Yeah, I know: The government has shut down. D-Day for ObamaCare is here. The leaders of Iran and the United States are seriously talking. And I want you to read about some law which will influence whether some investment advisor must follow a “fiduciary” or “suitability” standard in managing your dad’s rollover IRA account. But bear with me. This is important.
While we focus on other battles of consequence, the House may vote this week to enable the financial services industry to effectively squeeze your IRA or 401(k). And few may notice.
The fight in question concerns House bill H.R. 2374. Like many bills favored by the financial industry, it carries a feel-good Orwellian title: The retail investor protection act. Also like many bills favored by the financial industry, its provisions are superficially reasonable, and also opaque. As summarized at beta.congress.gov, the bill:
prohibits the Secretary of Labor from prescribing any regulation under the Employee Retirement Income Security Act of 1974 (ERISA) defining the circumstances under which an individual is considered a fiduciary until 60 days after the Securities and Exchange Commission (SEC) issues a final rule governing standards of conduct for brokers and dealers under specified law.
Amends the Securities Exchange Act of 1934 to prohibit the SEC from promulgating a rule establishing an investment advisor standard of conduct as the standard of conduct of brokers and dealers before it has ascertained: (1) if retail customers are systematically harmed or disadvantaged because brokers or dealers operating under different standards of conduct than those that apply to investment advisors under the Investment Advisers Act of 1940, and (2) whether adoption of a uniform fiduciary standard of care for brokers or dealers and investment advisors would adversely impact retail investor access or availability to personalized investment advice and recommendations.
Requires the SEC chief economist to assess the qualitative and quantitative costs and benefits of such a rule, and the SEC, based on that assessment, to make a cost-benefit determination, assess available alternatives considered, and ensure the rule: (1) is accessible, consistent, written in plain language, and easy to understand; and (2) shall measure and seek to improve the actual results of regulatory requirements….
By imposing delay and requiring new layers of difficult and resource-draining cost-benefit analysis, these provisions were actually designed to weaken and delay worthy regulatory efforts by the Securities and Exchange Commission and the Department of Labor to protect investors, which is why groups such as AARP, AFL-CIO, Americans for Financial Reform, Consumer Federation of America, Demos, Public Citizen, and the Pension Rights Center oppose H.R. 2374.
Investors certainly need the help. For millions of Americans, retirement saving comprises the most important and difficult financial challenge of their entire lives. Social Security actuaries estimate that a man reaching age 65 today can expect to live, on average, another nineteen years. A woman turning age 65 can expect to live, on average, another 21 years. Many people worry that they will outlive their savings. And they should be worried. Median retirement account balances among Americans age 55-64 have been estimated at $12,000. People often have housing wealth, too. But if you add everything up, most people fall short of what’s really required to finance their out-of-pocket medical obligations and other living expenses during a long period of retirement.
For most Americans, Social Security and Medicare will provide the majority of their economic support during retirement. A sound retirement security policy must protect these benefits and securely finance them. Well-designed programs to promote private savings can also be helpful—when they actually reach Americans who face greatest retirement risk.
The American tax code is riddled with efforts to do that. Millions of us save for retirement through 401(k) accounts, new and rollover IRA accounts, and similar vehicles. According to the Congressional Budget Office, tax expenditures associated with the exclusion of pension contributions and earnings total 1.1 percent of the nation’s gross domestic product, well over $100 billion annually.
Unfortunately, this system doesn’t work very well. A depressingly large fraction of these tax breaks go to affluent families in high tax brackets who have money to put aside. Millions of Americans dramatically under-save. Millions of unsophisticated investors pay excessive fees and invest poorly for their retirement. Improving the quality and integrity of these tax-favored investments is a key policy concern.
When, for example, people seek expert guidance in rolling over their 401(k) accounts into other investment vehicles, many are unaware that financial professionals they consult are often acting as salesmen, operating under “suitability” legal standards which too often allow these advisors to offer biased and self-interested advice. A clear “fiduciary” standard would require these professionals to provide optimal guidance from the client’s perspective. That’s what the debate over measures such as H.R. 2374 is really about.
Why is tighter regulation so necessary? Harvard economist Sendhil Mullainathan spearheaded one especially sobering audit study, in which professional actors told financial advisors that they needed assistance with retirement. In one arm of the study, actors told the advisors that their retirement savings were invested in low-fee, well-diversified portfolios designed by financial economists to be optimal investments for retirement. The majority of advisors thus approached failed this rather basic test of their ethics and that professionalism. Most advised their erstwhile clients to move their assets out of these appropriate investments into more costly products that were more lucrative to the advisor.
These findings reflected a widespread problem. When financial professionals face incentives to maximize their own commissions or when they benefit from third-party revenue-sharing agreements, many provide inappropriate advice that harms investors and undermines public confidence in our retirement savings system.
Heavily-marketed investment vehicles typically carry high fees and under-perform standard market indices. According to one study, broker-sold mutual funds dramatically underperform readily-available alternatives such as simple low-fee index funds. Most Americans could save substantially more than they do by following relatively simple strategies—and if they enjoyed greater protection against incompetent or unethical advice.
The Department of Labor is seeking to promulgate improved rules under which broker-dealers and advisers recommending retirement investments would be held to a clear fiduciary standard. It is a sad commentary that many in the industry oppose or seek to dilute these simple rules. Millions of families would actually benefit from expert guidance in managing their expenses, their savings, and their long-term investments. This guidance must be provided under conditions of greater integrity and clarity regarding the amount and source of professional compensation.
Some broker-dealer argue that the imposition of a fiduciary standard would lead them to charge investment clients directly, and that under this business model, low- and moderate-income consumers would receive more limited financial advice. There is some rough truth to this argument. It’s jarring to be charged $250 for a one- hour consultation. It goes down all-too-easily when the consultation is free, but results in (say) a 0.5% higher annual fee on a $75,000 rollover IRA account. If it took you a long moment to figure out the incredible difference in expense here, you are glimpsing another aspect of the problem.
Policymakers should remind small investors of one simple adage: If you’re getting advice for free, you’re probably the product. Especially when one considers the dubious value of so much paid advice, the gains to vulnerable investors from imposing more transparent fiduciary standards far outweigh the associated costs.
Millions of Americans could save far more than we do, could earn higher returns over time, and thereby improve our lives and face more secure retirements. Proper financial services regulation is a key tool in helping us to accomplish these goals.
We cannot allow predictable interest-group politics to derail proper regulation of the financial services industry. I know this stuff may seem unexciting compared to shutdown politics. It’s really important, too.