TIME Markets

Worst Chinese Share Drop in 8 Years Spooks Global Markets

Chinese benchmark index dived 8.48 per cent
Woo He—EPA A stock investor checks prices in a brokerage house in Huaibei, central China, on July 27, 2015

It was the fifth straight loss for the U.S. market

(NEW YORK) — The worst drop in China’s stock market in eight years helped drag down other markets around the world Monday.

The tough day follows declines in U.S. markets last week, when the three major indexes fell more than 2 percent as a number of big companies reported disappointing earnings.

Faced with a drop in stock prices in Asia, Europe and the U.S., investors moved into traditional safe havens. The yield on the 10-year U.S. Treasury note fell to 2.22 percent from 2.26 percent on Friday. The price of gold rose 1 percent.

Dividend-heavy stocks, like utilities, also gained. Investors favor high-dividend companies during times of volatility because they provide a reliable income stream.

“There remain very few buyers out there and there are some growing concerns that we’re looking at a slowdown in global economic growth,” said Sean Lynch, co-head of global equity strategy with the Wells Fargo Investment Institute.

The Dow Jones industrial average lost 127.94 points, or 0.7 percent, to 17,440.59. The Standard & Poor’s 500 index lost 12.01 points, or 0.6 percent, to 2,067.64 and the Nasdaq composite lost 48.85 points, or 1 percent, to 5,039.78.

It was the fifth straight loss for the U.S. market. The S&P 500 is still up about half a percent for the year. The Dow is down 2 percent and the tech-heavy Nasdaq is up 6 percent.

ASIA

The worries for investors this week started with an 8.5 percentage point plunge on the Shanghai market, the biggest one-day decline since February 2007. It was the latest big drop in the Chinese stock market, which has slumped since early June.

Some analysts said Monday’s dive was set off by brokerages restricting credit used to finance stock purchases, also known as margin trading. Chinese authorities took aggressive steps to stabilize the market after it tumbled last month.

“The continuous check on margin trading by security companies has triggered today’s sell-off,” said Xu Xiaoyu, a market strategist at China Investment Securities. “In addition, the recent economic data shows it still takes time for the economy to recover from its sluggishness.”

The precipitous rise and fall of the Chinese stock market has been one of the bigger topics of conversation for investors this summer.

By the time China’s Shanghai benchmark index peaked in early June, it was up 150 percent in the last year. The gains were originally driven by commentary in state media that called the stock market undervalued. That led investors to believe the government would ensure that stock prices gained.

When the Chinese stock market started falling, many investors felt the decline would bring a much-needed correction to that country’s stock market bubble. But many small Chinese investors jumped into the market near its peak and are now sitting on significant losses.

There are now concerns the 30 percent decline in the stock market is starting to do damage to China’s economy. A closely watched Chinese purchasing manager’s index fell to a 15-month low over the weekend, with analysts blaming the drop partly on the market.

“Rightly or wrongly, people are concerned about a global economic slowdown,” said James Liu, a global market strategist with JPMorgan Funds.

The Chinese sell-off ruffled other markets in Asia, though the scant amount of foreign investment in Chinese shares limits the ripple effects outside of Hong Kong, a semiautonomous Chinese territory that is also a financial center.

Hong Kong’s Hang Seng shed 3.1 percent and Japan’s Nikkei 225 dropped 1 percent. South Korea’s Kospi fell 0.4 percent.

EUROPE and the U.S.

In Europe, which has already had a volatile summer because of worries about Greece’s precarious finances, also fell broadly on Monday.

The Euro STOXX 50 index, the European equivalent of the Dow 30, fell 2.4 percent. Germany’s DAX lost 2.6 percent, France’s CAC-40 lost 2.6 percent and the U.K.’s FTSE 100 lost 1.1 percent.

Elsewhere, traders were turning their attention to the U.S. Federal Reserve as they try to assess when the central bank will start raising interest rates. The market appears split between those who think it will happen in September or December. The central bank will also meet this week, but few expect it to begin raising rates.

Traders also have the busiest week for second-quarter earnings reports this week, with 174 members of the S&P 500 as well as six members of the Dow average reporting their results.

