Conflicts & Capital Allocation

Abstract

The regulatory structure for financial advice now tolerates incentives motivating financial advisors to manipulate and deceive retail investors. While scholars thus far have argued for ways to improve investor protections, the literature has largely ignored how these flawed incentives affect the economy.

This Article contends that these flawed incentives cause financial advisors to negatively affect capital allocation throughout the overall economy.

This Article draws on literature about manipulation and deception in principal-agent relationships to show how conflicts of interest cause the market for financial advisor services to generate excessive intermediation, driving harms to the real economy. This Article uses case studies of non-traded real estate investment trusts and closed-end funds to illustrate how financial advisor conflicts of interest contribute to inefficient capital allocation and inefficiency in the market for institutional intermediation.

To address this issue, this Article argues that an effective policy response will address compensation incentives and focus on limiting the ability of conflicts of interest to skew capital allocation.

Keywords: securities, fiduciary, investment advice, financial advisers, commissions, compensation, REITS, Closed-End Funds, Intermediation