Yet Another Independent Study Highlights High Conflict-of-Interest Cost to Retirement Investors
Nothing can defeat a tired boxer more than the classic succession of quick punches known as the “one-two.” In the jargon of the sweet science, a “one-two combo” refers to a quick jab followed by a cross. You expect the first one. It’s the unexpected second punch, though, that knocks you out. Barely a month ago, NBER released an independent study the concluded conflicted advisers are more likely to keep and recommend affiliated funds even of those funds are among the worst performing funds. (See “Study: SEC Fiduciary Delay Costing Retirement Investors $1 Billion per Month,” FiduciaryNews.com, February 12, 2013) Based on the data in the study, the implied cost of allowing this conflict-of-interest was more than $1 billion a month.
Almost immediately on the heels of this NBER paper comes yet another independent study highlighting the high cost conflicts-of-interest pose to retirement investors. The paper, “Will Regulations to Reduce IRA Fees Work?” (Munnell, Alicia H., Webb, Anthony and Vitagliano, Francis M., Center for Retirement Research at Boston College, February 2013, Number 13-2), concludes 12b-1 fees alone cost IRA investors $2 billion in 2009. That doesn’t include the loss in performance returns alluded to in the NBER and earlier studies (see “Does New Study Seal the Deal for Fiduciary Standard – or Just Warn Plan Sponsors?” FiduciaryNews.com, January 19, 2011).
The CRR article focuses exclusively on IRAs and the DOL’s proposal to include IRAs under the ERISA fiduciary umbrella. Doing so, as the authors point out the industry claims, would place the broker’s ability to receive 12b-1 fees at risk. The researchers took two different approaches to determine the true impact of the DOL’s proposal. They conclude, “both cases, the estimated effects of the DOL reform are small and the reform’s benefits outweigh its costs.”
Although not formally peer-reviewed, Amy Grzybowski, the press contact designated on the CRR website, told FiduciaryNews.com the researchers did share early drafts of their white paper with other researchers and actively sought helpful commentary.
Needless to say, 12b-1 advocates have attacked the paper. The authors, perhaps anticipating this almost certain rebuttal, state in the paper the aforementioned $2 billion in 12b-1 fees accrued during 2009 “would amount to about 1 percent of their total (non-trading/non-underwriting) annual revenue ($200 billion).” Such a small number is almost certain within a standard accounting rounding error and suggests the industry may be exaggerating the impact of the DOL’s proposal. To date, the industry has provided no validate independent research to refute the conclusions of either this (CRR) paper or the various other papers cited earlier. The authors write, “It seems unlikely that broker-dealers are going to change what has been viewed as a successful business model for a 1-percent decline in revenues. Thus, the best prediction is that the DOL proposal will reduce fees modestly but will not cause any meaningful disruption in the provision of advice.”
At this venture, it would have been useful for this particular research team – or any of the others reaching similar conclusions as to the actual cost in underperformance – to ask the next logical question. “In my experience many investors do not understand how advisors are compensated and for any number of reasons seem to be too embarrassed to ask,” says Paul Powell, Managing Director at 401(k) Advisors in Dotham Alabama. One might figure with all these studies suggesting broker-sold funds and 12b-1 funds consistently underperform funds with no conflict-of-interest, investors in their right mind might want to ask questions before buying through a conflicted agent. Given the market size of the conflict-of-interest mutual funds, they apparently do not.
In essence, it might help regulators if researchers of papers like the CRR paper try to identify why investors make poor choices. Is it really because they can’t afford to receive advice from advisers with no conflict-of-interest? And, if they must solicit “advice” from agents with a conflict-of-interest, is it correct to apply the term “advice” to their service? Some have suggested these agents aren’t advising, they’re selling.
If January’s NBER paper jabbed at the brokerage industry’s conflict-of-interest problem, the CRR paper smashed a right cross into the jaw of conflicted agents. And although the CRR paper specifically addresses the DOL proposed new Fiduciary Rule, the SEC, in the midst of a cost-benefit analysis of its proposed Fiduciary Standard, must also be listening.
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