Obama Fires Fiduciary Starter Pistol to Mixed Reviews
When the President of the United States takes the podium to promote a cause, the issue becomes elevated. If you’re a proponent of that issue, you’d think you’d be happy. If you oppose the issue, you tend to mute the intensity of your voice.
But not always.
The current White House occupant has a tarnished reputation when it comes to promoting big ideas. His signature piece, known as the Affordable Care Act (a.k.a. “ObamaCare”) has suffered one technical glitch after another and faces the executioner’s axe in the Supreme Court. Whatever success it has had in bringing some of the previously uninsured under the health care umbrella will forever be marred by the President’s infamous (and, it turns out, not entirely correct) remark, “If you like your doctor, you can keep your doctor.” Similarly, his unilateral attempt to write immigration policy via executive order failed in Federal Court, and his efforts to regulate the internet via “net neutrality” (derisively called “ObamaNet”) face similar legal challenges.
So when a reputed home run hitter with such a pronounced track record of striking out wants to join your team, what do you do?
We spoke with members of both dugouts to get an assessment of whether President Obama’s sudden and highly visible insertion into the fiduciary debate will prove to be a game changer. Granted, his speech at AARP, with Elizabeth Warren riding shotgun, probably wasn’t the ideal imagery to inspire Middle America, but it has infused the industry. Unfortunately, all we had to see were a few reports, not the actual proposal.
The Basic Idea:
“We are all still digesting what we read and what was said by DOL Sec Perez, Rep John Delaney, MD, Sen Corey Booker, (S) NJ, Sen. Elizabeth Warren, CFPB Director Richard Cordrey, and President Obama,” says Kathleen M. McBride, Chair, The Committee for the Fiduciary Standard and Founder, FiduciaryPath, LLC. “The actual proposal is now at OMB and not available for the public to see as it goes through agency review and comment. So my comments are only on what’s on the WH and DOL sites and in the speeches — or what I’d hope will be in the proposal. It appears that they will first be tackling rollovers out of 401k-type accounts into IRAs and advice on IRAs. It’s an area of acute vulnerability for many investors and bad advice there can lead to disastrous outcomes for retirement savers. I’m hoping the proposal will ensure that advice on the 401k-type accounts at the plan level and the participant level will be required to be in the sole interest of the investor.”
In addition to addressing IRAs, it appears the proposal will look at other issues as well. Barbara Roper, Director of Investor Protection at the Consumer Federation of America, says, “The rule is expected to close two major loopholes in the definition of investment advice: the exemptions for one-time advice and the exemptions for advice where there is no mutual agreement that the advice forms the primary basis of the investment decision. These changes will bring the definition into better alignment with the definition of advice under securities laws and will make it far more difficult for brokers to evade their fiduciary obligations when they are clearly serving in an advisory capacity.”
While the actual proposal remains hidden in the OMB review process, the While House has provided supporting documentation for public view. “Although the actual details of the re-proposed ‘fiduciary’ regulation are not yet known with absolute certainty, the just-released White House Report titled ‘The Effects of Conflicted Investment Advice On Retirement Savings’ is clear that it wants to subject the ‘transaction-based’ broker dealer adviser to the same platform as the ‘advisory-relationship’ investment adviser, namely, a platform that carries a higher legal standard of care and does not allow for ‘conflicted’ advice,” says Marcia S. Wagner, Esq., Founder and Principal of The Wagner Law Group, whose offices are located in Boston, Tampa, Palm Beach Gardens, St. Louis and San Francisco.
What’s Missing from the Proposal:
Does the proposal go enough? Ary Rosenbaum, Managing Attorney at The Rosenbaum Law Firm P.C. in Garden City, New York says, “It really depends on what standard and language that the Department of Labor will use when making the proposed rule on this new ‘fiduciary standard.’ The devil, as they say, is in the details.”
It is clear some important elements were omitted from both the White House Report and the president’s comments. “One thing that was not mentioned today was the issue of titles,” says McBride. “Advisor, counselor, consultant, wealth manager and others convey a relationship of trust and imply a fiduciary relationship exists. I hope the proposal will ensure that only fiduciaries can use that type of title and that non- fiduciaries use a sales title.”
Exactly how the DOL will target conflicted compensation structures has yet to be explained. Ron A. Rhoades, Professor of Business at Alfred State College in Alfred, New York, says, “Many fiduciary advocates worry that commission-based compensation will be permitted. I don’t view this so much as an issue, as the problem of variable compensation. For example, if a higher commission exists to sell one product, over another, this generates a conflict of interest which is difficult to reconcile or justify under a true fiduciary standard.”
Indeed, the DOL has repeatedly acknowledged it will continue to allow the types of self-dealing transactions normally banned under a fiduciary relationship. “The DOL has promised to put out the draft prohibited transaction exemptions that will determine how the fiduciary standard will be applied in situations where conflicts of interest exist,” says Roper. “They’ve made clear that they will not prohibit commissions or 12b-1 fees, and they’ve suggested that they will be taking a principles-based rather than transaction-by-transaction approach to drafting those exemptions. Our expectation is that they will permit the conflicted payments subject to a requirement that the recommendations themselves be in the best interest of the customer and that the firm has policies and procedures in place to appropriately manage conflicts of interest. We believe this is an appropriate compromise that would strengthen protections for investors while maintain flexibility to apply the standard to a variety of business models.”