BIG PHARMA GETS BIGGER

Generic drug giant Teva Pharmaceuticals jumped $8.76, or 14 percent, to $70.61 after it announced it would buy Allergan’s generic drug division for $40.5 billion in cash and stock. Allergan’s shares also rose, up $19.01, or 6 percent, to $327.19.

CURRENCIES AND COMMODITIES

The price of oil fell to the lowest point since March as another steep drop in Chinese stocks caused concerns that demand from the world’s second biggest oil consumer would slip. Benchmark U.S. crude fell 75 cents to close at $47.39 a barrel in New York. Brent crude, a benchmark for international oils used by many U.S. refineries, fell $1.15 to close at $53.47 a barrel in London.

In other futures trading on the New York Mercantile Exchange:

— Wholesale gasoline fell 0.8 cent to close at $1.820 a gallon.

— Heating oil fell 3.4 cents to close at $1.596 a gallon.

— Natural gas rose 1.3 cents to close at $2.789 per 1,000 cubic feet.

In currency trading, the euro strengthened 0.9 percent to $1.1092 while the dollar fell 0.4 percent to 123.28 yen.

___

AP Business Writer Youkyung Lee contributed from Seoul, South Korea and researcher Yu Bing contributed from Beijing.

TIME Hillary Clinton

Hillary Clinton Courts Both Liberals and Wall Street with Tax Plan

Democratic Presidential Candidate Hillary Clinton Campaigns in Iowa
Bloomberg—Bloomberg via Getty Images Hillary Clinton, former U.S. secretary of state and 2016 Democratic presidential candidate, pauses while speaking during a campaign event in Cedar Rapids, Iowa, U.S., on Friday, July 17, 2015.

A rollout of economic policies continues

Hillary Clinton on Friday proposed a significant hike on capital gains taxes for some investors, a plan favored both by progressive economists and some Wall Street investors.

The proposal is intended to combat short-term investing, which Clinton argued diverts capital away from important business expenditures.

“American companies need to break free from the tyranny of quarterly earning reports so they can do what they do best,” Clinton said speaking at New York University in Lower Manhattan on Friday. “Real value comes from long term growth, not short term profits.”

Clinton’s capital gains plan calls for a sliding scale of taxes on investments, with some short-term investments taxed at higher rates than they are now.

Currently, top earners pay a tax rate of 39.6% on investments held for less than a year, a rate that matches those earners’ income taxes. After holding those investments for a year, the rate for top earners drops to 24%.

But under Clinton’s plan, the tax rate for top earners on capital gains would remain at 39.6% in the second year, and then drop at a staggered rate over six years to their current levels. It would amount to nearly doubling capital gains tax rates in the second year.

“The current definition of a long-term holding period—just one year—is woefully inadequate,” Clinton said, calling on companies to abandon what she has called “quarterly capitalism” in favor of more farsighted investments in research and development, talent and physical capital.

A six-year sliding scale, Clinton said, would “provide real incentives for long-term investments.”

Clinton’s plan for a tax hike is aligned with some voices on Wall Street and financial institutions. Larry Fink, the CEO of BlackRock, the largest asset manager in the world, called earlier this year for a plan similar to Clinton’s. In a March letter to the executives of the 500 largest companies in the United States, Fink recommended holding the capital gains tax rate at income tax rates for three years—39.6% for the highest earners—and eventually dropping over a period of 10 years.

“We believe that U.S. tax policy, as it stands, incentivizes short-term behavior,” Fink said, using language similar to Clinton’s speech on Friday. “We believe that government leaders around the world—with a concerted push from both investors and companies—must act to address public policy that fosters long-term behavior.”

A number of other major business figures have openly lamented so-called economic short-termism, including Dominic Barton, managing director of McKinsey & Co., Paul Polman, CEO of Unilever and others.

Economists, particularly those on the left, have also criticized the relatively low rate of capital gains tax, arguing it acts an income subsidy for the wealthiest Americans.

The Joint Committee on Taxation, a nonpartisan Congressional committee, found that low rates on capital gains taxes will deliver in 2015 an effective subsidy of $120.3 billion to investors, most of them wealthy: a separate report by the Congressional Budget Office found that 68% of the benefit of low rates on capital gains and dividends go to the top 1% of earners.

