Is There Anything the Government Can Do to Stop Wall Street From Ripping Off Retirees?

The following is the latest in a new series of articles on AlterNet called Fear in America that launched this March. Read the introduction to the series.


With Sen. Elizabeth Warren, D-MA, standing at his side applauding vigorously, President Obama recently threw his weight behind a new set of rules for investment professionals aimed at ensuring they act in their clients' best interest when retirement savings are involved.

Consumer advocates have been trying for years to make anyone who offers investment advice for 401(k) plans and IRAs a fiduciary under ERISA, the law governing private-sector pensions, but so far, the financial services industry has stifled such efforts.

If approved, the Department of Labor claims its proposed rules, which it has not yet made public, would change this, helping to address an enormous problem—sky-high fees and commissions that brokers and advisors often persuade investors to accept on products that may not be appropriate for them. A report by the Council of Economic Advisors (CEA), released shortly before the president's endorsement of the DoL rules, concluded that $1.7 trillion of IRA assets are invested in products that carry conflicts of interest—meaning the person who advised the purchase receive backdoor payments or hidden fees for having done so.

These conflicts result in a loss of about $17 billion per year on investors' holdings. But how do we know the DoL can stop these abuses—just by attaching a new word to the people who sell the products?

“You don't just say 'fiduciary duty,' click your heels together three times, and solve all these problems,” says Barbara Roper, director of investor protection at the Consumer Federation of America. “But you have to start somewhere, and establishing a standard that can be used to hold people accountable is a good place to start.”

The term “fiduciary” is itself a bit slippery, depending on the context. In states and cities that sponsor public employee pension funds, the mayor or governor is considered a fiduciary of the plan. Yet one of the reasons public plans in some places—think Illinois, New Jersey and Chicago—are so poorly funded is that legislatures, governors, and mayors have failed to make actuarially necessary contributions to the funds, sometimes for years running. Arguably, in some cases, they've violated an implied fiduciary duty to plan participants.

But, “generally speaking, you can't sue legislators and governors for not providing adequate plan funding,” says Norman Stein, an authority on pension and tax law and professor of law at Drexel University.

In the private sector, companies have developed their own techniques for finessing lawsuits under ERISA. In 2007, a legal newsletter for corporate executives advised, “If possible, push responsibility for plan amendments, investment selection and plan administration down as far as possible. Keeping your retirement plans out of the board room and the executive suite will go a long way to protecting senior executives.”

That doesn't mean extending the fiduciary standard for advisors to 401(k) and IRA investors shouldn't be welcomed. But the devil will be in the details, and we won't know how far the DoL will go in making exceptions to avoid Wall Street's wrath until the new rules are made public.

Retirees versus Wall Street

Here's the problem: It's hard for the investor to know what motivates the person offering the advice.

An independent financial advisor might dispense investment advice, but also receive a commission for selling a mutual fund, annuity, or other product offered by a firm she works closely with. If the advisor works directly for a securities firm, mutual fund house, or insurance company, she might wear two hats. Hat number one: She's an investment advisor registered with the Securities and Exchange Commission, subject to a loose “suitability” standard. Hat number two: She may also be a securities broker regulated by the Financial Industry Regulatory Authority, an organization set up by the financial services industry itself. She can offer “independent” advice under hat number one, then turn around and collect commissions for sales wearing hat number two, although her advice would still have to be in  the client's best interest.

The uneasy balance between professional duty and compensation structure creates the greatest danger for small investors when they near retirement and are deluged with offers to roll over their 401(k) balances into IRAs. As the baby boomers start to leave the workforce, this is becoming a tremendously lucrative business for financial firms; some $300 billion is already rolled over annually, according to the CEA report, and conflicted advice is costing these investors some 17% of their potential gains between ages 45 and 65.

The DoL says it will change all that by regulating advisors as fiduciaries under ERISA. That would mean they aren't allowed to earn commissions or hidden fees on the investments they recommend. They must operate in the sole interest of the client. But as a matter of practicality, and politics, the DoL has already indicated this won't be a blanket rule. There will be what's known as Prohibited Transaction Exemptions.

