar stocks you want, and then cast your own vote and lobby for those of your fellow Senators to finalize said law. After your portfolio increases in value based on this information, you are free to go ahead and cash in! If you are an RIA that hears about this though, you best not make any investments in solar on behalf of your clients…that, of course, would be horribly illegal.

Remember up top where we talked about allocation of investments? Well, brokers have some leeway on which investors they give those shares to, and take a guess which accounts get outsized allotments of IPOS? Hint: it’s people that the brokers might want to curry favor with, and those people tend to include elected officials.

If you are not sure how rampant this is, keep this in mind: the average Congressperson beats the market by 6% per year, and the average Senator by 10%. Your Senator is as good an investor as Warren Buffett…

There is actually more to this, including the discussion of general fraud provisions (RIA’s can’t lie, steal or cheat) that is applicable on a very large scale to the actions of elected officials. I think, however, that you probably get the point: our elected officials demand that others live up to significantly higher standards than those to which they hold themselves.