Dollars & Sense (March/April 2021) - The notion that making financial advisors freer to pursue their own self-interest is what’s best for workers and retirees must have even Adam Smith turning over in his grave. But that’s what Trump Secretary of Labor Eugene Scalia and Jay Clayton, Chairman of the Securities and Exchange Commission (SEC), would have you believe.
In December, Trump’s Department of Labor (DOL) implemented new rules for regulating the retirement industry. In the name of giving workers and retirees more choices for investing their retirement savings, they adopted the fiduciary standard of the SEC that a financial advisor must put their clients’ interest “above his own” and offer advice that serves “the customer’s best interest.” This regulatory change, according to Scalia and Clayton, will lower the fees clients pay for advice, which will give them access to additional investment guidance. But despite their repeated claims otherwise, the “best interest” standard leaves workers and retirees more vulnerable to conflicted advice than the previous standard that fiduciaries must offer advice “solely” in the interest of their clients. Their new rule would also widen the loophole that allows financial advice to be dispensed by financial advisors who are not governed by fiduciary responsibility rules.
It’s no wonder that AARP, the AFL-CIO, the Consumer Federation of America, and pro-labor members of Congress have all opposed the DOL’s disastrous rule change.
The Biden administration’s DOL, however, has the power to correct these changes that have compromised the safety of workers’ retirement savings. But first we need to understand the history of retirement plans and what we’re currently up against.
Today’s “Do-it-Yourself” Retirement World
In 1974 Congress passed the Employment Retirement Income Security Act (ERISA), the centerpiece of federal regulation of the retirement industry. To protect retirement plans and retirement savers, the ERISA classified most anyone who provided retirement planning advice or worked with retirement plans to be a fiduciary, i.e., someone obligated “to act prudently, solely in the interests of participants and beneficiaries, and generally without conflicts of interest.”
Regulating retirement finances was a difficult undertaking even then, but it was a much easier task than today for several reasons. To begin with, in the 1970s about two-thirds of private sector pensions were defined-benefit (DB) plans. With DB plans, retirement payments are usually determined by workers’ earnings and their number of years on the job, unlike the more prevalent defined-contribution (DC) plans of today. There were no 401(k)s—the investment plans employers offer their workers, who are then responsible for managing the plan. IRAs were only about 2% of retirement assets in the 1970s. Nor were there the nontransparent financial instruments at the heart of the financial crisis a decade ago, such as collateralized debt obligations (securities backed by other securities backed by bundles of mortgages).
By 2017, things had changed dramatically. Following two decades of nearly stagnant wage growth, especially for low-income workers, a quarter of U.S. adults had no retirement savings or pension, according to Federal Reserve Board data. Among adults with retirement savings, only about a fifth (22%) had a DB plan. Employer-sponsored retirement accounts (or DC plans) accounted for 55% of retirement savings. In a DC plan, workers contribute a percentage of their wages to their retirement account. The account then accrues investment returns that become the workers’ retirement income. Workers, not their employers, bear the risk associated with those investments.
Workers with retirement savings typically figure out how best to parse the complexities of today’s investment decisions without regular and ongoing financial advice. But what advice workers do get often comes with conflicts of interest (aka, “conflicted advice”) that have eroded their retirement savings.
A 2013 study conducted by the Obama administration’s Council of Economic Advisors (CEA) examined how conflicted investment advice affects U.S. retirement savings. Focusing on IRAs, CEA’s study found the median cost of conflicted advice—or the typical loss from the potential earnings of a clients’ deposit into their IRA accounts—to be about $17 billion each year, the equivalent of a one-percentage point reduction in the rate of return on savings investments. Worse yet, the CEA reported that those “with modest retirement savings” have historically “relied on types of advice often subject to conflicts.”
In the Best Interest of Whom?
The new DOL rules make these problems even worse. For starters, the arguments Scalia and Clayton invoke to explain the need for the new rules are not credible. The authors take it as an article of faith that more choice in investments is good for retirement investors. But recent studies suggest that more investment choices leave retirement savers flummoxed—a Columbia Business School study found that as the number of investment options proliferate, participation rates in 401(k) plans decline.
