Beware Of Lawmakers Trying To Protect Us
In the wake of the Dodd–Frank Wall Street Reform and Consumer Protection Act that was signed into law by President Obama in 2010, there’s been a five-year fight going on in Congress pitting investor protection against Wall Street profitability. What bothers me significantly is the deceptive way one side appears to be framing the discussion.
Some background first. When it comes to providing paid investment advice, there exist two federal laws, both created as a result of the Great Depression. The Securities Exchange Act of 1934 regulates brokers (among other things) and the Investment Advisors Act of 1940 regulates investment advisors like me. At the time brokers did not provide investment advice, they merely bought and sold securities for clients. But as the independent advisor profession expanded, the brokerage industry saw the opportunity for increased revenue and began to train their representatives not just to take orders but to actively recommend financial products. Most of their income came from trading costs as well as commissions from financial product sales. Putting aside whether or not you believe commissions are a good or a bad thing for investments, the real problem was that the 1934 Act provided a different level of consumer protection than the 1940 Act. The latter required that advisors put the best interests of their clients above their own financial interests (known as a fiduciary rule), while the former only required that recommendations by brokers be “suitable” for their clients. The weaker 1934 Act rule allowed brokers, especially those on commission, to sell mutual funds and other products to clients that provided them higher commissions, often at a higher cost to their clients.
Obama called on the Department of Labor (DOL) to update the rules that apply to all retirement advisors based on the fiduciary approach. As he put it, “It’s a very simple principle: You want to give financial advice, you’ve got to put your client’s interests first.” The DOL, after nearly five years of work, has recently posted the new rules for public comment, and here’s an excerpt from their fact sheet (http://www.dol.gov/ebsa/newsroom/fsconflictsofinterest.html ):
Today, the Department of Labor issued a proposed rulemaking to protect investors from backdoor payments and hidden fees in retirement investment advice.
- Backdoor Payments & Hidden Fees Often Buried in Fine Print Are Hurting the Middle Class: Conflicts of interest cost middle-class families who receive conflicted advice huge amounts of their hard-earned savings. Conflicts lead, on average, to about 1 percentage point lower annual returns on retirement savings and $17 billion of losses every year.
- The Department of Labor is protecting families from conflicted retirement advice. The Department issued a proposed rule and related exemptions that would require retirement advisers to abide by a “fiduciary” standard—putting their clients’ best interest before their own profits.
- The Proposed Rule Would Save Tens of Billions of Dollars for Middle Class and Working Families: A detailed Regulatory Impact Analysis (RIA) released along with the proposal and informed by a substantial review of the scholarly literature estimates that families with IRAs would save more than $40 billion over ten years when the rule and exemptions, if adopted as currently proposed, are fully in place, even if one focuses on just one subset of transactions that have been the most studied.
Not surprisingly, the financial services industry is fighting back. And they have good reason to do so. According to a report from Personal Capital Corporation (as reported by Bloomberg), the average total annual fees collected by eleven brokerage firms was over 1.6%, with Merrill Lynch topping the list at 1.98%. And the growth of the financial services industry has been enormous. In a paper entitled “The Growth of Finance,” Robin Greenwood and David Scharfstein of Harvard University determined that the financial services sector of the economy grew from 4.9% of GDP in 1980 to 8.3% in 2006, accounting for more than 25% of the growth of the services sector as a whole.
Right now there are two bills working their way through the legislative process that would require an affirmative vote by Congress before any final rule by the DOL goes into effect. In other words, the bills would give politicians the ability to reject the proposed rule. Peter Roskam, R-Illinois and Phil Roe, R-Tennessee, are leading the effort.
I support the DOL’s proposed rule, and at the same time I have no objection to the concept that lawmakers should have a say in the promulgation of such rules. Of course, one could argue that they have had plenty of time and opportunity to provide input to the DOL during the public comment period, and that creating a law giving them the power to block the rule might be considered a somewhat heavy-handed approach. But my objection comes primarily from the names they chose for the two bills: the Strengthening Access to Valuable Education and Retirement Support (SAVERS) Act and the Affordable Retirement Advice Protection (ARAP) Act. Neither bill improves access to or affordability of retirement advice, making those descriptions quite illusive. Even worse, the bills’ proponents have been quoted in the media as stating that this legislation will “protect the retirement savings of all Americans” from the DOL’s new rule and “help strengthen the retirement security of working families and ensure retirement advisors protect their clients’ best interests.” In reality, that’s exactly the opposite of what the bills were designed to do, which is to continue to allow brokers to earn a lot of money selling financial products that don’t have to meet the standard of being in the best interest of their clients.
I appreciate the value of positive spin on messaging. After all, ‘mouth-watering sushi’ sounds a lot more appetizing than ‘raw dead fish.’ Nonetheless, there’s nothing that annoys me more than communications intentionally crafted to obfuscate, conceal, or otherwise misinform people, especially when it comes to financial decision-making. I know this is common with political agendas. Nonetheless, there ought to be a law requiring that the names of bills in Congress be reflective of their actual intent. Hmm, maybe we need another bill…