By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends much of her time in Asia and is currently working on a book about textile artisans.
The Wall Street Journal reported last week in Who Is Winning With the Fiduciary Rule? Wall Street that the fiercely-resisted fiduciary rule has proven to be a boon thus far to Wall Street– contrary to the idea that its implementation would spell the end of Western civilisation as we know it:
The brokerage business fiercely fought the new retirement advice rule. But so far for Wall Street, it has been a gift.
The rule requires brokers to act in the best interests of retirement savers, rather than sell products that are merely suitable but could make brokers more money. Financial firms decried the restriction, which began to take effect in June, as limiting consumer choice while raising their compliance costs and potential liability.
But adherence is proving a positive. Firms are pushing customers toward accounts that charge an annual fee on their assets, rather than commissions which can violate the rule, and such fee-based accounts have long been more lucrative for the industry. In earnings calls, executives are citing the Department of Labor rule, known varyingly as the DOL or fiduciary rule, as a boon.
Now, taking my tongue out of my cheek for a moment. As I’ve written before, it’s no surprise that implementation of the fiduciary rule had more or less proceeded as planned– despite Trumpian sturm und drang to the contrary– given that Wall Street firms had taken steps necessary to comply given the rule’s planned implementation date before Trump was elected as President (as I wrote in this February post, Fourth Federal District Court Looks Likely to Uphold Fiduciary Rule). Notwithstanding Trump’s February memorandum directing the Department of Labour to revisit the rule–especially given the dubious legal significance of that action– firms were not going to roll back these arrangements.
Yet now it turns out that the new rule actually helps, rather than hurts, the bottom line of financial firms. Well, strike me pink and call me Rosy, as my high school English teacher, Mr. Gordon Muir, was known to say. According to the WSJ:
Primarily because of DOL and market appreciation, assets are growing in fee-based accounts, said Stifel Financial Corp. Chief Executive Ronald Kruszewski, on a call in July. In an interview, he said such accounts can be twice as costly for clients.
….
For some consumers, a fee-based account could make economic sense. Such accounts can also come with more services, and they theoretically align a broker’s interest with that of the client. Some customers are negotiating discounts on the fees they pay, and some are moving to lower-cost firms, data suggests and industry executives say.
“Whether it’s in clients’ best interest is unclear,” said Steven Chubak, an analyst at Nomura Instinet. But the fiduciary rule is ”incentivizing firms to accelerate conversions“ to fees from commissions, he said, and “certainly the amount charged on a fee-based account versus a [commission-based] brokerage account is higher.” The push is speeding up an industry trend toward fees, which offer more predictable revenue than commission-based accounts.
If It Helps Wall Street, Does That Mean It Hurts the Retail Investors It Was Allegedly Promulgated to Protect?
Given the WSJ’s reporting– which I have no reason to doubt per se, the obvious thought arose: if this helps Wall Street, doesn’t that come at the expense of account holders.
To which I have three responses.
First, we have no good idea what the actual cost or benefit of the current rule is to account holders. There were some estimates bandied about by the previous administration– the most widely cited being that the previous system cost investors 1% in returns or about 17 billion dollars in total per year. I’d like to see some better figures here. And given that the rule only took effect in June, and only partially– with the Labor Department now proposing to push off full implementation until January 2019– I wouldn’t be surprised that the evidence might be highly inconclusive.
Second, let’s suppose that the WSJ is correct– and that financial firms are even now reaping higher returns from their new, fee-based compensation than under the previous commission-based system. Is that necessarily bad?
Well, I would say, no, not necessarily– because under the previous system, firms had huge incentives– based on the expected commissions they would earn– to steer investors into at minimum unsuitable and in the worst case, outright dodgy investments. Even if investors are paying nominally higher fees to for their brokerage accounts, overall, they might be better off when the full cost of being directed to loser investments is considered. In other words, under the previous system, they may have paid Wall Street less for the privilege of investing, but overall, lost more on loser investments to which they were directed under the previous commission-based system. The fees/commissions paid may only have been a minor percentage of total losses.
