Fidelity's O'Hanley Is Wrong: DOL/EBSA Rulemaking re: Definition of Fiduciary Is Just Common Sense

FIDELITY'S ATTACK ON THE FIDUCIARY STANDARD

Wall Street is unleashing their attack dogs in order to try to stop the EBSA from re-releasing its proposed rule, "Definition of Fiduciary." Wall Street's lobbyists are out storming the Administration, and particularly the Office of Management and Budget (through which the rule must first pass, before it is released). And Wall Street, with its millions of millions of campaign contributions, is seeking support from Congress as well.

In an April 10, 2013 article written by Kenneth Corbin, Expected Fiduciary Rules Could Worsen Retirement Crisis, Fidelity Chief Warns, the author quoted Fidelity's Ronald O'Hanley, President of Asset Management and Corporate Services as stating: "The effect of this rule was clear: It would have shifted the legal line between investment advice and education, and thus dramatically curtail the valuable education and guidance investors receive today. The real outcome of this misguided proposal would be no education and no guidance for average and low-income Americans. They are the ones that are going to get hit most by this."

As you are likely aware, the Department of Labor's Employee Benefits Security Administration is likely to re-propose, this year, an expansion of the definition of "fiduciary" under DOL rules to encompass nearly all providers of investment advice to ERISA plans. In addition, under statutory authority already granted to it, it is likely to require that advice provided to IRA accounts also fall under ERISA's tough fiduciary standard. Of course, Wall Street and the insurance companies are opposed to this rule, for it would negate their ability to extract excessive profits from investors big and small.

This is not the first time Wall Street has played this card - i.e., threatening to leave individual investors "stranded." Each time Wall Street's business model, in which conflict-ridden investment advice is challenged, it THREATENS that the proposal would end services for "average and low-income Americans."

As if that would be a bad development! I say - let them end services!

As discussed below, Wall Street's rhetoric is an empty threat. There will be many, many advisors to take their place - and in the process of doing so individual investors and plan sponsors will receive better, higher-quality advice for far less in total fees and costs.

FIDELITY'S ILLOGICAL POSSITION IS UNFOUNDED, SELF-INTERESTED, AND GOES AGAINST SOUND ECONOMIC PRINCIPLES

Fidelity, through its executive, asserts that our fellow Americans will not be served if the fiduciary standard is applied. As I pointed out in an earlier blog post, this is a HOLLOW statement. My earlier words are worth repeating here:

• Wall Street's whining and attempts at obfuscation also ignore fundamental economic principles. In 1970, Nobel-Prize winning economist George A. Akerloff, in his classic thesis, The Market for "Lemons": Quality Uncertainty and the Market Mechanism, The Quarterly Journal of Economics, Vol. 84, No. 3 (Aug., 1970) demonstrated how in situations of asymmetric information (where the seller has information about product quality unavailable to the buyer, such as is nearly always the case in the complex world of investments), "dishonest dealings tend to drive honest dealings out of the market." As George Akerloff explained: “[T]he presence of people who wish to pawn bad wares as good wares tends to drive out the legitimate business. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”  Akerloff at p. 495.

• In other words, as long as Wall Street is able to siphon excessive rents from investors, through conflict-ridden sales practices resulting in higher costs for individual investors (and lower returns), the business model Wall Street seeks to preserve will continue to attract bad actors. It's only human nature ... "join our firm and your compensation potential is virtually unlimited" is Wall Street's "promise" - ignoring of course the requirement that the new employee is required to sell - not only expensive and often proprietary investment products, but indeed his or her very soul.

• Enhanced Standards of Conduct Will Fuel Demand, Supply and Quality ...

• [W]hat will happen if the fiduciary standard is applied to the delivery of advice to all plan sponsors, plan participants, and individual investors, through potential DOL (EBSA) and SEC rule-making? Economic principles and common-sense logic indicate that three dramatic developments will occur.

• First, once individual investors know that they can trust the words coming out of the mouths of their financial advisors, the demand for financial advice will soar. Currently far too many individuals distrust Wall Street, and - given their inability to discern between high-quality, fiduciary advisors and low-quality, non-fiduciary advisors, they simply choose to stay away from both. Additionally, the adverse smell of the non-fiduciary advisors infects the entire landscape of financial advisors.

• Second, we will see a surge in the availability (supply) of fiduciary-bound financial and investment advice. More and more actors will be attracted to become such fiduciary advisors. As many, many already have, they will be attracted to a true profession in which they sit on the same side of the table as the client and assist the client in achieving their hopes and dreams. They receive not just professional compensation from providing expert, trusted advice, but they also receive the immense joy from assisting their fellow man.

