Labor's fiduciary rule hurts American families
The proposed rule will restrict access to retirement advice, particularly for low- and moderate income workers.
The rule will cause the majority of retail investors to see average increased costs of 73 to 196 percent due to a mass shift toward fee-based accounts
The proposed changes will also harm small business retirement plans, which represent more than 9 million U.S households with approximately $472 billion in retirement savings.
The Obama administration will soon finalize its proposed fiduciary rule. The rule significantly constricts the availability of financial advice related to pension and retirement plans. It is estimated to affect $3 trillion that Americans hold in individual retirement accounts. The rule will be particularly harmful to low- and moderate-income workers seeking advice for their retirement planning.
Impact of Fiduciary Rule
FUNDAMENTALLY REDEFINING ADVICE
On April 20, 2015, the Department of Labor proposed rules to redefine the term “investment advice” related to pension and retirement plans. Under the Employee Retirement Income Security Act, a person who provides investment advice for a fee has a “fiduciary obligation” to provide advice in the sole interest of plan participants. The proposed rule would replace the current five-part test used to define who is a fiduciary with a much broader definition, expanding the number of people covered by the fiduciary standard.
Currently, brokers and dealers who provide services to retirement plans are not fiduciaries. They must meet a lower standard: that their recommendations be “suitable” for the plan participant. Brokers are already regulated by the Securities and Exchange Commission, which imposes rules to prevent fraud, ensure that fees are disclosed, and protect clients from unsuitable investments. Under DOL’s new regulation, brokers and dealers would be considered fiduciaries when they provide recommendations to participants in retirement plans.
In addition to broadening ERISA’s definition of investment advice, the rule provides seven carve-outs for situations that would not be considered investment advice. However, it specifies that none of these carve-outs apply when an adviser is acting as a fiduciary under ERISA, adding confusion.
DOL OVERSTEPS WITH ITS PROPOSED RULE
The SEC is the broader regulator of people and businesses providing investment advice. Under current law, registered investment advisers are fiduciaries and subject to the Investment Advisers Act. Brokers and dealers are subject to SEC oversight but not to the Investment Advisers Act, and they are not considered fiduciaries.
In February 2016, Senate Homeland Security and Governmental Affairs Committee Chairman Ron Johnson released a report charging that DOL disregarded concerns and recommendations from other regulators. Career staff at the SEC, the Office of Management and Budget, and the Treasury Department expressed numerous concerns to the Labor Department about its proposed rule. Officials at DOL disregarded many of these concerns and declined to implement recommendations from these agencies. The report concluded that DOL frequently prioritized the expeditious completion of the rulemaking process at the expense of thoughtful deliberation. Additionally, the report found indications that political appointees at the White House played a key role in driving the rulemaking process.
The proposed fiduciary rule does not coordinate well with existing SEC rules. It directly conflicts with some securities rules and will create different standards for others, leading to confusion in the industry.
“The Labor Department’s request suggests it is blindly moving forward with policy that has the potential to cut off access to affordable retirement advice for millions of Americans and their families.” – Senator Lamar Alexander, 03-07-2016
On February 29, the Department of Labor published a request for information on the outlines of a multiyear study to collect data on retirement planning, including financial advice. DOL noted that “relatively little is known about how people make planning and financial decisions before and during retirement.” The request for information was done after the fiduciary rule was sent to OMB for final review, suggesting the Obama administration is putting the regulatory horse before the cart.
REDUCES AVAILABILITY OF RETIREMENT ADVICE
Any change under ERISA to expand the number of advisers who are considered fiduciaries would reduce the availability of essential financial advice for people with retirement plans and pensions. The current rules allow advisers to earn commissions on the products they sell to clients as part of a portfolio. If a broker sells his client an annuity from a life insurance company, for instance, the insurance company could pay the broker a commission. That commission means that the broker can charge lower fees to the client for giving the advice. As a practical matter, this would no longer be an option under the new rule. Firms would have to make up that revenue in some way, likely by switching to a system that charges fees based on a percentage of the assets invested. Customers with less money invested would no longer be profitable for some firms. They could be moved into accounts that are simply not eligible for any advice at all. Firms might even have to close down investment advice call centers that can answer simple questions for clients who have uncomplicated accounts. These could be considered fiduciary advisers under the new rules, and the regulatory burden would make them unprofitable.