Clinton’s plan, some economists say, would reduce inequality in the tax code and create incentives for shareholders to hold longer-term investments.

Clinton’s proposal “is a way to target an inefficient tax subsidy—a tax subsidy that subsidizes growing inequality—in a way that encourages more long-term planning by investors,” said Harry Stein, director of fiscal policy at the Center for American Progress. “I view this as a piece of a larger agenda to encourage more of a long term outlook.”

Clinton’s plan is meant in part to slow activist investors, who tend to buy large amounts of company stock and call for higher dividends, share buybacks and other strategies to boost share prices. Some executives complain that makes it more difficult for companies to invest in long-term employees or facilities, stunting long-term growth.

Republicans have been quick to criticize the plan, pointing out that Clinton said during the 2008 campaign that she would not raise capital gains taxes above 20%, “if I raised it at all.” They argue that capital gains taxes harm economic growth by preventing investment.

“Sadly, Hillary is not wise enough to have learned the simple lesson from those decades: reducing the capital gains tax is part of any pro-growth agenda,” said Grover Norquist, president of the conservative Americans for Tax Reform.

Leonard Burman, the director of the nonpartisan Urban-Brookings Tax Policy Center and the top tax economist during the last two years of President Bill Clinton’s administration, said he doubted the plan would significantly change investor behavior.

“I’m sympathetic with her objective, but I don’t think her proposal is going to solve it,” Burman said. He added that the plan might actually encourage some shareholders to pull investments out of a company earlier than they would otherwise: under the new plan, investors who could sell shares after six months gain no tax benefits by waiting until after a year, and little benefit for waiting more than two.

Read more: What to Know About Hillary Clinton’s Economic Proposals

Clinton has laid out a number of specific proposals so far in her campaign intended to spur growth, including providing tax credits to businesses that hire apprentices, tax incentives to encourage corporate profit-sharing, as well as broader proposals like raising the minimum wage and supporting unions. The tax plan is part of Clinton’s slow-drip of proposals designed to boost economic growth and incomes.

It’s unclear if the proposal was enough to satisfy progressives, who are calling for significant overhauls of the tax code. Charles Chamberlain, executive director of the grassroots progressive network Democracy for America, suggested that the speech did not go far enough in targeting income inequality.

“If Secretary Clinton wants to earn the enthusiastic support of grassroots progressives that means standing up, staking out genuinely bold positions on income inequality, and aggressively taking on the powerful, greed-driven institutions that have dominated the Democratic Party and held back the prosperity of the American people for far too long,” said Chamberlain.

TIME Artificial Intelligence

Robots May Write Wall Street Analyst Notes One Day

85018532
Paul Giamou—Getty Images/Aurora Creative Wall Street in Manhattan, New York.

But critics are wary of the implications

Wall Street analyst notes may one day be written by robots — that’s if companies that make the artificial intelligence programs have anything to do with it.

One startup, Narrative Science, creates news articles generated by a computer program. The company has its sights set on financial services, too, The Wall Street Journal reports.

It’ll be a win for banks. They’re trying to boost efficiency and cut costs, and as the artificial technology becomes more advanced it can potentially take on more complex tasks, the report said.

The way Narrative Sciences’ program works goes like this: It sifts through information, such as regulatory filings, databases, and internal documents. Next, it uses an algorithm to put together the information in summaries or articles.

“It’s a very hot debate about whether the financial analyst community is going to be decimated by algorithms,” Celent Senior Analyst William Trout told the Journal. “Disruption, when it happens, happens very fast.”

“Analysts are overwhelmed with the work they typically have to do,” said Narrative Science CEO Stuart Frankel. Robots and automation “frees them up to do higher-value work.”

Wall Street isn’t the only place where robots may become more involved. Other jobs, such as cashiers and drivers, are seeing more automation, too.

TIME twitter

Twitter’s Dick Costolo: Wall Street ‘Accelerates Short-term Thinking’

Twitter CEO Costolo and Twitter co-founder Dorsey walk the floor of the New York Stock Exchange during Twitter's IPO in New York
© Lucas Jackson / Reuters—REUTERS Dick Costolo

Former Twitter leader discusses pressures of going public

Twitter going public proved to be a tougher task than former CEO Dick Costolo initially expected.