Nor will harmonizing the fiduciary rules of the DOL to conform to the “best interest” regulation used by the SEC benefit retirement savers. Uniform fiduciary rules might be more straightforward for financial advisors, but they put retirement savings more at risk by loosening restrictions on advisors. To fully maintain the safety of retirement investments, the government must enact protections that go beyond the SEC rules. AARP rightfully calls abandoning protections that go beyond securities regulation “antithetical to ERISA’s statutory language and legislative history.”
Then there is the SEC standard itself. A “best interest” standard may sound good. But the SEC regulation will do much less to protect retirement savers from conflict-laden advice than the original ERISA standard, which required fiduciaries to discharge their duties “solely” in the interest of the participants and beneficiaries. The SEC standard, on the other hand, requires fiduciaries to offer advice “without placing the financial interest or other interest of the broker-dealer ahead of the interest of the retail customer.” But advice that doesn’t put the advisor’s interest ahead of the client’s interest is not the same as doing what’s best for the client.
Scalia and Clayton assure readers that this SEC standard will keep retirement savers from receiving conflicted financial advice. But that’s just not the case. Financial advisors typically get paid an advisory fee. The “best interest” standard allows advisors to also accept payments from the firms whose financial instruments they recommend to their clients, such as from a mutual fund company. The Public Investors Advocate Bar Association saw the new DOL rule for what it was: “a gift to Wall Street.”
The DOL Rolls Over on Rollovers
Workers are especially vulnerable to conflicted financial advice when they rollover the money in their retirement accounts into an annuity or other investment, like a 401(k) or an IRA, to support them during their retirement. Scalia and Clayton acknowledge that these rollovers are “one of the most important decisions Main Street investors face.” According to the Investment Company Institute, “households transferred $431 billion from employer-sponsored (DC and/or DB) retirement plans to traditional IRAs in 2016.”
But the new DOL rule makes it more difficult for workers and retirees to get reliable financial advice about this important decision. Trump’s DOL reinstated the 1975 loophole-ridden list of exemptions that has allowed many financial advisors to escape fiduciary responsibilities. One exemption stipulates that only advisors who “regularly” advise their client are considered fiduciaries. This means that for the many workers and families without an ongoing relationship with a financial advisor, the financial advice they do receive will not be subject even to the new DOL rules governing fiduciaries. The DOL exemption for one-time financial advisors is also at odds with the ERISA. Nowhere does the ERISA require that advice must be provided “on a regular basis” for a financial advisor to be considered a fiduciary.
Safety First, but More Is Needed
All told, the Trump DOL’s new rules and their “best interest” regulation loosen restrictions on advisors, promote conflicts of interest, and fail to adhere to the fiduciary principle that advisors must act in the sole interest of their clients.
Back in 2015, the Obama administration’s DOL issued regulations that improved the security of retirement savings instead of eroding it. The Obama administration rules eliminated the requirement that financial advice needed to be given on a regular basis to be subject to fiduciary rules. Their rules also limited the ability of advisors to direct clients to products for which they receive a commission. Unfortunately, the Obama reforms were vacated in a 2018 Federal Appeals Court decision, which ruled that the Obama DOL regulations altered long-standing exemptions to the fiduciary responsibility rules and had encroached on the jurisdiction of the SEC.
At this point, the Biden DOL could either revise the Obama regulations (hoping for a more favorable court ruling) or implement a similar set of reforms. Either strategy would substantially improve the safety of retirement savings and would be consistent with the intent of the ERISA.
But considerably more needs to be done if the Democratic Party is to fulfill the promise in its platform to be “the party that advocates retirement security for all.” That starts with providing for those without retirement savings. Increasing monthly Social Security payments by $200 per month, as several Democratic senators have proposed, would surely help. But also much needed are policies that would rein in rapacious profit taking on Wall Street and provide Main Street with the financial support it needs to fuel a full-employment economy.
Those reforms would truly be in the best interest of workers and retirees.
JOHN MILLER is a professor of economics at Wheaton College and a member of the Dollars & Sense collective.