According to a March 27 Wall Street Journal article, some analysts predict that the rule will lead to fewer rollovers from 401(k) plans to IRAs when they leave a job. Under the proposed change, advisers will not be able to suggest a rollover without first having a potential investor sign a contract. The article says that this “is a requirement that many in the financial-services industry have called unworkable and burdensome.” Rollovers now account for approximately 90 percent of money going into IRAs annually. In the absence of advice to roll their money over to an IRA, a 2014 study concluded that millions of people, particularly low-wage and minority workers, will cash out their retirement plans. The people affected would see their lifetime retirement savings drop by 20-40 percent, or a total of $20 billion to $32 billion a year.
In 2006, the United Kingdom implemented a similar change in its law to move away from commission-based advice. A 2014 study into the effects of the switch found a move among some advisers toward higher net-worth customers, implementation of minimum account thresholds, and some banks exiting the market altogether. Even the government regulator conceded that “a survey of advice firms suggested that, over the last two years, the proportion of firms who ask for a minimum portfolio of more than £100,000 [approximately $144,000] has more than doubled, from around 13% in 2013 to 32% in 2015.”
Women and Minorities Most Harmed by DOL Fiduciary Rule
Former Clinton administration economist Robert Litan testified before Congress that the cost of depriving clients of personalized advice during a future market correction could be as much as $80 billion. This would be double the benefit the administration claims for the rule over the entire next decade, and it was a cost not considered in the Labor Department’s economic analysis. His criticism did not sit well with Senator Elizabeth Warren and other Democrats, and he was pushed to resign his position with the Brookings Institution.
Concerns with the DOL rule change are already causing some companies to exit the brokerage business in the U.S. Last month MetLife announced it was selling its brokerage business, and American International Group made a similar announcement in January.
A WEAKER RETIREMENT SYSTEM
For clients who remain eligible for fiduciary advice, the annual fees based on their assets could be much more expensive than the fees they previously paid in the form of commissions. This could diminish efforts by low- and moderate-income workers to save for their retirement. It would also reduce Americans’ overall retirement savings, contributing to the already dangerously low savings by lower-income people.
Higher up-front costs under the new restrictions could lead some people to skip opening an IRA in the first place. A July 2015 study by the consulting firm Oliver Wyman estimated that as many as 360,000 fewer IRAs would be opened annually as a result of the proposed rule. Additionally, 7 million IRAs would fail to qualify under the new rule for an advisory account due to the balance being too low to be profitable for advisers.
HIGHER RETIREMENT COSTS
According to Oliver Wyman, retail investors will see average increased costs of 73 to 196 percent due to a mass shift toward fee-based accounts. Low-income and middle class Americans who are unwilling or unable to pay these fees will effectively lose access to competent financial guidance.
Two retirement savings plans used by small businesses – SEP IRAs and SIMPLE IRAs – are popular with small businesses because they are inexpensive to set up and do not impose burdensome administrative or reporting requirements on employers. These plans have been successful in helping small business workers save for retirement. Nearly 10 percent of all IRAs are from SEP/SIMPLE-type plans, representing more than 9 million U.S households. As of the end of 2014, there were approximately $472 billion of retirement savings in these plans.
The proposed fiduciary rule would be particularly onerous for small business plans. In a 2014 survey by the U.S. Hispanic Chamber of Commerce, 30 percent of small businesses said they would be at least “somewhat likely” to drop their plan if the rule were implemented. Fifty percent of small businesses with a plan indicated they were at least “somewhat likely” to reduce their matching contribution, offer fewer investment options, and increase fees charged to plan participants if the rule is implemented.
The Labor Department’s own regulatory impact analysis estimates the proposal’s compliance costs “to be between $2.4 billion and $5.7 billion over 10 years.” These costs will be paid by Americans trying to save for their retirements.
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