President Barack Obama wants to crack down on advisors who get commissions for selling retirement plans. On the surface, his goal seems noble. But it ignores reality, targeting the wrong people and misunderstanding the problem he perceives.
Obama, who I have nothing against, recently endorsed the Department of Labor's controversial proposal to impose fiduciary obligations on brokers and advisors working with retirement plans, insisting that new rules are a needed consumer protection to prevent billions in costs due to bad advice.
During remarks to the AARP, Obama stressed the importance of imposing a cohesive standard mandating that all brokers and advisors providing advice to retirement accounts act in their clients' best interests to guard against conflicted advice that could harm investors.
"The challenge we've got is right now there are no uniform rules of the road that require retirement advisors to act in the best interests of their clients, and that's hurting millions of working and middle-class families," Obama said in his address.
Did it ever dawn on the president that a large percentage of the folks providing assistance to retirement plan participants are also members of the same “middle class?”
During the 2007-09 financial meltdown, where was the consumer concern? Numerous Wall Street stalwarts designed financial products for unwary investors. Some of these firms were actually betting their own assets against the investor. But did any top executive at one of these firms go to jail? No. The leaders of the carnage claimed ignorance.
Insurance companies, for decades have marketed high-cost, high-surrender charges and low-performing annuity products to educators. Where was the outrage over these vehicles, called tax-sheltered annuity accounts, or TSAs? Did anyone ever call fixed annuity providers to task? Apparently, Obama’s plan does not focus on these investment products.
I recall a meeting with an insurance company president some years ago. I asked him why TSAs had such historical low return to savers. His response was, “A 1% savings account is far better than none at all.”
Obama’s proposal seems to rest on the belief that investments always will go up. If they don’t, then the brokers selling them are at fault. “There are a lot of very fine financial advisors out there, but there [are] also financial advisors who receive back-door payments or hidden fees for steering people into bad retirement investments that have high fees and low returns," Obama told the AARP gathering. "So what happens is these payments, these inducements, incentivize the broker to make recommendations that generate the best returns for them, but not necessarily the best returns for you."
Let’s see if I have this right. As long as the value of the retirement plan assets increase, it’s good. However, if the plan assets decrease in value the broker or advisor is to blame? Oh, and if, God forbid, the broker or advisor received any payment or compensation, he’s surely guilty of something.
And if our supposedly evil broker sold a 401(k) participant an investment with high fees and commissions, who do you think designed the product for sale in the first place? Not the broker. If an industry-wide defect exists that harms retirement investors, why not fix it from the top down, not the bottom up?
The White House Council of Economic Advisers pegs the cost of conflicted advice on middle-income families at $17 billion per year. The CEA estimates that conflicted advice cuts one percentage point off average annual returns for middle-class savers.
The Labor Department first proposed an expanded fiduciary definition under the Employee Retirement Income Security Act, or ERISA, in 2010. But the agency withdrew the proposal the following year amid broad criticism that it would impose onerous restrictions on the industry – and cause financial professionals to abandon retirement investments, leaving low and moderate-income Americans in the lurch.
At its core, the proposed rule would require retirement advisors to make recommendations and investment decisions that are in the best interest of clients, known as the fiduciary obligation. That is a tighter requirement than the suitability standard, which brokers historically have operated under. With suitability, they must reasonably believe an action is in the customer’s best interests.
Trouble is, the division is not so neat. Many brokers are dual registered, meaning they also operate under the fiduciary standard. Large numbers of them have earned the Certified Financial Planner designation, and that mandates that they act as fiduciaries. And the majority of brokers are not working for large firms, and thus do not have house brands of mutual funds to sell.
The proposal does not aim to do away with sales commission, which are how brokers traditionally get paid. But if commissions are the problem, why not outlaw them? Of course, they’re not the problem, but Obama’s logic doesn’t hold up by vilifying them and then giving them a pass.
Several industry trade groups issued statements expressing concern with the rules.
The National Association of Plan Advisors charged that the "White House launched an attack on advisors and so-called 'hidden fees' and 'backdoor payments' by moving forward with a regulation that has its own hidden backdoor effect – keeping many Americans from working with the trusted advisor of their choice, even in the critical decision regarding rollovers from their 401(k) and 403(b) plans."
“People should be protected from unfair and deceptive practices," NAPA Executive Director Brian Graff said in a statement. "But all indications are that this rule will block Americans from working with the financial advisors and investment providers they trust simply because they offer different financial products – like annuities and mutual funds – with different fees."
Kenneth Bentsen, chief executive of the Securities Industry and Financial Markets Association, said: "The new regulation could limit investor choice, cause inconsistencies as different regulators would apply different standards to the same retirement accounts, prohibit access to investor guidance, and raise the costs of saving for retirement."
If a retirement plan participants feel they can go it alone, they are free to make their own choices. The outcome will be a product of luck and their own knowledge. However, if one requires assistance in the selection and management of a diversified retirement portfolio, the advisor must receive fair compensation. This is true for a plumber, electrician, accountant or attorney. If they would rather perform these functions on their own, there’s always Home Depot.
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Phillip Q. Shrotman is founder and president of Principal Planning Service, Inc. in Long Beach, Calif. He was a professor in the Business Division at Long Beach City College for over 29 years, where he held the position as Coordinator for Financial Planning and Insurance for the college. He holds a Community College Instructors Credential from the University of California at Los Angeles and a master’s from the University of San Francisco. He also holds the profession designations of General Securities Principal of the Financial Industry Regulatory Authority (FINRA), Series 7 and 24. He has appeared as a guest on KABC Talk Radio and various television and radio programs.
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