Thursday, June 18, 2015

Why You Should Support the DOL's Conflict of Interest Rule

Mrs. G.'s Exchange for a Worse Fixed Annuity. 

Mrs. G., an 88-year old widower, wanted to increase her monthly income. She had previously purchased a nonqualified tax-deferred annuity from a brokerage firm, seven years before. She went back to the broker to "annuitize" it - i.e., start taking monthly payments from the annuity.

But the broker didn't do what she requested. Instead, the broker did a "tax-free exchange" into another, new annuity. But, as interest rates had declined over the seven-year period, the rate of return on the new annuity was a paltry 1% a year. If the broker had simply annuitized the existing annuity, the guaranteed rate of return during the annuitization period was 3%.

The annuities were both from insurance companies that were very highly rated, in terms of their financial strength. In all other respects, the terms of the annuitization were identical, except for the rate of return.

The result - Mrs. G. got less in monthly payments. Not a huge amount less on a monthly basis, but over the 10-year period of the annuitization (longer if Mrs. G. lived past age 98), the difference would end up being substantial.

Mrs. G. came to me. At the time I was a practicing attorney. After reviewing the prior annuity contract and the new annuity contract the broker had sold to her, I immediately wrote a letter to the broker-dealer firm. Their reply? The broker-dealer firm said that the new annuity was "suitable" for Mrs. G., and that Mrs. G. had signed all of the paperwork, and had no claim.

I knew filing a complaint with the industry's arbitrator, NASD (now known as FINRA) would be an uphill battle. I advised Mrs. G. to not undergo the stress of arbitration, at her age.

What was astonishing to me then, and what remains astonishing to me now, is that the broker simply lacked a "duty of care." The broker could act out of self-interest and undertake a recommendation in which the broker received a great deal more (i.e., the commission on the sale of the new annuity), rather than to do what was in the best interests of the customer. The broker could, in fact, undertake a recommendation that any intelligent, objective person would conclude was patently against Mrs. G.'s best interest.

But, Mrs. G., who "trusted" her broker, was not capable of asking the right questions. She was financial unsophisticated - as most Americans are. Even if she had been capable of asking the right questions, chances are she would not have pressed the issue. This is because behavioral biases each of us possess often compel us to not challenge those whom we trust.

Mr. and Mrs. T.'s "Suitable" But Poor Investment Portfolio. 

Recently I was approached by two highly educated young professionals to review their portfolio. What did I find?
  • Their "dual registrant" (broker/investment adviser) had them sign forms that acknowledged that the brokerage firm was not obligated to act in their best interests. Of course, Mr. and Mrs. T. were unaware they signed these forms - it was one of a stack of forms presented to them when they opened accounts with the firm.
  • The couple were sold non-publicly traded REITs. These are highly illiquid investments. Why were they sold? Because the compensation paid to their brokerage firm on them - 10% up-front commission (plus more by means of "marketing expense reimbursements") was much than would be received if a publicly-traded (liquid), lower-cost and better REIT were recommended. (Yes, to get brokers to sell lousier products, product providers incentivize brokers with higher commissions and other types of payments.) But, the product was "suitable."
  • The couple were also sold oil and gas limited partnerships. These, too, are highly illiquid investments. And, the long history of the prior oil and gas limited partnerships associated with this general partner suggest that it is highly unlikely that Mr. and Mrs. T. will ever recoup their initial investment, much less achieve a reasonable rate of return. Some due diligence would have uncovered this fact - but, a broker does not possess such a strong obligation of due care. Rather, only enough diligence was required to ensure that the investment was "suitable." One again might wonder why the broker sold this investment. The answer seems clear - it paid a much higher commission to the brokerage firm, and the individual broker, than most other investments would have.
  • Mrs. and Mrs. T. were also sold a number of high-cost mutual funds - that paid the brokerage firm additional compensation (on top of commissions paid) in the form of 12b-1 fees, payment for shelf space, and "soft dollar" compensation.
  • And, Mr. and Mrs. T.'s portfolio was structured very tax-inefficiently. As a result, they paid much more each year in taxes than they should have.

Many, Many More Examples of Harm Exist.

I wish I could say these were just isolated incidents. But it is not.

In my decades of service as an estate planning and tax attorney, then investment adviser and Certified Financial Planner(tm), time and time again I have seen brokers recommend highly expensive products to clients - products that pay them enormous amounts of compensation.

As seen above, it is not just the "Mrs. G.'s" of this world who are harmed. It is also highly intelligent Americans who "trust" their "financial advisor" (as most do). But, in many cases, this trust is not deserved.

Numerous conflicts of interest pervade the securities industry. These conflicts of interest provide economic incentives to provide poor advice. And, unfortunately, the "suitability standard" protects brokers from accountability for such poor advice.

In essence,  the conflicts of interest that so pervade Wall Street today substantially interfere with the attainment, by Americans, of their retirement and other lifetime financial goals, hopes, and dreams.

The U.S. Department of Labor Seeks to Rectify Today's Sad State of Regulation with the Requirement That Nearly All Advisors to Retirement Accounts Be Fiduciaries.