There is also concern about the so-called “seller’s exemption.” “Where will the DOL draw the line between ‘sales’ and ‘advice’?” asks Rhoades. “Will the ‘seller’s exemption’ provided be ambiguously written, so that it can swallow up the rule itself, much as ‘solely incidental’ has been defined out of existence with respect to the broker-dealer exemption from registration under the Advisers Act? Will ‘blanket’ exemptions be provided for certain additional compensation arrangements which are problematic under even the ‘best interests’ criteria for granting exemptive relief, such as permitting payment for shelf space and other forms of revenue-sharing.”
The White House Report mentions the failure of disclosure to achieve its objective. Indeed, academic studies support this conclusion (see “Exclusive Interview with Yale’s Daylian Cain: Just a Sugar Pill? Disclosure’s ‘Ah-Ha!’ Moment,” FiduciaryNews.com, October 18, 2010). Brian Graff, Executive Director of National Association of Plan Advisers, in Washington DC, says, “What fascinates me is that the whole dog and pony show repeatedly mentioned hidden fees, but it doesn’t appear the proposal will deal with transparency. Instead, they’re trying to shut down business models.” Graff feels the research alluded to in the White House report cannot be viewed as legitimate since there are currently no required disclosures from which to predicate such research. He says, “Any academic analysis cannot test something that does not exist. Disclosure has worked in the 401k market. As proof all we need to see is how the new fee disclosure rules have increased competitiveness among plan service providers”
Will the Proposal Go Too Far?
Although we don’t see the actual proposal, the materials provided by the administration offer a clear indication of the direction things are going. Wagner says, “After stating the distinction in legal standards between ‘fiduciary’ and ‘suitability,’ the White House Report zeros in on its findings for the IRA market that there is a clear correlation between conflicted advice and lower returns. This will be a cornerstone of the DOL argument for its new fiduciary rule: Because non-fiduciary advisors are not subject to the fiduciary prohibitions on self-dealing and only are subject to the lesser standard of “suitability,” non-fiduciary advisors are able to recommend investment products, such as IRA Rollover options, that carry the highest payout to that advisor despite the ‘conflict’ due to self-interest.”
Indeed, Graff says, “Our biggest concern is in the area of rollovers. The President suggests employees not roll there 401k asset over in a private IRA and, instead, keep their money in their former company’s 401k plan.” Graff doesn’t see that as in the best interest of the employee. He says, “There are all sorts of things an employee will want to invest in that are not available in the plan.” Many feel it is in the best interest of plan sponsors to avoid retaining former employees in their company plans (see “Ex-Employees Who Don’t Rollover – Will 401k Fees Increase Plan Sponsor Liability?” FiduciaryNews.com, June 28, 2011).
The White House Report, and presumably the new proposal itself, appears to have been thoroughly researched, reflecting the latest in academic research. In what might best be described as rhetorical jujitsu, the administration may have given the industry precisely what it asked for, much to the chagrin of the industry.
“I think the industry thought it had a winning argument when they pushed for a thorough economic analysis to justify the rule, and they are clearly horrified at how that has played out,” says Roper. The CEA report relies entirely on independent academic research. It is quite open about the assumptions underlying its estimates of investor harm. And it is actually quite conservative in its estimates.” (For a fuller explanation of this academic research, including the relevant citations, see “401k Plan Sponsor Fiduciary Alert: Conflicts-of-Interest More Important than Mutual Fund Expense Ratios,” FiduciaryNews.com, January 13, 2015).
Roper says the “industry strategy now seems to be to protest what they describe as an attempt to cast aspersions on an entire industry. But it is really just a compilation of not at all controversial statements. Financial firms offer incentives to brokers to sell products based on factors other than the best interests of their customers. Brokers, not surprisingly, often respond to those financial incentives (often backed by strong pressure from higher ups in the firm). Investors can end up paying more as a result, and those increased costs have a significant impact on long-term retirement investments. If that weren’t true – if financial incentives didn’t influence behavior – why on earth would the financial firms still offer them?”
“The real meat is the re-proposed reg,” says Wagner. “The White House Report is really a set of economic facts, used to support the assertion that non-fiduciary advice equals lower returns because of conflicts. It could well be that the stats are ‘cherry picked’ to support the assertion. The success of the reg will be dependent upon, among other things, how the industry responds with its own set of facts. The White House Report relies on a great deal of empirical analysis to support its conclusions as to the costs of conflicted advice. Opponents to the White House Report will clearly adopt Mark Twain’s refrain that statistics, a kind of ‘lie,’ are used to bolster weak arguments because they appear to be so persuasive. The reality here is that while the White House Report has skillfully presented facts and figures on the correlation between conflicts and investment performance, there are likely some equally persuasive statistics opponents will rely upon to overcome those arguments.”
