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Memo to Industry: Get Behind Fiduciary Rule

It's hard to argue against putting retirement clients' interests first.


In the mid-1960s, with the United States lacking a clear path to win the Vietnam War, former Sen. George Aiken, R-Vt., suggested that America declare victory and withdraw from the fight. With respect to the Department of Labor’s proposed fiduciary rule for retirement advice, the financial-services industry should declare victory on behalf of investors and stop fighting these inevitable, necessary regulatory reforms.

To recap, on Tuesday the Department of Labor proposed an amendment to the fiduciary definition under ERISA, the Employee Retirement Income Security Act. In short, the proposal would require any individual receiving compensation for providing investment advice to a plan sponsor, plan participant, or IRA owner making a retirement investment decision to adhere to a series of fiduciary duties--that is, to act in the best interests of their clients. The rule is based, in part, on a Council of Economic Advisors analysis showing that when individuals receive what the White House calls "conflicted advice," they tend to enjoy lower investment returns. Obviously, battling these reforms produces optical challenges: Who wants to come out against operating in clients’ best interests or in favor of conflicted advice?

Perhaps it is no surprise, then, that Merrill Lynch head John Thiel recently struck a conciliatory tone, reportedly saying that he was open to working with the DOL on a "best interest" standard of care. Perhaps some Merrill brokers were unhappy with Thiel’s stance, but his position makes sense--if the rule is almost certain to be implemented, it is better for the industry to have meaningful input.

And just as surely as a Chicago winter will arrive, the rule is coming. (In these parts, we start thinking about winter pretty early.) President Obama appeared with DOL officials in February and directed them to adopt such a rule. Generally speaking, when a president comes out strongly in favor of this sort of administrative rule-making, he gets his way.

The proposed rule is, quite frankly, pretty long, so it will understandably take some time for industry participants to react to it. However, prior to the issuance of the rule, some industry groups had expressed skepticism about the intellectual justifications for what they consider a potentially overbroad fiduciary rule.

In a letter to The New York Times, Paul Stevens, the head of the Investment Company Institute, a fund industry trade group, criticized the White House’s economic argument for a fiduciary rule. Relying on an analysis prepared by the ICI’s chief economist, Brian Reid, Stevens argued that the government’s analysis was "fatally flawed." Stevens particularly criticizes the White House’s Council of Economic Advisors for claiming that investors in IRAs pay fees that are 1 percentage point higher than costs paid by 401(k) investors. Without getting too far into the weeds about this argument, it is true that at least one part of the CEA’s white paper oversimplified the comparison between IRA and 401(k) fees.

The Securities Industry and Financial Markets Association, which represents a range of financial-services organizations, says that the regulators’ initiatives need to reflect that investor protections exist under current law. Moreover, SIFMA chief Kenneth E. Bentsen Jr. said that a DOL fiduciary standard may "cause a detrimental impact on all American savers, especially middle class investors, and the retirement system as a whole."

Leaving aside the overblown rhetoric--really, all American savers, including people with a deposit account in a bank, will suffer if brokers adhere a fiduciary standard?--the critics of a fiduciary rule have a point. There are some protections for investors who receive poor broker-provided advice on their retirement accounts. And smart people can poke some holes in the Administration’s economic arguments in favor of the fiduciary rule.

For me, the issue comes down to the harm that can and does come to individual retirement investors in the absence of the fiduciary rule. Take the case of an investor who works for an employer who offers a low-cost, well-diversified target-date fund. When this investor leaves her employer, it can set in motion a chain of events that could include a broker recommending a high-cost portfolio of funds that offer him the highest commissions. Is that really the way we want our retirement system to work?

Also, is there really anyone prepared to argue that retirement investments driven by conflicted payments are likely to produce better investor outcomes than operating under a "best interest" standard?

Another reason for the brokerage industry to get behind this rule: From its perspective, this fiduciary initiative could have been much broader. Under Dodd-Frank, the SEC has the authority to impose a fiduciary standard on all broker activities, not just those retirement matters subject to the proposed DOL rule.

Moreover, the DOL took pains to ensure that with adequate disclosure and compliance safeguards the proposed rule would allow brokers to continue to pursue commission-based retirement business. That stands in stark contrast to regulatory actions in much of the rest of the world. For example, the U.K. and Australian governments have already banned commissions paid to advisors by fund managers.

In short, there are few reasons for the industry to oppose the fiduciary rule and many to support it. As  Bank of America Corporation (BAC) CEO Brian Moynihan said of the fiduciary rule on Wednesday’s earnings call for the bank, "We believe that doing what is in the best interests of your customers is absolutely the right thing to do." The industry will move to a fiduciary standard, according to Moynihan, "and we expect to help move it there." Here’s hoping that the rest of the industry will join Bank of America.

Scott Cooley is Morningstar's director of policy research and formerly served in a variety of analyst and management roles at the firm. He is also a graduate student at the University of Chicago, focusing on political science. Unless specifically indicated otherwise, the views that he expresses in this column are his own.

Scott Cooley does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.