White House Backs Fiduciary Changes
On Monday, the White House announced new plans to help avoid "conflicts of interest" in the market for retirement advice. Almost simultaneously, the President's Council of Economic Advisors produced a research report presenting findings on the impact of conflicts of interest on retirement account values.
To understand the current debate, it is helpful to remember that there are two standards of responsibility for those providing financial advice, something we have blogged about previously. The source of the problem stems from inconsistencies in federal securities laws; broker dealers are regulated under the Securities and Exchange Act of 1934, while investment advisers operate under the Investment Advisers Act of 1940. Currently, broker-dealers are only beholden to the suitability standard, while investment advisers must adhere to the more stringent fiduciary duty standard, which requires they act in the best interests of their client and fully disclose any conflicts of interest.
Over the decades since these laws were enacted, broker-dealers have begun to offer, emphasize, and market their capacity to provide investment and retirement planning services, which were traditionally the domain of investment advisers. As a result, investors often fail to understand the difference between broker-dealers and investment advisers and may be unaware of the guidelines their chosen adviser is obliged to follow. In the aftermath of the credit crisis, the Dodd-Frank Act charged the SEC with converging the two standards, avoiding the resulting confusion for retail investors. So far, the SEC has not made any changes, and the Department of Labor (which previously attempted to introduce a fiduciary standard for those providing services to 401(k) and IRA plans) withdrew its submission after serious outcry from the industry.
Retirement accounts have drawn the attention of the President for one primary reason, summarized elegantly in the chart below. Since the 1970's, US workers have seen their prime source of retirement funds shift from defined benefit to defined contribution sources. Under defined benefit (DB) plans, the employee was guaranteed a stream of future income, and the obligation to provide for those funds was on the employer. Under a defined contribution (DC) plan, the amount of money that is contributed to the retirement account is defined, but how that account is invested (and therefore what it will be worth in the future) is up to the employee.
DC plans are 'owned' by employees and follow them from job to job, something that matches the current work demographics more closely than DB plans which assumed that the employee would work for the same company from their mid-20's to retirement. Regardless, the shift created a new imposition upon employees: they needed to know how to invest their present dollars to meet their future needs. While DC plans account for both employer and employee contributions, Individual Retirement Accounts (IRAs) are completely separated from employment and allow only individual contributions. Investment performance in these accounts is subject to the choices made by the individual account owner. While the plan administrator of the company selects the investments that will be offered under the DC plan, the individual is responsible for monitoring and selecting investments for inclusion in an IRA.
Making their own investment decisions in order to adequately provide for their own retirement is a new task for many Americans, who have relied on a variety of sources to help them. Given the conflicting standards for dealing with clients, there are a number of different areas where the White House sees conflicts of interest, outlined in the table below.
There have also been some concerns raised that brokers have been encouraging clients to roll their 401(k) plans into IRAs, where all investments are available, and then placing them into investments that earn higher fees for the broker or broker's firm.
The CEA's report estimates that the annual cost of conflicting advice is $17 billion per year. The White House has given the Department of Labor two months to introduce a standard that would make advisors fiduciaries when dealing with 401(k) or IRA accounts. DOL says that it will not be the same standard that it introduced in 2010, but will reflect additional perspectives it gained during the comment period for that proposal. SEC Commissioner Daniel Gallagher was critical of the DOL, commenting that, "investors benefit from choice; choice of products, and choice in advice providers. This is something the nanny state has a hard time comprehending.” Industry participants have aligned themselves with the SEC, which feels it is better suited to make these types of rule changes, while the White House has aligned itself with the DOL. In his speech, President Obama noted that, "just because we've proposed this new rule doesn't mean that it becomes law. ..What I won't accept is the notion that there is nothing we can do." Once DOL introduces its new standard within the next couple months, we expect a vigorous comment period to ensue. The final law will likely involve cooperation with the SEC as well. As a result, the degree of change this will bring for advisors in the retirement marketplace remains to be seen.