Cultural changes overshadow reform

A shift in culture for investment advisers is overtaking regulatory reform in scope and significance. Although subtle evidence of the shift can be observed in the United States, it is readily apparent in Australia and New Zealand, where I recently visited. In meetings with regulators, leaders of professional associations, financial advisers and trustees of institutional funds, the major topic of conversation wasn't the status of regulatory reform but how the attitudes, values and practices of advisers and financial services firms are in transition. Cultural shifts occur when major events disrupt the prevailing paradigm and instigate changes in both beliefs and behaviors. The global financial crisis shook investor confidence in the financial system and in financial services providers. It served as the primary generative factor for cultural change. In country after country, regulatory-reform initiatives reflect a common view of what must change to help restore confidence, reduce conflicts of interest, increase transparency of costs and conflicts, raise professional-competency standards and hold market participants more accountable for behavior that undermines investor confidence. Although we tend to think of regulatory reform as an end result of the global financial crisis, it is more appropriate to view it as a secondary generative factor within the overall process of a cultural shift. Once the common worldview of the necessary direction of change formed, legislators and regulators began to act in accordance with that view.

BIG CHANGES

Although cultural changes that are in motion tend to stay in motion, the form of those laws and regulations can have the effect either of accelerating or slowing the pace of change. For financial services firms that are deeply entrenched in the old paradigm of a sales/fair-dealing culture, the transition to a professional- advice/fiduciary culture is neither welcome nor easy. Consequently, trade associations of insurance companies and broker-dealers have invested heavily in lobbying against meaningful reform. These efforts are likely to be successful in preventing the U.S. financial services sector from keeping pace with other countries able to react to change more readily. However, it is important to understand that the primary role of legislators and regulators is to set the minimum standard of conduct. It is the prevailing culture and, by extension, the market that will dictate how high the standard eventually will be set. Much as with the introduction of a disruptive technology, every cultural shift has innovators, market leaders and market laggards. Innovators are those who help to instigate and promote the cultural shift, such as legislators, regulators, investor advocates and visionaries within the financial services field. Market leaders are the early adopters who realize that their business model must change to align with the new paradigm. Market laggards cling to the old paradigm even as they lose their best advisers and executives to the market leaders. The laggards ultimately adapt, merge with a leader or go out of business. In Australia and New Zealand, the rigor of regulatory reform is forcing all advisers and financial services firms to make strategic business decisions. Although market laggards are focusing on the new rules, market leaders are looking beyond the rules to how their businesses should be structured in order to excel in the new fiduciary environment. They are improving their investment due-diligence processes, implementing conflict-free compensation structures and developing rigorous training programs that go beyond simple compliance by requiring continuing education to address adherence to fiduciary principles. They are also building stronger relationships with lawyers and accountants who come from longer-established professional fields and are presenting their value proposition to prospective clients in terms of the quality of their advice, rather than the appeal of particular products that they offer. In the United States, despite the absence of a clear regulatory imperative, the market leaders are doing the same things. The big difference is that the laggards haven't been forced to confront the cultural shift that is under way. Ironically, this means that the most ardent opponents of the fiduciary standard, the laggards, will be victims of the success of their opposition as they become increasingly uncompetitive. Blaine F. Aikin is chief executive of Fiduciary360 LLC.