ICYMI: The White House just released new rules protecting retirement savers. Here’s why they’re needed.
On Wednesday, the Department of Labor released the final version of its fiduciary rule requiring brokers to put their retirement saving clients first -- placing the customers' interest ahead of their own.
Though this may seem self-evident, the rule has been ferociously fought by the financial services industry. Among other things, the industry complained that the proposed rule would be too costly, especially for small brokers, and pile on too much paperwork. In its defense, the Labor Department argued that the rule would save as much as $17 billion a year lost by small investors placed into risky or inappropriate investments by advisors hiding their conflicts of interest. The department modified some aspects of the proposal to meet some industry objections, but kept most of it intact. A Labor Department fact sheet on the rule, which will begin to be phased in next April, is here.
I examined the necessity for the rule last year, and reprint that column below. I also examined the advertising campaign launched by the financial advice industry to kill the rule. A video from that campaign can be found below too.
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The idea that investment advisors owe a higher duty to their clients than to their own pocketbooks is an old one, often detested by Wall Street.
So the announcement Monday from the White House that it will impose such a standard on advisors in the individual retirement account and 401(k) business may be a big step forward.
This is a huge win for the middle class. We are putting in place a fundamental principle of consumer protection.
— --Labor Secretary Thomas Perez
We say "may be," because the actual details of the Obama administration's rule are still nebulous. The details, to be promulgated by the Department of Labor, won't be known for weeks, even months. So there are still questions about what exactly the rules on advisors will say and how they'll be enforced.
What is known is that the administration intends to impose a fiduciary duty on advisors in the individual retirement account market. In the simplest terms, this means that advisors with a conflict of interest in steering you to an investment -- they get a commission from the investment promoter, say -- are on the wrong side of the rule.
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In some corners of Wall Street, this is a dangerously radical idea. Back in 2010, Sen. Susan Collins (R-Maine) asked a lineup of Goldman Sachs investment bankers whether they had a duty to act in their clients', not their firm's, best interests?
They squirmed. "I believe we have a duty to serve our clients well," one witness replied, carefully. Another conceded: "Conceptually it seems like an interesting idea."
The correct answer to the question of whether investment bankers have a duty to act in their clients' best interest, however, was "no."
When it comes to Americans' retirement accounts, the issue is especially urgent. Since the 1970s, Americans' retirement resources have shifted inexorably from accounts managed by professional investment advisors -- defined-benefit plans in which any investment shortfall has to be made up by the employer -- to those managed by the workers themselves.
Most workers don't have the experience or expertise to appraise what they're being sold. (It's hard enough for experts to find their way through thickets of conflicts.) The result has been a steady draining of peoples' retirement accounts through inappropriate investments that only fatten Wall Street.
According to a report from the Council of Economic Advisors issued Monday in conjunction with the announcement, "the aggregate annual cost of conflicted advice is about $17 billion each year." As Jared Bernstein, the former economic advisor to Vice President Joe Biden, observes, Wall Street types vociferously dispute the figure. But they don't offer a better estimate.
Such a loss, amounting to 1 percentage point in investment return per year, would cost the average retiree five years in retirement resources, the report says.
It's not hard to take advantage of an individual trying to figure out what to do with a retirement nest egg. The White House report suggests that problems arise especially when people transfer their 401(k) balances into an IRA, perhaps because they've moved or lost a job. This entails taking funds out of professionally-selected mutual funds offered to 401(k) account holders by their employer, and putting them in a new set of funds or new investments entirely.
The White House points out the built-in disadvantage faced by most people in this situation: rolling over a 401(k) into an IRA might happen once in their lives. It's the only time they must choose among investment products, making it "one of the most complicated savings decisions they will face in their lifetime." Most people face this decision later in life, when they have the largest nest egg to lose.
The difficulty resembles the problem most consumers have when buying a car. Think you can beat the car salesman at his own game? You might make five or 10 auto purchases in your life. The average car salesman makes 11 sales a month.
Still think you can beat him at his own game?
Since 1974, the report says, investment customers have faced a "proliferation of index mutual funds, discount brokerage, exchange-traded funds, online trading, and more. ... An abundance of investment options and the way in which investment decisions are framed may challenge financial decision-making and lead to worse outcomes for savers. It's difficult for customers to know even what standards and ethical rules their investment advisor is bound by, because they differ according to what role he or she is playing in any given situation.
Industry lobbyists say requiring brokers to meet a fiduciary standard that applies today only to registered investment advisors, a special category of money managers, "will lead to more lawsuits against the industry and add burdensome compliance requirements," Bloomberg reports. That sounds like a good thing, insofar as it prompts advisors to act more honestly.
The industry says it will mean that brokers will abandon the small-investor segment. Good riddance. As Bernstein observes, "If it’s such a freakin’ problem to introduce measures that enforce acting in the best interests of average people saving for their retirement years, then maybe there’s a hitch in your business model."
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