Why Wall Street Is Howling Over The Big New Reform Coming Down The Pike

The Obama administration is moving forward with a plan that could bring a sea change to how retirement advisors must treat their clients, while financial industry-allies in Congress engage in another round of push back.

The new rules for retirement advisors that the President and consumer advocates are pushing address a conflict of interest the White House estimates costs retirement savers $17 billion annually. The problem? Contrary to what many investors believe, the advisors who direct them to retirement funds are not always required to act in their clients’ best interests.

“People have incentives to push people in products that might not be the best for them, and when we’re talking about longterm retirement savings even a small difference can make a big impact in the longterm retirement savings,” Anne Tucker, a professor at Georgia State University College of Law, told TPM.

Due to decades-old loopholes in the current law, retirement advisors can direct their clients towards investments that compensate the advisors but are not the best option for the investor. This higher standard of responsibility is known as a “fiduciary duty.”

“The way broker-dealers are often compensated is they get a percentage of retirement investments in vehicles in which their clients select, so they have incentives to place their clients or their customers in certain products that they get compensated for,” Tucker said. “The idea is this conflicted advice costs individuals because they may be being encouraged to invest in vehicles that are higher fees, or may not produce the same longterm returns on their retirement investment.”

To use one example from a White House-cited report: “A retiree who receives conflicted advice when rolling over a 401(k) balance to an IRA at retirement will lose an estimated 12 percent of the value of his or her savings if drawn down
over 30 years.” That amounts to five fewer years a retiree can afford to live off of his or her investments, the report said.

The proposal from the Department of Labor would essentially require that financial advisors behave in their clients’ best interests when offering retirement investment advice, something that three-quarters of investment advice consumers assumed already was the case.

“It’s wrong, it’s been going on for a long time, most people don’t realize it is happening and the Department of Labor has created a rule that will address the problem,” Stephen Hall, a securities specialist at the investor advocacy group Better Markets, told TPM.

The proposed regulations would close many of those loopholes, while still allowing for some exemptions. The rule change would allow advisors to continue to be compensated by funds they direct investors to, but they would have to more clearly disclose the fact of that compensation to their clients. They would also be required to enter into a contract declaring they nonetheless will act in their clients’ best interest.

“The rule’s biggest strength is that it fundamentally changes the way that retirement advisers will view their relationships with clients,” Arthur Laby, a professor at Rutgers School of Law, told the New York Times. “It sends a strong message that any behavior short of a fiduciary standard of conduct is unacceptable.”

The regulation is being championed by Sen. Elizabeth Warren (D-MA), who appeared at the February press conference with President Obama to announce the administration’s renewed effort — after a failed attempt in 2010 — to address the conflict of interest in retirement investment.

“It’s hard enough for Americans to save for retirement without having to worry about whether they are getting retirement advice they can depend on,” Warren said in March.

The proposal itself was rolled out by the Department of Labor in April. Not surprisingly, the financial industry is fighting it tooth and nail, claiming the regulations will result in higher costs for investors.

“For a century, Wall Street’s ‘sky is falling’ predictions about regulations have never come true and they’re not going to happen this time,” Hall said. “The fact is the advisors fighting this rule are going to adjust to it, and if they don’t, a large and growing community of advisors will make sure that all Americans get financial advice at affordable fees.”

But the financial industry has some friends in Congress, who are have launched their own attempts to stall the rule change. House Republicans held two hearings Wednesday geared at the issue, one in the Financial Services Committee and another in Ways and Means. The former committee passed legislation that would require the SEC to take the lead on the “conflict of interest” question, a measure to essentially halt the Department of Labor’s effort. However that bill is not expected to go anywhere in the Senate.

Some Democrats have also pushed back at the Obama administration’s efforts. One group of lawmakers is urging the Department of Labor to consider making the laws more broad, in effect, watering them down.

The fight over the regulations has even spilled over into the typically-staid D.C. think tank world. This week, Warren called out a paper written by a non-resident scholar at the Brookings Institute critical of the proposal. The senator suggested that its author, Robert Litan, was influenced by the the Capital Group, the mutual fund manager that sponsored Litan’s study, a claim Litan denied. Brookings swiftly demanded Litan’s resignation on different grounds, pointing to Litan’s violation of a Brookings’ rule prohibiting non-resident scholars from touting their Brookings affiliation during congressional testimony.

The heavy pushback the Obama administration has received on the Hill reflects the kind if impact the regulations will have on the industry, as well as individual investors.

John C. Bogle, the founder and former chairman of the The Vanguard Group, told attendees at a June speech, “The proposal of this simple ‘putting investors first’ standard is being opposed with a vengeance that I’ve rarely witnessed.”

Photo illustration by Christine Frapech; Photo credit: Associated Press