President Obama made headlines this week by publicly endorsing rules that will more tightly govern the behavior of financial advisors. The rules aren’t new – the proposed regulation is actually a rewrite of a scrapped 2010 rule that brokerage firms successfully squashed.
On the surface, you’d wonder why anyone would fight the concept. It’s fairly simple. Obama and the Department of Labor want to create a “fiduciary standard” that requires brokers to put their clients interests before their own. Sounds fair. But with any government regulation, banks and brokerage firms are worried about unintended consequences and costs associated with additional red tape.
While the full scope of the fiduciary standard has yet to be fleshed out, the goal is clear. The government wants to put an end to "backdoor payments and hidden fees” that accompany products that don’t benefit retirement savers but result in commissions for advisers, usually pricey investment retirement accounts (IRAs) and annuities. Jason Furman, chairman of Obama's Council of Economic Advisers, said these products cost future retirees north of $17 billion a year.
So why is the industry up in arms over the rules? Well that depends who you are talking to. Sketchy advisers who make money off of expensive products that likely won’t benefit their clients obviously would like to continue the practice.
“There really are a bunch of advisers that push products in their own self-interests,” according to one broker employed by a bulge-bracket bank who requested anonymity. However, most of those people work as independent advisers, he said, because bigger firms have significantly more compliance and regulatory oversight.
For him to sell an annuity, he needs managerial and corporate approval. “These layers of protection exist in all of the wire houses but are much less common among advisers who hang a shingle,” he noted.
That said, advisers who already claim to be following this fiduciary standard are also worried about the rules, especially if they are implemented with a broad brush stroke. The Securities Industry and Financial Markets Association said the proposal “would lead to a number of negative consequences for individual investors."
Ironically, the rule could hurt the small investors that it is designed to protect, industry proponents say. Costs associated with the additional paperwork and the certainty of greater litigation expenses could put an end to commission-based accounts that smaller investors typically rely on, leaving only fee-based accounts that they probably can’t afford. Savers with assets under $50,000 would likely be dropped, industry groups told Bloomberg.
Plus, there is the reputational harm, both to financial advisers and the products that do make sense in certain situations. “This law is inevitably going to make people afraid of financial advisers and lead them down a path of peddling random stocks in their ETrade account,” said the bulge-bracket adviser. “And, while some of them may get lucky here and there, they will miss out on Social Security planning, income planning, risk management, estate planning, tax strategies, and ironically some of those products that actually do serve a really useful purpose from time to time.”
Obama may not have helped the industry’s reputation when he noted in his speech that some advisers are “selling snake oil.”
At the end of the day, the success of the fiduciary standard will be all about its implementation. “If it's done well then it probably makes sense,” said another adviser.
But like so many issues, there is a wide gap between theory and practice, said Paul Werlin, president of Human Capital Resources, a wealth management recruiting firm. “The devil is indeed in the details here, and my confidence level is pretty low when it comes to regulators getting the details right,” he said. “I think the law of unintended consequences will be in full play.”
Next up for the Department of Labor is a comment period. Surely they’ll get plenty of them.