The Trilateral Dilemma in Financial Regulation

Abstract

In choosing financial products and services, consumers often rely on financial advisers to recommend products or services. With surprising frequency, these advisers receive side payments or other forms of compensation from the firms that provide the products or services the advisers recommend. Many times these payments are not clearly disclosed to consumers; often they are entirely secret. These practices, which I label the trilateral dilemma of financial regulation, raise concerns that advisers may be giving their customers biased advice. Side payments of this sort also have the potential to increase the cost of financial products and services. In this article, I describe how trilateral dilemmas have arisen in many different sectors of the financial services industry, including mortgage lending, retirement savings, investment management, insurance brokering, student loans, and banking services. I then review the many different regulatory strategies that Congress and regulatory agencies have employed to police trilateral dilemmas and assess the efficacy of these techniques in solving the problems that side payments of this sort pose. I also evaluate the possibility that side payments and other forms of indirect compensation may in fact be an efficient or at least innocuous means of financing the cost of distributing financial products and services. The article concludes with a brief discussion of how consumer education might address trilateral dilemmas.

Keywords: financial institutions, agency costs, mortgage lending, predatory lending, student loans, mutual funds, pension plans, insurance companies, securities firms

JEL Classification: G2, G21, G22, G23, G24, G28, G38, K23