Frank Thoughts: The Bigger Story
Frank Boland
March 30, 2012

Imagine resigning from a $500,000 a year job with an open ended future, on principle.  Greg Smith, a young Goldman Sachs derivatives salesman, did just that and wrote an OP-ED column published in the New York Times.  The next day the story was on the front page.  But there is an even bigger story.

Greg Smith said about Goldman, “I can honestly say that the environment now is as toxic and destructive as I have ever seen it.  To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money.” There is an old Wall Street proverb that describes the inherent conflict.  “The job of a broker is not to make money for a customer, but to make money from the customer.”  And Goldman Sachs is, after all, a brokerage firm.

In 1982 there was a paradigm change in the investment business.  Paul Volcker, then Fed Chairman, after years of fighting inflation with rising interest rates, cut interest rates.  That policy change, inadvertently, created a seminal change in the brokerage industry.  The business moved from a client-focused business to a transactional customer business, overnight.  The transactional business quickly dwarfed the relationship business.  And that’s when the trouble began.  Goldman was hardly unique.

Wall Street was originally dominated by large, privately owned, investment banks.  But after 1982 these firms went public.  When they were private the partners owned all of the profit, but they also owned the risk and liability, including possible personal bankruptcy.  Once public, only stockholders were at risk.  This created what became known as the privatization of profit and the socialization of loss.

The real issue is the distinction between a customer and a client.  A customer is one who buys goods or services from a business.  A client is one who pays a fee for professional service.  The issue is realizing which you are, a customer or client.  In the arcane world of the investment business, there is a huge distinction!  A brokerage customer has only to be treated with the issue of suitability.  Example:  You cannot sell a 90 year-old a speculative technology stock with high risk.  But you can recommend a “suitable” stock that you hold in inventory and hide a generous commission in an opaque trade, which Goldman and other brokerage firms routinely do.  A registered investment advisor is held to a different standard - a Fiduciary Standard.  The advisor must always act in their clients’ best interest, always.

Most brokerage firm’s customers do not understand this, or even know this difference exists.  Naively, they think their stock broker is acting in their best interest.  But as Mr. Smith, formally of Goldman Sachs, scathingly points out, that is often not the case.  The Fiduciary Standard applies only to the investment advisor, the money manager charging the CLIENT a fee.  Of course, brokerage firms continue to call their customers “clients.”  It sounds classier.

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