And, I’d like to make a third point. It seems to me that a fee-based system is more transparent, and makes it easier for investors to shop around– and shift their business to other brokerages– if their present arrangements seems to be unduly expensive. So, that if even at the moment– after less than a couple of months of the new rule being partially in place– the still-developing fee-based system has investors shelling out more in fees, as this system is fully implemented, that won’t necessarily be the case (assuming that the Labor Department doesn’t gut the rule entirely– more on that below).
What Comes Next?
Does this mean the fiduciary rule is here to stay? Well, not so fast. The WSj also reported last week in Labor Department Seeks 18-Month Delay in Fiduciary Rule:
The Labor Department is proposing to delay the fiduciary rule’s compliance deadline by 18 months, a move that experts say suggests the retirement-savings rule will emerge from a re-evaluation with significant revisions.
The agency, which has been reassessing the Obama-era rule’s economic impact, said Wednesday in a court document that it submitted a proposal to push the Jan. 1, 2018, compliance date to July 1, 2019. The document, filed as part of a lawsuit in the U.S. District Court for the District of Minnesota, also says the Labor Department is considering loosening restrictions on the types of transactions that are prohibited under the rule, including insurance products and rollovers of individual retirement accounts.
The fiduciary rule “is likely here to stay, but its impact could be significantly reduced over the next few years if exemptions from the rule are significantly expanded,” said Jamie Hopkins, a professor at the American College of Financial Services.
The details on what the Labor Department will do are vague, according to the New York Times in Labor Dept. Seeks Delay of Consumer Protection Rule for Financial Advisers. For the moment, the Labor Department is not expected to tamper with the basic standard that brokerages are expected to follow in their handling of client accounts. But over the longer run, reconsideration of other elements appear again to be in play, such as the rule’s legal liability standards, which allow consumers to sue investment advisers and the financial firms with which consumers hold their retirement accounts for breach of the new fiduciary standards. As I discussed in this earlier post, Goodbye Fiduciary Rule? Department of Labor Delays Implementation Until June. the Trump administration has proven to be an assiduous opponent of expanding legal liability, and I see no reason for an exception to be made here.
Bottom Line
What I fear may happen is that the Labor Department will now act to neuter elements of the rule that are not business-friendly. But that’s only an intuition on my part, and it will be necessary to wait and see just what the agency comes up with in this regard.
8 comments
Comments are closed.
None of the delay and actions by Wall St appears focused on benefiting their customers.
Can I mage a wager?
Fee Income >> Commissions.
So the fiduciary duty supposedly prohibits brokerages from putting the interest of the firm ahead of that of the client. In other words if the firm is holding on to a bad investment, they can’t simply slough it off on to their unsuspecting clients. My question here is, how is this enforceable?
Back in the 90s, a friend of mine started doing online investing and paid to see the higher level stock quotes, ie he could see not only the price and volume but also who was doing the buying and selling. His father was a large investor with Merrill Lynch who still invested the traditional way using their brokers’ recommendations. One day my friend saw Merrill selling off huge chunks of a company that his father had said Merrill had just recommended to him as a buy. My friend told his father who went screaming into the brokerage demanding to know why they thought they could fleece him. They asked how he found out and when he told them his son had spotted the their trade, Merrill told him they’d make sure he was on the A list from then on, which was evidently their internal list of client’s not stupid enough to openly fleece. A year or so later the Feds caught Merrill doing what my buddy had already noticed and slapped them with a hefty fine.
So in the above instance this was enforced, however it would seem to be pretty easy to avoid, especially as the Feds are ostensibly looking out for this type of thing. What’s to stop a firm from claiming they they still thought shares of company XYZ were a buy they were recommending to clients, they were only selling some shares of XYZ themselves in order to take profits, or something to that effect?
And as Synoia touched on, what’s to stop them from simply steering customers into stable blue chip funds that have huge, ever increasing fees? Sure they could always go with another firm who has a similar investment with lower fees, if such an animal actually existed. My guess is that these firms will to collude to make sure it doesn’t though. Collusion happens quite frequently I would assume – I’ve seen evidence of it firsthand when I worked for WAMU – and I doubt it has suddenly stopped judging by the lax enforcement of just about everything these days.