This is precisely what Graff maintains. He says, “There are other academic studies that show investors benefit from having an adviser.” He maintains the studies in question assume any savings is due to investors “doing it themselves” and not using advisers. You can judge for yourself by looking at the actual study (see “Yet Another Independent Study Highlights High Conflict-of-Interest Cost to Retirement Investors,” February 26, 2013).
But many see Graff’s rebuttal as a bit stale. McBride says, “Opponents to the fiduciary standard have been repeating the old, unsubstantiated rhetoric. It’s not true, and they know it.”
Rosenbaum agrees. He says, “The opponents will still use the same arguments they have always used, they will claim that brokers will abandon small plan and small IRA savers because of the new standard and that will increase investing costs. There have been studies that brokers have funded to suggest that plan sponsors will eliminate their retirement plans because of this increase standard, but they claimed that retirement plan sponsors would eliminate their plans after the fee disclosure regulations and that didn’t happen.”
Still, Graff’s comments bear more investigation. Wagner says, “The statistics referred to in the White House Report do not mention how plan participants would have done without the advice – conflicted or not – but merely see the advice as increasing cost, without providing sufficient weight, or really any weight, on the benefits of the advice.”
And this simple fact may just appeal to the typical investor. “The academic studies mentioned in the White House Report do not attach any fundamental value to the brokerage relationship and that’s the flaw in those studies,” says Graff. “It’s cheaper to fix car yourself than pay your mechanic, but who will do a better job. The inherent premise in these studies is that the broker adds no value. We can’t discount the value of the broker. People save more when they use an adviser.”
The Power of the Presidency:
Despite the uneven success the president’s proposals have had, his involvement cannot be understated. “The chances for the DOL rule to be finalized increased dramatically when the White House decided to throw its support behind this proposal,” says Roper. “That doesn’t by any means ensure that the rule will be adopted. There’s too much money at stake to expect industry to back down, and they have plenty of allies in Congress. But White House support should ease the rule’s passage through OMB, and it makes legislative attacks on the rule more difficult. It isn’t a silver bullet, but it is a very good development.”
Indeed, this new proposal has some advantages over past efforts. “I think this is very different from, say, health care initiatives, with the construction of enormous online resources across 50 states of different health insurance requirements,” says McBride. “Here, we already know how fiduciaries operate and that’s a good model for moving ahead.”
The initiative, however, has long been a political hot potato. Wagner says, “Given the current Republican party strength in Congress, it may be very difficult to successfully introduce a re-proposed fiduciary regulation, invite public comment and debate, and reach accord on a final regulation prior to the next Presidential election. There is a very determined industry position joined with the majority party in Congress to oppose the expanded fiduciary proposals. However, the Obama Administration is drawing a line in the sand as well, and we are in for a very spirited debate as the regulatory process unfolds.”
The political reality, though, is that this is one area where the administration can proceed with the benefit of Congress. “Since this would be DOL rule making jurisdiction,” says Rosenbaum, “it’s less about the president’s political capital and more of whether the DOL can withstand congressional pressure from Republicans and Democrats that is funded with Wall Street lobbying money.”
Graff conceded “The level of political involvement has been ratcheted up tremendously. It improves the chances of the proposal being successful. The only way this gets stopped is if Congress stops it. There could be some legal action, but, unlike ObamaCare, it would be more difficult to overturn in court unlike. Essentially, the president can do this by fiat.”
Still, there remains one political obstacle that could thwart the entire effort. “My biggest fear,” says Rhoades, “is that the Administration may negotiate away the DOL rule, or delay it, in the context of next year’s budget negotiations (as they gave up another slice of Dodd Frank early this year). There is a huge amount of money being thrown at the fiduciary issue by Wall Street and insurance lobbyists. The action will likely occur in Congress, which will in turn seek to pressure, and negotiate with, the Administration over the DOL’s fiduciary standard.”
Where We Stand Today:
For fiduciary proponents, they have never gotten any closer to the Promised Land. For once, regulators have taken the issue as seriously as advocates have maintained they should. “They have taken their time to get this economic analysis right, and it is very robust,” says McBride. “It’s eye popping. Progressive firms will take a leadership role and adapt their culture to the fiduciary model. Professor Robert A. Prentice, of University of TX at Austin, notes that when people conform to an existing standard of law/rules/norms that is a low standard, they all do what is the normal low behavior. When the standard/rules/laws are raised, the norms of conduct must rise to the new norms, a higher standard. That then becomes the norm. It’s interesting.”
“The strong flurry of activity over the last day or so is a clear signal that the Obama Administration continues to view the legal and business framework for ‘fees’ and ‘conflicts of interest’ as an area in need of reform, making it a very high priority on the agenda for national retirement policy,” says Wagner. “The renewed vigor of the Obama administration in support of its Department of Labor also reveals a reality well known to all: the political campaign of 2016 has begun.”
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