• Third, the quality and quantity of advice will also soar. Currently Wall Street's legions are primarily "asset gatherers" and product salesperson. Much of the training provided is on how to sell - i.e., to close the deal. Fiduciary financial advisors, on the other hand, bound by  fiduciary standards, are required to exercise due care in all aspects of the advice they provide. Clients will receive better budgeting advice, increased levels of savings, and better investment advice.

• I can hear those on Wall Street bemoan such logic ... "Surely, you jest," they would say. "No advisor can afford to serve small clients, without selling expensive products to them!"

• Yet I ask, what is the compensation paid on a Class A mutual fund, for a client who has $20,000 to invest? 5.75%, plus a small (0.25% or less, typically) trailing 12b-1 fee (in theory, in perpetuity) - in addition to [often-high] fund management and administrative fees and the fund's often exorbitant and mostly hidden transaction and opportunity costs. So a Wall Street firm (and its representative) would receive a $1,150 sales load, plus more over time?  The fact is, there are many financial advisors out there right now who will provide advice for $1,150 - or far less. This advice will be provided under hourly-based compensation or for a flat fee or under some other form of professional-level compensation arrangement. And the advice provided won't be just relating to the sale of an expensive product; rather for the same or lower fees paid by the client the professional fiduciary advisors will provide the clients with better financial advice and investment advice, and far more comprehensive advice at that.

• Let fiduciary advisors be paid professional-level compensation for truly expert advice in the client's best interest. Wall Street may be unable to extract enough rents to survive under the fiduciary standard, but there are plenty of independent, objective, trusted professionals who will take Wall Street's place, and do a far better job for the individual investor in the process..

WHAT IS FIDELITY'S EXECUTIVE REALLY SAYING?

Perhaps this.

• We, the conflict-ridden purveyors of products, can't make our large profits if we can't charge high fees for small investors. 

• We should be entitled to provide advice as non-fiduciaries to plan sponsors and to plan participants, under the "suitability" standard - which essentially permits us to recommend almost any investment product we offer.

• We don't want "purchaser's representatives" - fiduciaries who in the proper exercise of their due diligence compare our investment products to those of other product providers, seeking out the best products for inclusion in qualified retirement plan accounts and IRAs. We'll lose market share if this occurs - and we'll be unable to extract large profits.

• Don't mess with our business model. It's highly profitable for us! Don't move our cheese!

• Our fellow Americans don't deserve the greater retirement savings, better investment results, and greater retirement security that the fiduciary standard will offer.

WHAT FIDELITY CHOOSES TO IGNORE

Economies of Scale Exist in Qualified Retirement Plans.  What Fidelity's executive fails to note, as well, is that qualified retirement plans enjoy a tremendous opportunity, in most instance, for economies of scale. Well-run large retirement plans often have fees relating to investment advice which are of a flat fee nature, or single-digit basis points. Why is this important? Because academic research clearly demonstrates that fees and costs matter, in terms of the returns individual investors receive.

Fiduciaries Shop for Clients, and Keep Fees/Costs Reasonable.  Yet only fiduciaries have an obligation to keep total fees and costs reasonable. This is the REAL REASON Wall Street wants the fiduciary standard to not apply to either ERISA accounts or to IRA accounts. It would disrupt their ability to extract excessive rents from millions of our fellow Americans.

Disintermediation Disrupts Wall Street's Excessive Seizure of Rents. The result of applying the fiduciary standard is disintermediation. This is what Wall Street really fears! Right now Wall Street consumers 30% to 40% of the profits generated by the U.S. economy. Yes, really!  For more discussion on this point, see Bob Veres' excellent March 1, 2013 Inside Information blog post, Parasites Who Would be Fiduciaries.  (If you don't subscribe to Bob Veres' excellent blog, with its large amount of practice management tips, views of recent developments, and thought-provoking articles that challenge your existing preconceptions on so many issues relating to investments, financial planning, and the profession, why don't you do so now?)

Two Standards - One for the Rich, One for the Poor?  Perhaps Wall Street wants Americans to be served under two different standards. Only the "rich" would be entitled to fiduciary advisors; all others must deal with the excessive fees imposed by conflict-ridden models. Of course they don't want this. They want to be able to extract excessive rents from the rich, too!