To aid individual Americans, in April 2015 the U.S. Dept. of Labor proposed to extend the application of fiduciary standards to all nearly all of those who provide investment recommendations to investors in ERISA-covered qualified retirement plans [such as 401(k) plans] and to investors in IRA accounts. Nearly all advisors providing investment advice to 401(k) plans and IRAs would be required to adhere to a duty of loyalty (act in the "best interests" of the client), act with due care (as an expert professional), and with utmost good faith (i.e., with complete candor and honesty).

Sounds reasonable, doesn't it? In fact, it is what individual investors desire - trusted, objective advice from an expert. And that's what the fiduciary standard is all about.

The fiduciary standard is all about the advisor being on YOUR side - as a representative of you, the client. And not being on the side of the investment product manufacturer - i.e., not being a "product salesperson."

The U.S. Securities and Exchange Commission's Failure to Apply Fiduciary Standards, and It Even Now Permits Core Fiduciary Duties to be "Waived" or "Disclaimed"

Some financial advisors already adhere to the fiduciary standard, although - quite frankly - to varying degrees. The U.S. Securities and Exchange Commission (SEC) enforces the fiduciary standard on "registered investment advisers." Unfortunately, the SEC permits some financial advisors to "disclaim" or "seek waivers" of the fiduciary duties of due care and loyalty. Often this is done when a new customer of a "dual registrant" firm signs one of those 50+ page packet of forms and disclosures. These "disclaimers" and "waivers" then permit the brokerage firm or insurance agent to receive additional compensation from the product provider. This additional compensation, in turn, effectively reduces the investment returns that the customer receives.

Of course, rarely do individual investors understand what they are signing. If an investor did understand the disclosures and waiver forms - they wouldn't sign off on them ... because it is a fundamental truth that no client would ever provide informed consent to be harmed.

The SEC's failure to insist upon avoidance of most conflicts of interest, and its implicit approval of firms' disclaimers of their fiduciary duties, as well as the SEC's non-application of fiduciary standards to brokers whose primary function is now providing "advice" (not executing trades), are all part of a long litany of SEC failures to protect individual investors. No wonder the U.S. Department of Labor felt compelled to step in.

The SEC is now considering whether to adopt fiduciary duties for brokers who provide personalized investment advice. Given the "revolving door" among SEC staff between government and Wall Street (and the law firms representing Wall Street), and given four decades of inappropriate decisions by the SEC on fiduciary issues, we are not hopeful that the SEC will "get it right."

Consumers: Search for Fee-Only Financial Advisors.

In my years of service as a Professor, teaching undergraduate students about financial planning and investments, I have noticed a slow evolution toward fiduciary advice. It's what consumers want. (It's also the preferred business model advisors desire to operate under - on the same side of the table as their clients.)

Fortunately for individual investors, today many financial advisors voluntarily avoid the many serious conflicts of interest which pervade Wall Street. We call these trusted advisors "fee-only" advisors.

There are several organizations of fee-only advisors individual investors can turn to, in order to locate these trusted, fee-only advisors. Each organization assists consumers, through its online search tool, as well as additional educational information on their web sites, to locate the fee-only advisor who best suits each consumer's needs. These organizations include:
  • The National Association of Personal Financial Advisors, the nation's oldest and largest association of fee-only personal financial advisors, whose fee-only members charge either a percent of the assets managed, a flat fee for project work, annual retainers, hourly fees, or some combination of the foregoing (;
  • The Garrett Planning Network, a pioneer in the provision of hourly fee-only financial and investment advice (;
  • Alliance of Comprehensive Planners, whose member provide annual retainer fee arrangements to assist clients in all aspects of their situation (; and
  • The XY Planning Network, a relatively new but rapidly growing organization in which advisors offer reasonable monthly fees for ongoing advice (

All of these organizations support the general thrust of the U.S. Department of Labor's proposal - that all financial and investment advisors should be fiduciaries.

Consumers: For Added Protection - Secure a "Fiduciary Oath" From Your Advisor.
The Committee for the Fiduciary Standard (CFS) also generally supports the DOL's proposed rulemaking.

And the CFS also suggests to consumers that they act to protect themselves. For investors to receive additional assurance that their advisor is truly acting in their best interests, CFS suggests that individuals request their advisor to sign this "Fiduciary Oath":

I believe in placing your best interests first. Therefore, I am proud to commit to the following five fiduciary principles:
  • I will always put your best interests first.
  • I will act with prudence; that is, with the skill, care,
    diligence, and good judgment of a professional.
  • I will not mislead you, and I will provide conspicuous, full
    and fair disclosure of all important facts.
  • I will avoid conflicts of interest.
  • I will fully disclose and fairly manage, in your favor, any
    unavoidable conflicts.

What if your "financial advisor" refuses to sign off on the Fiduciary Oath? It's a clear sign that you, the consumer, should secure a second opinion - and fast. (And don't believe the many "excuses" some financial advisors will assert, as to why they can't sign the oath.)

