Sunday, August 30, 2015

The New Disclosure Requirements for Oregon Conservators and Why they should be Putting the Money they Manage in Index Funds

The Oregon legislature recently changed what professional fiduciaries must disclose when they ask to be appointed conservator for an incapacitated adult, and what they must include in the annual accounts to the court. Once the law goes into effect, professional fiduciaries, in addition to the long list of disclosures already required, must disclose details about their money management skills, their fees, and the fees of those they will hire to manage the money of the protected person. In annual accounts they will have to disclose the fees paid from conservatorship funds to brokers and money managers. The new law focuses on the murky relationship between conservators, money managers, the prudent investment rule, and appropriateness of paying brokers to manage money for protected persons.

For a long time informed retail investors have known that actively managed funds do not and probably cannot outperform investments managed by a computer. Investment managers are not worth what they get paid and their fees can easily turn profitable investments into money losers. The new law forces professional fiduciaries to ask themselves why they are giving professional money managers a cut of the protected person's money.

The New Rule

Under the new rule a proposed conservator must now disclose the following:
  • The professional experience, investment credentials and licensing under ORS Chapter 59 of the fiduciary or person acting on behalf of the professional fiduciary. 
  • Any revenue sharing agreement between the fiduciary and another person and the manner in which those fees will be computed 
  • An acknowledgment that the fiduciary will invest money of the protected person according to the prudent investor rule (which is in the trust code
The new law then requires that conservators, in their annual accountings, disclose to the court any fees taken from the funds of the protected person by brokers or money managers. That means conservators are going to have to ferret out and reveal how much Edward Jones is charging the protected person for its sage advice and include that amount in the accounting. This has not always been done in the past and is not easy to do.

What problem does this new law solve?

The more cynical in Oregon’s elder law community see the new law as an effort by Allan Trust, our biggest home-grown trust company, to squeeze the competition. Businesses that have done the legwork and put together the capital to become trust companies (or banks) can serve as trustees of trusts without court appointment and can serve as conservators for incapacitated people without posting a bond. Non-trust company fiduciaries (I have written about them here and here and here) can only serve as trustees if they are court appointed and must post a bond in conservatorship cases.

Most non-trust company professional fiduciaries are social workers at heart who manage the protected person’s money as a sideline. Under the new law these social worker types will have to disclose their lack of experience in money management and tell who they intend to use for that purpose. I have never heard of fee-sharing between a non-trust company conservator and a brokerage house, but if it is going on it is going to have to be disclosed. Compliance with the new disclosure requirements will not be difficult and I don’t think it will have much effect. The new disclosures will be buried in the pages of disclosures a professional fiduciary must already make. I doubt that many clients considering a professional fiduciary have been fooled into thinking that their chosen fiduciary with a masters in social work it also a hedge fund manager.

In addition to disclosing their experience in investing, professional fiduciaries will be required to swear allegiance to the prudent investor rule. The rule comes from the trust code and conservators have always had an obligation to follow it. They now must swear under penalty of perjury that they will. The prudent investor rule has been around for a long time and simply requires that trustees invest prudently, diversify, and consider a variety of economic factors when investing. It is a commonsense rule that guides most reasonable investors whether or not they are professional fiduciaries. You can read it here.

Finally, conservators will have to disclose in their annual accounts the money taken from the funds of the protected person to pay brokers and money managers. This could be a problem for a lot of conservators and brokers, but requiring it is a good thing.

I have looked at a lot of brokerage statements when writing final accounts for a protected person. There is no line on these multi-page forms where the brokerage tells you how much it received for managing the funds. I survived college, law school, and a fair amount of post-doctoral work. I have practiced law for decades. Even with all this education, the statements sent to me by most brokerages are incomprehensible. I know from the practicing law that simplicity of expression requires intelligence and hard work. I could therefore conclude that the complexity of brokerage statements is because stock brokers are both dumb and lazy. I really don’t think that is the case. I think there is an intentional effort to disguise what is going on and how much is being charged. With the new requirement that has to change.

I have often listed the opening and closing balances of a brokerage statement and then passed on brokerage the statement to the court. The annual accounts I have submitted like this have been approved. That is fine for the dead and disabled, but when it comes to my own money, I have no intention of paying the high fees for active money management. I let computers do the work.