“Everything boils down to the PTEs,” says Roper. There's likely to be a seller's exemption, for any service provider selling its own products directly to a 401(k) plan, if it doesn't give advice. Look also for an exemption for firms that provide investor education along with their financial products, so long as it doesn't include specific investment advice. And DoL has said repeatedly it won't ban commissions outright, as some European countries have done.

How far will the DoL decide it has to bend over to get Wall Street to go along? In 2010, when the DoL was in the midst of its last, failed effort to regulate financial advisors' conduct, Sen. Susan Collins offered an amendment that would have required anyone providing financial advice to act in the best interests of their clients. But she carved out an exclusion for brokers who sell proprietary products, such as variable annuities and mutual funds. That outraged groups like the Consumer Federation, since some of the worst abuses—and highest charges—have involved variable annuities and actively managed mutual funds.

If the DoL follows a similar path, the new rule could be not much better for small investors than the current, inadequate protections. Roper says she's “cautiously optimistic” this will not be the case, while on one matter, at least, she expects the rule to be a big improvement.

Brokers currently enjoy considerable wiggle room as to when “advice” is regulated and when it isn't. If they offer “one-time advice” on a particular transaction, for example, they're not deemed to come under ERISA rules, Roper notes. Even when they offer advice more frequently, they sometimes speak of it as “episodic advice” and continue to claim they shouldn't be held to a fiduciary duty because their advice isn't ongoing. Roper expects the DoL rule to sweep away such ambiguities: advice will just be advice.

More ambitious goals that would, arguably, protect investors better may be harder to achieve—but the DoL rule should push conduct in a better direction. “I wish we would ban the practice of different broker compensation arrangements for different investments,” says Stein, “so that the broker won't make more by selling one type of investment rather than another. But is this is not possible, I'd like to see some rules focusing on keeping a broker's financial interests from influencing his or her advice.”

More generally, based on a White House memo that leaked in January, Roper says the rule is likely to say that when an advisor also receives a 12b-1 marketing or distribution fee on a mutual fund, for example, it must have policies in place to identify and disclose those conflicts of interest and must have a reasonable basis for believing the arrangement is in the best interest of the customer. “If you put 'best interest' on top and require them to manage any conflicts, it does make it more likely that certain things will slip through,” Roper says, “but it's the right approach both politically and from a policy perspective.”

How much protection will that really offer?

“Just improving disclosure would help at the margins, but it is not a sufficient protection for many IRA and 401(k) participants, who may not understand the disclosures and don't have the time or resources to learn what they mean,” Stein warns. “We know that a lot of people don't pay attention, and the brokers' ability to sell may even be enhanced if they say they've got a conflict of interest. Just telling the customer can signal to a customer that you must be really trustworthy to point this out.”

Given intense industry opposition, however—“From the point the industry got the DoL to withdraw [its previous proposed] rule, it has had nothing to say to the DoL except, 'Don't do a rule'”—the regulators have a difficult needle to thread politically, Roper concedes. Republican congressional leaders last week said they would reintroduce legislation preventing the DoL from issuing its rule until the SEC finishes its own study of whether to introduce a fiduciary standard. “Never discount the industry's ability to gin up an 'insurmountable obstacle,'” says Roper, “but the DoL won't give them something indefensible politically, the strong support from the White House makes it much for difficult for industry and their congressional allies to kill it.”

All of which suggests that the political dynamic regarding retirement saving advice could play out similarly to the tug-of-war that resulted in the Dodd-Frank law regulating Wall Street. In that case, heavy opposition caused a fairly simple rule prohibiting banks from engaging in proprietary transactions to morph into a far more complex—and less effective—set of rules, not all of which have yet been implemented.

Now as then, it's all a matter of what's in the PTEs—Wall Street’s loopholes.

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