And, of course, I reject any notion that those with lesser investment assets don't deserve fiduciary protections. In fact - they are the most in need.

FIDELITY'S HOLLOW MESSAGE

Fidelity's O'Hanley goes on to say: "We should be doing everything we can to expand, promote and perhaps require financial education in the workplace. Investors certainly need protections in place, and we need to make sure the proper protection's in place, but their best interest can only be served if the regulatory framework allows for a wide range of tools to serve the needs of investors and provide low-cost guidance, education and advice that they want and need," O'Hanley added, calling on lawmakers and industry representatives "to keep the pressure on Labor and reject any proposal that would limit the availability of education and guidance to workers."

Let's examine the highlighted statements above.

"Serve the best interests of the investor?"  Wall Street tosses the term "best interest" around like it doesn't mean anything. It does - it means respecting the trust placed in advisors by each and every plan sponsor, plan participant, and individual investor. Don't toss around "trust" with such disregard! It always appalls me when a representative of Wall Street invokes the term "best interests" to argue AGAINST the fiduciary standard of conduct - the only standard of conduct that ensures that the best interests of the individual investor is protected under the law!

Provide low-cost guidance, education and advice that they want and need?  Yet, academic research demonstrates that the fiduciary standard, through disintermediation (followed by some reintermediation at much lower total levels of fees and costs for the receipt of fiduciary advice), results in the "low-cost" guidance, education and advice that investors are really looking for. Indeed, conflicted advice results in higher fees and costs, endangering the retirement security of tens of millions, if not hundreds of millions, of our fellow citizens. For a good and concise summary of this recent research, please read Chris Carosa's excellent Feb. 2013 blog post, Yet Another Independent Study Highlights High Conflict-of-Interest Cost to Retirement Investors.

"Limit the availability of education and guidance?" O'Hanley cites no academic research in support of this conclusion. The only thing that is limited by the fiduciary standard is the greed of Wall Street. For more on this point, please refer to the prior discussion, as well as to two articles I wrote many months ago for RIABiz:

• One-Man Think Tank: The fiduciary standard may sink Wall Street's advisors-on-yachts. Should we care?
• One-Man Think Tank: What would Adam Smith say about the fiduciary standard?

WE WANT TO PROTECT OUR FELLOW AMERICANS - BY APPLICATION OF THE FIDUCIARY STANDARD TO INVESTMENT ADVICE UNDER ERISA AND TO IRA ACCOUNTS. WHAT SHOULD WE - EACH ONE OF US - DO NOW?

I would suggest several actions which YOU, personally, can take TODAY.

First, write to the Employee Benefits Securities Administration, and specifically to its courageous leader, Mrs. Phyllis Borzi. A suggested letter might be as follows (but please add your own comments and feelings AND examples):

• Office of Regulations and Interpretations
• Employee Benefit Security Administration
• Attn: Definition of Fiduciary Proposed Rule
• Room N-5655
• U.S. Department of Labor
• 200 Constitution Avenue, NW
• Washington, DC 20210

• Re: Definition of Fiduciary, Expected Re-Release of Proposed Rule

• Dear Asst. Secretary Borzi and the EBSA Regulatory Team:

• The actions you have taken to increase the disclosures made to plan sponsors and plan participants are most welcome. These actions have already saved individual investors tens of millions of dollars each and every year. But your task is only partially complete. Hence, I write to urge the U.S. Department of Labor's Employee Benefits Securities Administration to re-propose the rule, "Definition of Fiduciary," with a strong rule which provides that all plan sponsors, plan participants, and IRA account holders receiving investment advice receive such under ERISA's strong "sole interests" fiduciary standard and its related prohibited transaction rules.

• I am aware that Wall Street's legions of lobbyists are telling all that will listen, and without any substantive backing, that the imposition of the fiduciary standard would deprive individual investors of investment advice. This has not been my experience, however. (Describe your experiences, if any, here.)

• Indeed, many financial and investment advisory firms today serve the small investor under a fiduciary standard of conduct. These independent fiduciary investment advisers often provide far more comprehensive advice - including the all-important advice relating to debt reduction, savings, and tax strategies - which purveyors of investment products seldom offer. They do so for fees which are fair and reasonable.

• Moreover, since fiduciaries possess the obligation to ensure that the total fees and costs are reasonable (an obligation not shared by non-fiduciary "advisors"), it has been my experience that the total fees and costs paid by clients of fiduciary independent investment advisors are usually ___% to ___% less than the fees and costs paid when sold products in a non-fiduciary environment.