The Prudent Investor Rule, Conservatorship Funds, and Actively Managed Funds

The prudent investor rule comes from the trust code and requires that a trustee invest funds using a set of common sense guidelines. I apply these same guidelines to my own investments. Being that I don’t want to pay brokerage fees, I could take the time buy stocks and bonds on my own based upon my risk tolerance and my financial goals. But I don't. Managing money is boring to me compared to the practice of law. I don’t want to do it and don’t want to pay high prices to have it done for me. So I invest in index funds.

Index funds are computer managed and track a market. The biggest provider of index is Vanguard. I bring it up by name only because it is the largest of the index fund providers. I have one fund that tracks the Standard and Poors 500. When the market goes up I make money. When the market goes down, I lose. I have other funds in a fund that mixes income, asset growth, and risk avoidance so that I can retire at a target date. The fee for having my funds managed is less than half a percent of the amount invested. There is no load (fee) for putting money into the fund and I do not incur capital gains because some bozo is buying and selling stocks in my account trying to beat the market. With little effort and little expense I meet my personal needs and, incidentally, the requirements of the prudent investment rule.

It has been a poorly kept secret for decades that money managers cannot outperform the market. There are two reasons to believe that professional money management cannot be worth its cost. One is empirical: the other is logical.

  • The Empirical Argument: Professionally managed funds available to retail investors have never beaten the market as a whole over any significant period of time. 
  • The Logical Argument: If the market is efficient, the price of an asset in the marketplace is its value. Thus, if your brilliant broker can buy an asset at a price below its value and sell at a price above its value, then either the market or the broker is corrupt. 
The proponents of managed funds depend upon tall tales and superstition. With millions of fund managers playing the market it is impossible that some of them will not beat the market for a period of time before returning to the mean. These stories of success are always trotted out to distract potential customers from things like math. Someone wins the lottery too. We do not, however, pay past lottery winners to pick our numbers for future lotteries.

The empirical evidence and economic theory are consistent. If the market is fair it will reflect the true value of an asset. If a stock picker can produce returns better than the market, it is either because the market is flawed or the picker has the kind of inside information that should put him in jail. When a decent return on investment in the market is three percent, the stock picker charging two percent for his efforts is taking almost all the return for himself. Managed money for average people in the modern world of big data is an elaborate scam.

The downside of managed money can be seen here. The web page is run by the Financial Industry Regulatory Authority (FINRA). Sign in and find the fund that your broker recommends and look up the costs. Then take a look at returns. Look up the Vanguard funds, or other index funds. Managed funds are simply not worth the money. Conservator’s have used and kept retail brokerage accounts for years because it was accepted and brokers advertise on television. We used to get our plane tickets from travel agents. It is time to change. With conservators now required to report and justify the high money management costs, perhaps the time to change is now.

Complying with the Prudent Investor Rule with Index Funds

In a nutshell the prudent investor rule requires the conservator to maximize net income while minimizing risk. Individual situations may require different balances of income and capital appreciation. Some conservatorships may have particular financial goals, and conservators will always struggle when they have come into possession of unusual assets. Many times, however, a conservator obtains possession of existing investments held by the protected person and is charged only with making sure that the funds are invested pursuant to the rule so that adequate resources are available for the protected person’s long term care.

Within a short time after being appointed, a conservator will be able to estimate the life expectancy of the protected person and care costs. If funds will exceed the cost of care, the conservator will have to consider the protected person’s estate plan and the interests of heirs. Other income, tax status, other assets and special goals will play a part in the investment decisions, but even non-trust company fiduciaries are familiar with balancing these factors.

With the considerations in hand, the conservator can browse the various funds at a company like Vanguard that offers a smorgasbord of funds with asset mixes designed to meet particular needs. As I mentioned, my own asset mix is aimed at retirement. The asset mix for a particular protected person might be quite different from mine, but with a reasonable amount of attention the conservator could quickly have an investment mix that meets the rule.


The new Oregon disclosure statute may be a blessing, but not for the reasons the legislature had in mind. The disclosures themselves will be buried among the long list of disclosures professional fiduciaries must already make. I doubt anyone will be choosing their professional fiduciary based upon the fiduciary's commitment to the prudent investor rule. However, if fiduciaries start to take their obligations seriously and begin seriously looking at index funds as a way to satisfy the rule and reduce costs to the protected person, everyone in the system--with the exception of stock brokers--is likely to benefit.

1 comment:

  1. Thank you for this important information! I hope more people will find their way to your site before they're fleeced.