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Does Your Broker Have Your Best Interests at Heart?

The Obama Administration pushes for brokers to be held to a fiduciary standard for retirement accounts.

On Monday, President Obama announced that he endorsed the Department of Labor's forthcoming proposal to reduce conflicts of interest in the provision of retirement advice, an initiative that would likely have the greatest impact on brokers. For many activities, brokers currently must meet only a relatively unrestrictive "suitability" standard, rather than the tougher "fiduciary" standard that governs the activities of registered investment advisors operating under the Employee Retirement Income Security Act, or ERISA. With apologies to Neil Armstrong, this initiative is a small step for regulators, and also a small step for investors. But it is nevertheless a step worth taking.

The Council of Economic Advisors has issued a report arguing that because brokers do not operate under a fiduciary standard, many of them provide "conflicted advice" that proves costly to investors. In particular, the CEA believes that when investors change jobs, brokers frequently persuade them to roll over assets from well-performing, lower-fee 401(k) investments to IRAs that may contain inferior investments. The CEA believes brokers' investment advice may be influenced more by the desire to generate commissions and earn sales awards for higher-fee funds, rather than serving the best interests of the client.

The CEA cites a number of academic studies that it says support its position. (The CEA paper contains a full bibliography.) For example, in a 2007 paper, Harvard researcher Daniel Bergstresser and his co-authors found that relative to direct-sold funds, broker-sold funds deliver lower risk-adjusted returns, even before taking into account the impact of loads and other distribution fees.

The Bergstresser research does not weigh in on whether investors fare better with RIAs than with brokers. After all, registered investment advisors get paid, too--often charging 1% of assets each year--but Bergstresser does suggest that brokers systematically recommend funds that underperform alternative investments. So, it seems likely the CEA has identified a real problem.

The brokerage industry has reacted harshly to the forthcoming DOL proposal. Kenneth Bentsen, Jr., the CEO of the Securities Industry and Financial Markets Association, said in a statement that the forthcoming DOL 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." In short, if brokers must meet a fiduciary standard, some argue, it may mean that they will stop serving smaller investors, who might otherwise become unprofitable clients.

Matt Fellowes, a Morningstar executive and former Brookings Institution scholar, says that he does not buy the brokerage industry's arguments. Fellowes--the founder and CEO of Morningstar-owned HelloWallet, which provides independent financial guidance to employees--says that "Access (to advice) without integrity doesn't mean anything." Fellowes also asks, "Why would any individual talk to an advisor who doesn't have his or her best interests at heart?"

David Blanchett, Morningstar's head of retirement research and a former financial advisor, says that rather than constraining the provision of financial advice, he thinks the DOL regulations might actually prompt more investors to seek it. Blanchett says, "Planning for retirement is incredibly complex, and many Americans are likely going to need help along the way. Moving to a fiduciary standard will potentially result in the dual benefit of individuals receiving better advice as well as individuals being more willing to seek the services of a financial advisor."

Still, in terms of fixing the problems with American retirement policy, one should not overestimate the benefits of the DOL rule. Fellowes notes that only 15% of workers currently speak with a financial advisor, so most of them simply are not touched by advice, whether conflicted or independent.

Moreover, for many Americans, the larger problem is not that they fail to get the best advice for their retirement accounts, but that they do not save for retirement at all. Only about half of Americans have access to a workplace retirement plan--and even among those who are eligible to participate in a 401(k) at work, about one in five choose not to do so in a given year. And when they change jobs, many 401(k) participants take tax-inefficient distributions, rather than leaving their assets in retirement accounts. For example, Fidelity has found that younger workers with relatively small retirement balances are particularly likely to cash out their 401(k)s.

To be sure, these issues of retirement access and savings are far more consequential than the DOL's forthcoming rule. Further, the proposed DOL rule has prompted opposition not only from the securities industry but also from Congress, where a just-introduced bill would delay the DOL's ability to introduce a fiduciary standard. Nevertheless, the DOL's impending rule, if adopted, has the potential to provide meaningful benefits to workers. Call it one small step in the right direction for investors, even if it seems like a giant leap to the brokerage industry.