• If non-fiduciary advisors, with their extraction of excessive rents, withdraw from serving the retirement market with conflicted advice, this would be a welcome development. Tens of millions of our fellow Americans will be aided. Many, many advisors are willing to be fiduciaries and to serve our fellow citizens in that capacity. Individual investors and plan sponsors will receive better advice, for far less fees and costs. The retirement security of Americans will be substantially enhanced.

• I have personally seen the result of non-fiduciaries serving the retirement market ... (set forth one or more additional personal examples here).

• In summary, please continue your efforts to re-propose a strong rule, in which my fellow Americans are protected through the application of the fiduciary standard of conduct to all investment advisory activities relating to retirement plan and IRA accounts.

• Respectfully, /signature/

Second, write to your Member of Congress and to Your Senators. A suggested letter might read:

• I write to urge you to support the U.S. Department of Labor's Employee Benefits Securities Administration re-proposal of the rule, "Definition of Fiduciary," with a strong rule which provides that all plan sponsors, plan participants, and IRA account holders receiving investment advice receive such under ERISA's strong "sole interests" fiduciary standard and its related prohibited transaction rules.

• I am aware that Wall Street's legions of lobbyists are spreading false information to you. They seek to inform you, without any substantive backing, that the imposition of the fiduciary standard would deprive individual investors of investment advice. This has not been my experience, however. 

• Indeed, many financial and investment advisory firms today serve the small investor under a fiduciary standard of conduct. These independent fiduciary investment advisers often provide far more comprehensive advice - including the all-important advice relating to debt reduction, savings, and tax strategies - which purveyors of investment products seldom offer. They do so for fees which are fair and reasonable. 

• Moreover, since fiduciaries possess the obligation to ensure that the total fees and costs are reasonable (an obligation not shared by non-fiduciary "advisors"), it has been my experience that the total fees and costs paid by clients of fiduciary independent investment advisors are usually ___% to ___% [Ron's experience is 30% to 70%] less than the fees and costs paid when sold products in a non-fiduciary environment.

• If non-fiduciary advisors, with their extraction of excessive rents from the retirement portfolios of our fellow citizens, are restricted from serving the retirement market with conflicted advice, then tens of millions of our fellow Americans will be aided. They will receive better advice, for far less fees and costs. The retirement security of Americans will be substantially enhanced.

• PLEASE SUPPORT THE DOL/EBSA'S EFFORTS. THE RETIREMENT SECURITY OF OUR FELLOW AMERICANS - AND THE ECONOMIC PROSPERITY OF THE UNITED STATES ITSELF - WILL BE MUCH BETTER ASSURED WHEN THE RECIPIENTS OF INVESTMENT ADVICE CAN TRULY TRUST THE ADVICE THEY ARE PROVIDED UNDER THE FIDUCIARY STANDARD OF CONDUCT.

• In summary, I urge you to support the DOL/EBSA's rule-making efforts.

• Respectfully, /signature/

Third, if you are an investment adviser who has accounts with Fidelity, send them a message.

• Michael Durbin, President, Fidelity Institutional Wealth Services, 82 Devonshire St, Boston, MA 02109 (or write to your service team leader)

• Dear Mr. Durbin,

• I am very disappointed with the comments made by Ronald O'Hanley, Fidelity's president of asset management and corporate services, at the recent U.S. Chamber of Commerce function, in opposition to the EBSA's re-proposal of its rule, "Definition of Fiduciary."

• I urge Fidelity to reconsider its position. The fiduciary standard of conduct will better ensure the retirement security of tens of millions of our fellow Americans. By taking this position, Fidelity is acting in a fashion which is adverse to the best interests of our fellow citizens, and indeed adverse to the interests of America itself.

• Should Fidelity continue to advocate the interests of Wall Street and insurance companies over the interests of our fellow citizens, I must re-consider my choice of custodian.

• Respectfully, /signature/

THE TIME TO ACT IS NOW.

It's time the gloves came off. Don't let the courageous folks at EBSA undertake this battle alone. DOL/EBSA needs our assistance when going up against Wall Street and its legions of lobbyists and the substantial sway these influence pedalers possess over some members of Congress.

It's time to speak out. It's time to counter the hollow messages of Wall Street and insurance companies. It's time we act, together, for the betterment of the financial and retirement security of millions and millions of our fellow Americans.

YOU can make an IMPACT.  Please write your letters today.

Thank you. - Ron