Is there anything in the proposed rules that would set a cap on what these firms are allowed to charge for certain services?
What is to stop them from doing this? In the past? Nothing. Now? It would probably take a lawsuit, but since there’s now the expectation of fiduciary responsibility you at least have something to stand on which you didn’t before. High fees are easy to keep track of, easy to ship off your accounts somewhere else, as Yves points out.
Wall Street will inevitably game whatever rules exist. Having a legal requirement to act in your best interest sounds, to me, better than the reverse.
Happy year 1 jerri-lynn…another informative thought piece
The big problem with this rule is its construction and implementation. Ask anyone in the business. Instead of using the SEC fiduciary rule registered investment advisors use, the Department of Labor invented their own. It is a contraption. A kludge. One small firm I’m familiar with, three advisors and two clerks, that already follows the SEC fiduciary rule, will have to hire another clerk just for the DoL rule. Some of the DoL rules aren’t specified…just wait to see how the lawsuits are decided to know how much is a “fair” charge, etc.
Most workers do not need to pay 1%- 2% for an intermediary to select a core retirement fund. With technology today and independent education in the workplace on understanding QDIA’s, over $17 billion can go into pockets of middle class and retirees. Further, our virtual platform, eliminates the need for using broker dealers for the trillions of dollars in IRA’s. Unbundle investment management costs and expertise from “planning”. Workers can go direct, in their SEP’s, SIMPLES and IRA’s to the nations top SEC registered investment companies. No intermediary is necessary.
The part of the DOL rule that is most critical to the average worker is the ban on mandatory arbitration and use of SRO FINRA. Industry is working hard to ensure that part of the Rule is not implemented. That is is the only part of the rule that can make a difference, along with the elimination of the IRS five part test, that mandates “advice” in an IRA account be mutual. Further, dual registrants are still permitted and there is no enforcement mechanism, since Congress has not yet given FINRA the ability to enforce the breach of fiduciary duty under the IAA Act of ’40.
Further, calling a broker, with no expertise on investment selection a “fiduciary” questions how due diligence can be performed and enforced if they are not experienced and trained fiduciaries. Many have no education beyond high school and whose primary role is sales. Given this lack of ability to conduct due diligence questions how courts can enforce BICE.
Time is long overdue to eliminate these redundant intermediaries using today’s technology. One can understand SEC disclosures with easy to use online tools and one-time training for life to ensure transparency as to costs and performance, including portfolio turnover. Why won’t employers promote such independent technical training in the workplace so every worker can make informed transparent choice? The many lawsuits against the top workplace provider of education and their use of managed accounts (that GAO has criticized due to lack of audited performance) and payments for shelf space in the workplace answers that question.
In sum, Congress created the Investment Advisers Act of ’40 and Investment Company Act of ’40. The current distribution model for retirement product evades these rules and there is no longer any regulation of audited performance/portfolio turnover. It is a brilliant business model that has reason in prominence, to the detriment of the consumer, since the advent of defined contribution plans. A direct method of distribution eliminates these intermediary channel conflicts.
The answer is to eliminate the redundant intermediaries, unbundle intermediary investment management from “planning” assistance for an hourly fee and let professional money managers, who file audited performance at the SEC, do the investment management. Technical training, with today’s technology, provides the transparency so one can make an informed choice as to what is in their best interest.
This rule has positives about fees and fiduciary requirements, but it is designed to herd everyone into index funds and be a boon to litigators. Ending the class action boondoggle for the tort lobby and providing better flexibility on investing alternatives is a better reform path for the rule.
Currently, the rule increases costs for smaller players and benefits large financial firms over small firms. Most regulation has the effect of crushing small business, not helping citizens and erecting higher barriers to competition for large firms.
Newly fee-based accounts might build wealth better than they did as commission-based accounts. )The latter incentivize churning or near-churning.) That is, they’d build wealth better if buying and holding really is more effective in the long run than is chasing day to day fluctuations.