The exec, who finishes his post atop the popular social media service on Wednesday, said in an interview with The Guardian that the pressures of meeting Wall Street expectations were severe.

“When we took the company public, I had an expectation that the market would evaluate us based on our financial metrics first and foremost,” he told the publication. “I probably would frame the way we were thinking about the future of the company differently, understanding how we were in retrospect evaluated.”

Costolo added: “You always want to keep focused on the long-term vision, yet when you go public you’re on a 90-day cadence and there’s a very public voting machine of the stock price that accelerates that short-term thinking.”

There’s an ongoing search to find the next CEO of Twitter; co-founder Jack Dorsey will lead the company in the interim. Costolo stepped down from the top spot unexpectedly earlier this year.

Costolo spoke with Fortune’s Christopher Tkacyzk in April to about his thoughts on leadership and free speech in the workplace.

MONEY legal

Wall Street Executive Must Pay $18 Million In Sexual Harassment Suit

Speakers At The Hedge Funds Asia Summit Hosted By Bloomberg Link
Bloomberg/Getty Images Benjamin Wey, Chief Executive Officer at New York Global Group.

Benjamin Wey, CEO of New York Global Group, was accused of pressuring a female employee into sex and then firing her once he found out she had a boyfriend.

Wall Street CEO Benjamin Wey must pay $18 million to a former employee for sexual harassment, retaliation, and defamation, a federal court ruled on Monday.

The Associated Press reports that Benjamin Wey, the chief executive officer of investing firm New York Global Group, was accused of using his authority to coerce Hanna Bouveng into having sex on four occasions before firing her six months later. According to Bouveng, the firing occurred when Wey found another man in her $3,600-a-month Tribeca apartment that Wey had helped pay for.

Following Bouveng’s firing, the 25-year old Swedish native claims Wey tried to ruin her reputation by calling her a “street walker” and “loose woman” on his blog. Her lawyers also say Wey traveled to Bouveng’s new job at a cafe in Stockholm, Sweden, in order to intimidate her. “The message was: ‘Wherever you are, whatever you are doing, I am going to find you and I am going to get you,” said Bouveng’s attorney during the trial.

Wey argued he and Bouveng never slept together and that the woman’s party-going lifestyle eventually led to her firing. However, the court found in favor of Bouveng and ordered the CEO to pay $2 million in compensation and $16 million in punitive damages.

Read next: Goldman Sachs Bans Interns from Pulling All-Nighters at the Office

MONEY mutual funds

Why the Simplest Investing Option Is Still the Best

illustration of house of $100 bill cards
Taylor Callery

Stock-picking fund managers have started the year strong. But indexing still has the edge.

On Wall Street, the knives are out for index funds. In the past few months this low-cost strategy—in which funds buy and hold all stocks in an index like the S&P 500 instead of picking and choosing—has been called a fad, a mania, and mindless. It has been blamed for market volatility. One recent anti-index broadside, a report by Wintergreen Advisers, even pins runaway CEO pay on the funds.

Why are proponents of “active” management so riled up? Maybe it’s because of this: Since 2009 investors have yanked $257 billion out of actively managed stock portfolios while pouring $1.1 trillion into stock index funds.

Sour grapes? Or should you worry that index funds’ popularity is a bubble ready to deflate? Let’s take a look at three popular arguments against indexing.

Argument #1: It’s a Stock Picker’s Market Again!

Diversified stock funds gained 2.6% in the first quarter of 2015, vs. 0.95% for the S&P 500 index. Yet over the past one, three, five, and—keep counting—10 years, less than 25% of blue-chip stock funds beat their index.

Argument #2: Okay, But Wait Until a Bear Market Strikes…

It seems like common sense that active managers should do better in a down market, since index funds must hold all the stocks in a market—in good times and bad. In the 2008 bear, however, most active managers fell at least as much as their bogey, says John Rekenthaler, vice president of research at Morningstar.

Active funds looked stronger during the dotcom crash in 2000. A bubble in one part of the market meant some managers could hide in cheaper small-cap and value-oriented stocks. These days, though, even traditional value stocks look pricey. “Where is the refuge for active managers in this market?” asks Rekenthaler. “I don’t see one.”

