C&B Notes

Zweig Riffs on Conflicts and ‘Sophistication’

Virtually every brokered transaction involving securities contains conflicts of interest.  Regulation and disclosure provide cover to the conflicted rather than protection to the buyer/seller in many cases.  It seems to us that a more rational strategy for market participants is caveat emptor.

From the 1940 edition of Security Analysis: “[T]he sale of securities is not a profession but a business, and is necessarily carried on as such.  While in the typical transaction it is to the advantage of the seller to give the buyer full value and satisfaction, conditions may arise in which their interests are in serious conflict.  Hence it is impracticable, and in a sense unfair, to require investment banking houses to act as impartial advisers to buyers of securities; and, broadly speaking, it is unwise for the investor to rely primarily upon the advice of sellers of securities.”

Tackling what he calls the myth of the “sophisticated investor,” Jason Zweig notes how the toxic mix of complex products and overconfidence can make fools of investment professionals:

As Scitofsky argued, the deliberate escalation of complexity enables sellers to compete on dimensions other than price and quality.  In the ultimate irony, the sellers of complex products will promote themselves on the basis of their specialization in making ignorant customers feel “sophisticated.”  (Just think: You used to have merely a “stockbroker” or a “financial planner.”  Now you can have a “wealth manager”!)

As Warren Buffett has said, what matters isn’t how expert you are, but how well you understand the limits of whatever expertise you have.  Psychologists have highlighted a critical pitfall with human expertise: The more people know, the more they come to believe they know even more than they actually do.

We’d all be better off if the term “sophisticated investor” were taken out to the back of the barn and buried under the manure pile, where it belongs.

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