For more information on questions you might ask your financial advisor, see two of my prior posts:

Wall Street's Brokerage Firms and the Insurance Companies Seek to Stifle the Application of Fiduciary Standards of Conduct.
Be aware that Wall Street's reaction to the Department of Labor's proposal, to expand fiduciary duties, was quite unfortunate and contrary to the interests of individual investors. As reported in the media:

SIFMA - the lobbyist for mainly large Wall Street brokerage firms: "The Securities Industry and Financial Markets Association released a white paper by the law firm Morgan Lewis & Bockius asserting that brokers are already 'thoroughly' regulated under current Securities and Exchange Commission and Financial Industry Regulatory Authority Inc. rules."

FSI - the lobbyist for mainly independent brokerage firms: "FSI Chair Blasts White House Fiduciary Memo as 'Offensive'"

FINRA, the professed "self-regulator" for all U.S. broker-dealer firms and their registered representatives, and Wall Street's industry-funded watchdog: "Richard Ketchum, chairman and CEO of the Financial Industry Regulatory Authority, devoted his entire opening remarks at FINRA’s annual conference, held the same day in Washington, to criticizing DOL’s plan."

Wall Street and the insurance companies extract extremely high and unreasonable rents from individual investors, and by so doing fuel their enormous compensation, bonuses, and high profits. The fiduciary standard challenges their entire business model. No wonder they profess that the DOL's rule is "unworkable."

It's not surprising that Wall Street and the insurance companies would be opposed to a true fiduciary standard, as one of its requirements is that all compensation be "reasonable." In other words, perhaps the only way the DOL fiduciary standard is really "unworkable" is that it is "unworkable" for them - to continue to derive excessive fees and other compensation at the expense of Americans.

The fiduciary standard also requires expertise in recommending investments, and that fees and costs of any investment product recommended also be reasonable. Many brokers have little or no expertise at all in managing investment portfolios; Wall Street is also afraid it would have to spend money training them.

Wall Street's False Assertions Should Be Refuted. 

Wall Street, in fighting against the fiduciary standard, has asserted a number of falsehoods and half-truths. I, in reply, have sought to provide insight into the reality of why Wall Street says these things. Here are Wall Street's two major arguments, and my own counter to these falsehoods:

Wall Street: "Small investors can't be served under the fiduciary standard."

Wall Street: "We already serve investor's 'best interests'."

Wall Street's other arguments, such as that it will be "too costly" for them to serve investors when a fiduciary standard is applied, also fall to the wayside. All you have to do is look to the many, many current investment advisory firms serve many, many investors under a fiduciary standard. Millions and millions of investors are served - properly - and with far less extraction of fees and costs than occurs under Wall Street's failed "product seller" business model. These fiduciary advisors avoid conflicts of interest, and in so doing align their interests with those of their clients.

Yet, Wall Street fights on. Broker-dealer firms and the insurance companies flood Washington, D.C. with millions and millions of dollars. Many of these dollars flow into Congressional campaign coffers to try to get the U.S. Congress to stop DOL's rule-making efforts.

Wall Street's lobbyists also falsely state that existing rules adequately protect investors. Wall Street's major lobbyist, SIFMA, even proposed a new rule that it said would adequately protect investors. But, a close look at SIFMA's proposal reveals that it falls woefully short of the important protections offered by a fiduciary standard. See "Wall Street's Deceptive 'Best Interests' Proposal".

Hope ... for "Mrs. G.",  "Mr. and Mr. T.", and Individual Investors Everywhere

The battles over the standards of conduct providers of investment and financial advice should adhere to will continue.

While Wall Street's money machine and hundreds of paid lobbyists flood D.C., consumers - individual investors trying hard to save and invest for their financial futures - possess some powerful allies on their side. These organizations include: AARP; Better Markets; Americans for Financial Reform; Pension Rights Center; Consumer Federation of America; The Certified Financial Planner Board of Standards; Financial Planning Association; National Association of Personal Financial Advisors; AFL-CIO; and the American Federation of State, County and Municipal Employees (AFSCME). And many more. See

What's at stake? The financial futures of our friends and neighbors. Even the economic future of America itself.

How so? Through prudent, principles-based regulation and the proper application of the fiduciary standard upon providers of personalized investment advice to retail investors and retirement plan sponsors:
·   Greater trust in financial advisors will result, and individuals will deploy a greater portion of their savings to the capital markets;
·   As greater capital formation occurs, the cost of capital is lowered for U.S. business;
·   Greater and lower-cost capital formation thereby provides the fuel for greater future U.S. economic growth and prosperity;
·   With their financial futures better secured through lower-cost, more prudent investments, individuals accumulate far more for their retirement needs;
·   As a result, burdens are lifted from federal, state and local governments to provide for their many senior citizens; and
·   This leads to lesser government expenditures and, over the long term, lower income tax rates for both business and individuals, further propelling U.S. economic growth in the decades ahead, and permitting increased investments in the education and infrastructure necessary to support such growth.
Hence, let us all rally upon the DOL's proposal. While some tweeks may be required to make it work a bit better, the DOL's "Conflict of Interest" proposed rule will greatly aid in achieving the results set forth immediately above - a better future for all Americans.

I urge each of you to submit your comments to the U.S. Department of Labor, in support of its rule. [Email:; include RIN 1210-AB32 in the subject line of the message.]

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