Argument #3: If Indexing Gets Too Popular, Active Funds Will Win.

One reason it’s hard to beat the market is that whenever you bet on a stock, there’s another clever trader taking the other side. If everyone indexes, though, maybe there’s less “smart money” in the market to match wits against, making it easier to find opportunities in mispriced stocks. We’re a long way from that day, though. Indexing still accounts for just 15% of the money in various kinds of U.S. funds. Besides, if active funds did start beating the market consistently, you can count on money, both smart and dumb, pouring into those strategies. At that point watch the odds shift back to indexers.

TIME Investing

Shaq Wants to Make IPOs a Slam Dunk For the Average Investor

Orlando Magic add Shaquille O'Neal to team's Hall of Fame
Orlando Sentinel—TNS via Getty Images Shaq says IPOs should be a slam dunk for average investors.

The legendary basketball player wants to recruit more individuals to invest in them

Shaquille O’Neal wants to recruit more individuals to invest in IPOs at a time when more and more of the deals are turning out to be air balls.

The legendary basketball payer is investing in Loyal3, a brokerage firm that wants to give more individual investors access to initial public offerings, according to The Wall Street Journal. Shaq is also joining the San Francisco company’s advisory board and said he will help promote the company’s mission.

Loyal3 was started three years ago, and is run by Barry Schneider, a former golf company executive. Loyal3’s executive vice president Bill Blais is a long time Wall Streeter, and a former Goldman Sachs and Morgan Stanley investment banker. Loyal3 doesn’t run its own deals. It partners with other investment banks to get a small chunk of an IPO, typically 5%, that it then markets to individual investors. Wall Street has typically doled out IPO shares to its best customers, usually large investment funds and rich investors. Instead, Loyal3 sells the shares it receives on a first-come, first-serve basis to investors with as little as $100 to invest, and for no commission. Loyal3 says companies like to have the brokerage in on their deals because individual investors tend to be more loyal investors than large institutions.

Despite the highly sought after nature of IPOs, they tend to be risky investments, and Shaq is running into the IPO game at a time when the quality of many of the most recent deals is clearly looking deflated.

Of the 37 companies that went public in the first quarter of the year, just 10% had operations that were turning a profit, down from 43% in 2013. And the performance of the deals has waned. Shares of the average IPO have risen just 15% this year. That’s better than the market, but far less than 40% return of two years ago, though that is based on full year.

Many noteworthy IPOs have tumbled recently. Shares of Etsy have fallen nearly 50% from where they closed on their first day of trading. Etsy also set aside a chunk of its IPO shares for individual investors, selling 5% of its shares online through Morgan Stanley. Etsy also sought to limit the number of large investors in the deal. Loyal3 was not involved in the offering. Some have blamed the unusual structure of the IPO for why the shares haven’t done so well. Other IPOs this year, like that of cloud company Box, have also been duds.

Loyal3 has been involved in 13 IPOs, including some high profile deals like camera company GoPro [fortune-stock symbol=”GPRO”], shares of which are up nearly 150% from its 2014 IPO. Pet Insurance company Trupanion, another deal Loyal3 has been in on, have not done as well, down 20% from it’s IPO price. It’s not clear how well Loyal3’s deals have done overall. Loyal3 does not include its complete list of IPO deals on its website. The company did not respond in time to comment for this piece.

Read more on IPOs: The IPO used to be a moment of glory. Now it’s a sign of desperation

TIME Hillary Clinton

Why Hillary Clinton Prefers to Talk About Community Banks

Democratic presidential hopeful and former Secretary of State Hillary Clinton arrives for a meeting with parents and child care workers at the Center for New Horizons in Chicago on May 20, 2015.
Scott Olson—Getty Images Democratic presidential hopeful and former Secretary of State Hillary Clinton arrives for a meeting with parents and child care workers at the Center for New Horizons in Chicago on May 20, 2015.

Like many Democrats, Hillary Clinton has talked tough about reining in mega banks. But as her presidential campaign has gotten underway, she’s focused on the homier side of the financial industry: community banks.

