There’s still great uncertainty about what direction financial regulation is going to take, particularly in view of Republicans’ newfound control of the House of Representatives.  Back in July, headlines like this one, trumpeting replacing a “suitability” standard with a fiduciary standard, were a dime a dozen.  (I won’t go into the differences between the two standards here.)

I believe one unintended consequence of setting the broker/dealer bar at “fiduciary” instead of “suitable” might well be a significant hit to the closed end fund (CEF) business, and here’s why:

Take a look at this graphic, straight off the cover of a recent CEF (no names, as it really doesn’t matter), and let’s reconvene immediately below:

Every single financial advisor who committed clients’ funds to this CEF IPO plunked down $25 in cash in exchange for $23.875 in cash – which will remain in cash until the fund begins to scale into its investments under whatever its mandate might be.  It is exactly for this reason that stablizing bids are used by underwriters for some period of time (usually up to 90 days) to support the price.  That said, it’s just about a lock that once the stabilizing bid is removed, the price is going to drift down toward the Net Asset Value (NAV).  Rare indeed is the CEF that does not break its issue price when the stabilization is removed. Which begs the questions:  Why buy CEFs on the offering?  Knowing it’s virtual certainty that a CEF will break its issue price, why not wait until it does so?  Would/could buying a CEF on the offering be considered a breach of an advisor’s fiduciary duty?  What compelling reason would there be to participate in the offering?  Whatever the CEF investment, it may well be suitable for a given investor — of that there can be no doubt.  But if the bar is raised to fiduciary, committing a client’s funds on the offering becomes, in my very humble opinion, less defensible, particularly given what we know about how the vast majority of CEFs trade in the short-term aftermarket.

Is anyone aware of a CEF that did not break its issue price in the first 2 – 4 months of trading?  I’d be very interested in knowing.

What say ye?  What am I missing?

Category: Apprenticed Investor, Investing, Legal, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

11 Responses to “Might “Fiduciary Standard” = A Blow to CEFs?”

  1. Julia Chestnut says:

    You are right, BR, but I’d go farther: IPOs of anything typically wind up below the offering price about a year in (if not sooner). I’ve noted this for a long, long time. Picking the IPO that is going to pull away from the pack looks, in my estimation, closer to an art (or a gamble) than a science.

    And yet, everybody keeps putting customers in IPOs. Hey – while we’re at it, I think the sophisticated investor rule needs some attention, because to my mind those are just people with enough assets to be an attractive mark.

    But I’m drifting off topic.

  2. BuffaloBill says:

    Welcome again to the world of fiduciary risk and the law of unintended consequences. Frankly, I don’t believe you’re missing a thing.

  3. dead hobo says:

    I have no problem with holding advisors to a fiduciary standard. I will never forget finding out that my elderly relative, who needed the savings, lost a bundle in 2007 because an idiot advisor keep the cash invested in about 20 funds just to earn commission. The advisor had no regard concerning the actual need for the funds. As a spillover consequence, I cashed out and stayed out of the 2009 rally because I thought I might have to support my relative and there was no certainty about the stability of the economy while the markets acted without regard to economic fundamentals. My elderly relative changed advisors and jumped back in and by sheer luck is earning money from a jones to take too much risk. I washed my hands of any obligation to provide support if this advisor screws up.

    To me, all cash managers, advisors, and the like will rationalize any reason to sell a financial product to anyone since they get paid regardless of if it goes up or down. The fiduciary standard is needed as a matter of basic consumer protection.

  4. pistol495 says:


    TPZ is the first that comes to recent mind. There certainly have been more. It seems that when there’s significant demand for the underlying security it can go up especially when the offering is limited to a few houses.

    TPZ is a combo of MLP equity and bonds. It is clear that this has been an area of investor appetite over the last year +.

    The fiduciary concept is something that will be debated for quite some time.

  5. pistol495 says:

    I stand corrected. TPZ broke its IPO price but quickly rebounded. My guess is much quicker than other you have reviewed and for the reasons in the prior post


  6. JimmyDean says:

    You’re spot on BR. I was a broker at 2 major US wirehoues for 8 years (I’m an independent now) and these closed-end funds are regularly pushed by management. Very often there are roadshows for these funds to ensure the spotlight is on them and the salesforce (ahem, I mean the financial advisors) are aware they are available.
    The closed-end funds pay 3% to the broker so they’re a huge revenue stream for the firms and they are issued every month so the revenue stream to the broker and the firm is pretty consistent.
    That said, if you care at all about your clients at all you don’t touch this stuff. Closed-end funds can be decent investments occasionally, but you’re right you never want to buy on the offer. If fiduciary responsibiltiy is foisted on the brokers the closed-end fund IPO business should dry up, though the lawyers and lobbying groups for the banks and brokers are certainly capable of creating or finding some loophole that could allow it to cointinue.
    Regularly recommending closed-end funds to clients is considered somewhat dirty business by a lot of reputable brokers and advisors, even though a good number do it anyway.

  7. Lyle says:

    Jimmys anecdote suggests that the sales and advice function should be totally divided. Brokerage houses should use the web and hire order takers only who are explicitly not allowed to suggest any orders to the client. The financial advice business should be a business that charges for time and materials for the advice, no sales commissions. In fact the advisor should not be able to make any trades on their own.

  8. vailrider says:

    I still can’t believe the nearly 20% loads piled onto private REIT investors… I can’t think of a better target for the consumer protection agency. No rational or slightly educated investor would ever invest in those vehicles… yet the 7% broker commissions keep the cash flowing in every day…

  9. [...] Are closed-end funds at the offering by definition not a ’suitable investment’?  (Big Picture) [...]

  10. Takeyourfinger says:

    What about Morgan Stanley China A shares, ticker CAF?

  11. philipat says:

    You’re quite correct. An extension of the “Fiduciary” standard might even be that CEF’s tend to under-perform their comparable non-CEF peers, so should they be recommended at all, especially to a small investor?