Time for Advisers to Speak in Plain English

October 21, 2019
In The News

If you think your job is tough, try simplifying financial disclosures.

A new Securities and Exchange Commission rule requires brokers and financial advisers to describe their services, fees and conflicts of interest in " plain English" and a maximum of four pages.

But, as my dad used to say, nothing is harder than making something look easy. The SEC needed roughly 165,000 words and almost 170 pages in the Federal Register to specify how advisers and brokers should "reduce retail investor confusion."

The new disclosure, called Form CRS, makes financial information simpler -- but not simple enough. Investors don't just need to learn what to ask, but why the answers matter.

"The simplest test of communication is whether the person you're communicating with understands it," Rep. Sean Casten (D., Ill.) told me this week. "And the American people don't seem to understand these disclosures."

A bill sponsored by Rep. Casten would require the SEC to conduct detailed tests, including "one-on-one cognitive interviews" with individual investors, before introducing new disclosures.

Rep. Casten's bill, passed by the House of Representatives on Oct. 17, isn't likely to make it through the Republican-controlled Senate.

An SEC spokesperson declined to comment. The agency's chairman, Jay Clayton, said in a speech in July that the amount of feedback and investor testing that the SEC used to develop Form CRS was "extensive -- perhaps even unprecedented." Firms have until June 30, 2020, to comply with the new rule.

The testing that the SEC conducted while preparing the rule isn't entirely encouraging.

In an online survey, the Rand Corp. studied how long people spent reading the information in a draft version of Form CRS. They typically spent 46 seconds reading about fees and costs and 22 seconds on conflicts of interest.

Why didn't people take more time on such disclosures?

Most investors aren't stupid or irrational. We are, instead, what I like to call "blazy": busy and lazy. In a world where information is almost infinite, but time and attention are limited, none of us want to think any harder than we have to.

So it's rational to use shortcuts to make decisions. If you have a few hours to spare this weekend, you can attend your child's soccer game, read The Wall Street Journal or study a disclosure for a brokerage account you're about to open.

Chances are, you'll go to the whole game, read most of the Journal (thank you very much), but end up opening the brokerage account without plowing through any of the fine print.

Being blazy keeps investors from doing their homework.

Among households that own mutual funds, for example, 22% said fees and expenses are "not very important" or "not at all important," according to a 2018 survey by the Investment Company Institute, a fund trade group.

In a separate survey for the SEC, investors were asked about six common types of fees. For each type, roughly a quarter of investors couldn't say whether they paid it or not. More than 20% insisted they don't pay any fees at all.

And because most of us regard ourselves as ethical and competent, we often fail to understand how widespread and harmful advisers' conflicts of interest can be. Someone we trust seems much less likely to put his interests ahead of our own -- even though conflicts are the everyday currency of Wall Street.

So, before reporting fees and expenses, disclosures should say something like: "The cost of investments and financial advice is the single most controllable factor in how much your money can grow over time. The more you pay, the less you will get to keep." Then you should be able to see an adviser's fees compared with the average, and to the high and low, costs available industrywide.

Before discussing conflicts of interest, disclosures should say: "Your financial advisers are obligated to put your interests ahead of their own. However, advisers still may earn more on some actions or recommendations than on others. That can lead them to put their own interests ahead of yours, raising your risk and lowering your return. No adviser can avoid all conflicts of interest or claim to be conflict-free." Then you should be able to see how the number and severity of a given adviser's conflicts compare to those of other advisers

Such comparisons should be visual: color-coded from red to green, for instance, or arrayed on a scale from 1 to 10. Form CRS gives firms some latitude to do that, but probably not enough.

And evaluating whether a particular adviser's fees are competitive will remain a guess. Before Form CRS, no one could tell what the average financial adviser charges to manage $100,000, $250,000 or $1 million. After Form CRS, that won't be much clearer, because the reporting of fees still isn't thoroughly standardized.

As Rep. Casten says, "Let's communicate as clearly and efficiently as we can -- more like Hemingway, less like lawyers."