At a roundtable in Cedar Falls, Iowa, Clinton spoke on Tuesday less about tightening oversight on Wall Street and more about loosening regulations for banks on Main Street. She argued that red tape and paperwork for small banks across the country are holding back small businesses by making it harder to get much-needed loans.

At times, listeners might have even mistaken Clinton for a moderate Republican.

“Today,” Clinton said, “local banks are being squeezed by regulations that don’t make sense for their size and mission—like endless examinations and paperwork designed for banks that measure their assets in the many billions.”

“And when it gets harder for small banks to do their jobs, it gets harder for small businesses to get their loans,” she said. “Our goal should be helping community banks serve their neighbors and customers the way they always have.”

Community banks tend have less than $1 billion in assets, are usually based in rural or suburban communities and are the kind of place your uncle in Idaho might go for money to open an antique shop. Touting small businesses is a tried-and-true trope for candidates on both sides of the aisle. For office-seekers from Barack Obama to Marco Rubio, the subject is as noncontroversial and all-American as crabgrass.

The difference, then, comes at how politicians want to handle bigger banks. Congress right now is debating how far to exempt banks from certain regulations. Democratic lawmakers generally want to reduce them only for smaller banks; some Republicans want to exempt all banks, an approach Clinton criticized.

Big banks in the United States have become increasingly large and powerful in the seven years since the financial crisis. Of the 6,000-odd banks in the United States, the five largest control nearly half of the country’s banking wealth, according to a December study. In 1990, the five biggest banks controlled just 10% of the industry’s assets.

Small banks complain that federal regulation in the aftermath of the Dodd-Frank legislation is contributing to a decline in their numbers. Annual examinations at a community banks, for instance, require staff to walk regulators through paperwork. Filling out paperwork and paying for compliance lawyers to deal with new Dodd-Frank stipulations are burdensome extra costs, banks say. And new rules can impose high damages on lenders who do make unsafe loans.

“There’s an inherent advantage in scale,” said Mike Calhoun, president of the Center for Responsible Lending, pointing out that small banks often have more trouble paying for regulation compliance. “Community banks, being smaller, have less business to spread the cost of regulations over.”

It’s an issue that resonates with Iowa bankers, says John Sorensen, president and CEO of the Iowa Bankers Association. “A lot of the banks we have across Iowa are small businesses with 10 to 30 employees that have been interrupted in their ability to serve their customers through a good part of Dodd-Frank,” he said.

But some say the discussion about scrapping community bank regulations as Clinton suggests is a distraction. Small banks were in steady decline for many years before Dodd-Frank, and they are protected from liability on certain loans that big banks are not. And regulators argue that preventing risky mortgages of the kind that brought on the financial crisis is a good thing.

Much of the push to deregulate community banks comes from bigger institutions who want exemptions from regulation themselves. “If you were able to somehow magically trace who is whipping up frenzy about regulator burden on small banks, you’d find its trade associations at the behest of bigger banks,” said Julia Gordon of the Center for American Progress, a left-leaning think tank that has supplied some top officials in the Clinton campaign.

During the roundtable, Donna Sorensen, chair of the board of Cedar Rapids Bank and Trust and a participant on Tuesday, suggested to Clinton that more U.S. Small Business Administration-supported loans come with no fees. Clinton took notes and nodded in assent.

“If we really wanted to jumpstart more community bank lending, part of what we would do is exactly that—raise the limits to avoid the upfront fee” for businesses that need loans, Clinton said.

Clinton did not say specifically what regulations she would remove if she were elected president, but locals in Independence, Iowa, where Clinton stopped by for a visit after her small business roundtables, asked her to hold true to her sentiments. Terry Tekippe, whose family owns an independent hardware store, walked onto the street as Clinton walked by. “Keep us in focus,” Tekippe said.

“I want to be a small business president, so I am,” Clinton called back as she continued down the street.

TIME Banking

New Survey Confirms Exactly What Everybody Hates About Wall Street

Five Years After Start Of Financial Crisis, Wall Street Continues To Hum
John Moore—Getty Images A street sign for Wall Street hangs outside the New York Stock Exchange on September 16, 2013 in New York City.=

Almost a quarter of bankers said they'd break the rules

Wall Street bankers are feeling a greater willingness to violate laws and ethics to get ahead, according to a new survey that finds no discernible impact from years of record fines and tightened regulations.

