Rep. Ann Wagner, R-Ballwin, scored a victory recently when the powerful House Financial Services committee voted to kill the “fiduciary rule” for retirement advice proposed by President Barack Obama’s administration.
Wagner has been leading the charge to kill the rule, which she says will hurt small investors by making advice too expensive. Obama’s side says it could save those investors $17 billion a year — the cost of subpar advice from brokers enriching themselves at clients’ expense.
The committee vote is the first step on an uphill effort to block the rule. If it passes Congress, Obama will probably veto it.
So, let’s see what they’re arguing about.
The Labor Department rule would turn advisers — read stock, bond and insurance brokers — into “fiduciaries” when they give advice on retirement accounts. That means they must place their clients’ interest above their own when advising people on 401(k)s, IRAs and the like. Many clients expect their advisers to do that anyway. But legally, most don’t have to.
So, it boils down to this: Wagner thinks we can trust brokers. Obama doesn’t.
A fact about the investment advice business: Conflicts of interest are rife. Investments that are best for the client don’t always bring the biggest payoffs for brokers or their bosses.
This can put good advisers in an ethical pickle: They want to do right by their clients, but financial forces tempt them toward the dark side.
For instance, a broker selling stock on commission makes money when you trade a lot, but that is rarely good strategy.
A broker might make a 4 percent commission on putting you in load mutual funds. But there’s often a 7 percent commission on choosing a deferred annuity or 10 percent on non-traded real estate investment trusts. Many of these conflicts, such as that annuity commission, are invisible to the client.
Brokerages often sell bonds out of their own portfolio. So, the brokerage makes more profit if you pay a high price for the bond.
Mutual fund companies often pay brokerages extra if they put a lot of clients’ money in their funds. The system gives the broker an incentive to sell the funds that pay the brokerages.
The money for these payouts comes out of the fund investor’s hide.
Some brokers are urged to beat the drums for their own company’s branded mutual funds, because the brokerage makes money managing them.
Some conflicts are visible if the client knows where to look. For instance, funds sold by brokers usually have higher expenses than no-load funds that clients could buy on their own.
But clients don’t know where to look. They come to advisers because they don’t understand investing.
Under the law, most brokers aren’t required to give clients their best advice. Their recommendations must only be “suitable.”
A broker can’t put a 90-year-old life’s savings into a couple of high-risk stocks. That’s not suitable. But he can recommend a mutual fund that pays a fat commission, knowing that a cheaper choice would be best for the client.
Despite this, Wagner thinks the advice industry merits the public’s trust. She says her own financial adviser is like a member of her family.
Advisers are not “snake oil salesmen,” she told a group of insurance people last May. “It’s amazing how you all have been villainized. You all are family to the customers you serve.”
Brokers know they live on word-of-mouth recommendations. If they don’t do well by clients, clients can walk — and talk.
Obama’s administration counters with its own study claiming that conflicted brokers are giving bad advice to boost their own pay. The effect is to lower investment returns by about 1 percent, equaling $17 billion per year in losses to clients.
Along comes the Labor Department with a proposal to solve that. It would make brokers fiduciaries, and give them two ways to get paid when dealing with retirement accounts.
They can charge investors a fee for advice and forsake the conflicts of interest. Or, they can keep the current commission model, with all the conflicts, but sign a contract with their clients promising to put the client first. Brokers would have to tell clients what they’re actually paying — exposing those behind-the-scenes payouts. They’ll have to set up websites showing how each investment product compensates the brokerage.
So, what’s wrong with that?
Wagner says advisers will have to drop their middle-class clients to avoid bureaucratic costs and legal risk. The rule “harms the very people it claims to protect: low- and moderate-income Americans,” she says.
She’s echoing the cry of the brokerage industry, which hates the Obama proposal. That industry is big in St. Louis. With Edward Jones, Stifel Financial, Scottrade and Wells Fargo Advisors all based here, St. Louis has the biggest concentration of retail brokerage honchos west of Wall Street.
The securities and insurance industries gave $456,000 to Wagner’s campaign in the 2013-2014 election cycle, according to Open Secrets, a campaign finance tracking group.
INDUSTRY MAKES ITS CASE
Here’s the problem as the industry sees it: A fiduciary rule makes it easier to bring legal claims against brokers when investments go bad. Did the broker really believe that the commission-paying mutual fund was the best choice? Can the broker prove it?There are costs involved in disclosing what clients are actually paying, and satisfying the Labor Department that they’re doing it right.One solution would be to move more investors to “wrap” accounts. The investor pays a fee each year, but commissions on many trades are dropped. This eliminates some conflicts, but not all.
Many wealthier clients already have that arrangement. But a 2 percent wrap fee isn’t much on a $25,000 account. Many brokerages require $100,000 for a fee-based account, and 65 percent of people with IRAs don’t have that much.
So, the industry says it would have to abandon the little guys, denying them investment advice on their retirement.
Retirement savers could actually lose $109 billion over 10 years, the effect of less advice and the expense of complying with the rule, according to the Investment Company Institute, which represents mutual fund companies.
On the other hand, is the advice you get from a conflicted broker better than no advice at all? If small investors realized what they are paying now, they might never sign up.
And Obama supporters doubt the industry will dump small investors, because cumulatively they have lots of money. In 2012, workers took $300 billion out of low-cost company 401(k) plans and rolled them into IRAs, where brokers can make a buck on them.
There are other pay models. Some “fee only” advisers already sell their advice on a set-fee or hourly rate. They accept no other compensation and usually recommend low-cost investments.
At the University of Missouri, Michael Guillemette takes a middle view. He’s an assistant professor of personal financial planning, who trains tomorrow’s financial advisers. Being a fiduciary in a commission-based system would indeed be tough, he says.
“It’s difficult in my mind to justify significantly higher expenses. I think that’s what they’re worried about,” said Guillemette. “I see why there is trepidation.”
Then again, doctors, lawyers and accountants already work under a fiduciary standard, and they do quite well, he notes.
A form of financial adviser — called a registered investment adviser — is already a fiduciary, and they’re doing well, too. Certified Financial Planners pledge to act as fiduciaries, although the law doesn’t require it. However, like all advisers, they prefer clients with lots of money.
Guillemette thinks the Labor Department’s rule is much too complex, and complexity costs. Instead, the department should simply declare brokers to be fiduciaries, he said. That would be enough.
If other professions can figure it out, so could the brokerage industry. The Labor Department has heard an earful from the industry. It’s revising its rule, and plans to make a final call early next year.