One-quarter of respondents said they would violate insider trading laws to make a $10 million return as long as they knew they wouldn’t get caught, according to a survey of 1,200 financial professionals conducted by University of Notre Dame at the behest of the law firm Labaton Sucharow. That was actually a slight uptick from the previous survey, when the percentage stood at 24%.

Respondents weren’t exactly impressed with regulatory oversight either. Nearly half deemed the regulatory agencies ineffective at detecting and prosecuting illicit behavior.

 

MONEY fiduciary

If Humans Can’t Offer Unbiased Financial Advice to the Middle Class, These Robots Will

Wall Street says it can't be a "fiduciary" to everyone who wants financial advice. But the new breed of "robo advisers" is happy to take the job.

Fast-growing internet-based investment services known as robo-advisers have already begun to upend many aspects of the investment business. Here’s one more: Potentially reshaping the long-standing debate in Washington over whether financial advisers need to act in their clients’ best interests.

If you work with a financial adviser you may assume he or she is legally obligated to give you unbiased advice. In fact, that’s not necessarily the case. Many advisers—the ones who are technically called brokers—in fact face a much less stringent legal and ethical standard: They’re required only to offer investments that are “suitable” for you based on factors like age and risk tolerance. That leaves room for brokers to steer clients to suitable but costly products that deliver them high commissions.

The issue is especially troubling, say many investor advocates, because research shows that most consumers don’t understand they may be getting conflicted advice. And the White House recently claimed that over-priced advice was reducing investment returns by 1% annually, ultimately costing savers $17 billion a year.

Now the Labor Department has issued a proposal that, among other things, would expand the so-called fiduciary standard to advice on one of financial advisers’ biggest market segments, Individual Retirement Accounts. A 90-day comment period ends this summer.

Seems like an easy call, right? Not so fast. Wall Street lobbyists contend that forcing all advisers to put clients first would actually hurt investors. Their argument? Because advisers who currently adhere to stricter fiduciary standards tend to work with wealthier clients, forcing all advisers to adopt it would drive those who serve less wealthy savers out of the business. In other words, according to the National Association of Insurance and Financial Advisors and the U.S. Chamber of Commerce, a fiduciary standard would mean middle-class investors could end up without access to any advice at all.

(Why, you might ask, would anyone in Washington listen to business rather than consumer groups about what’s best for consumers? Well, that is another story.)

What’s interesting about robo-advisers, which rely on the Internet to deliver automated advice, is that they have potential to change the dynamic. Robo-advisers have been filling this gap, offering investors so-called fiduciary advice with little or no investment minimums at all. For instance, Wealthfront, one of the leading robo-advisers, has a minimum account size of just $5,000. It’s free for the first $10,000 invested and charges just 0.25% on amounts over that. Arch-rival Betterment has no account minimum at all and charges just 0.35% on accounts up to $10,000 when investors agree to direct deposit up to $100 a month.

Of course, these services mostly focus on investing—clients can expect little in the way of individual attention or holistic financial planning. But the truth is that flesh-and-blood advisers seldom deliver much of those things to clients without a lot of assets. What’s more, the dynamic is starting to change. Earlier this month, fund giant Vanguard launched Personal Advisor Services that will offer individual financial planning over the phone and Internet for investors with as little as $50,000. The fee is 0.3%.

The financial services industry says robo-advisers shouldn’t change the argument. Juli McNeely, president of the National Association of Insurance and Financial Advisors, argues that relying on robo-advisers to fill the advice gap would still deprive investors of the human touch. “It all boils down to the relationship,” she says. “It provides clients with a lot of comfort.”

But robo-adviser’s growth suggests a different story. Wealthfront and Betterment, with $2.3 billion and $2.1 billion under management, respectively, are still small but have seen assets more than double in the past year.

And Vanguard’s service, meanwhile, which had been in a pilot program for two years before it’s recent launch, already has $17 billion under management.

Vanguard chief executive William McNabb told me last week that, although Vanguard had reservations about the specific legal details of past proposals, his company supports a fiduciary standard in principle. Small investors, he says, are precisely the niche that robo-advisers are “looking to fill.”

 

 

 

 

 

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