DOL Conflict of Interest Rule: A Message to Congress

Executive Summary: What Wall Street Does Not Want Congress to Know.

• Brokerage firms and insurance companies are already adapting to the DOL's Conflict of Interest (Fiduciary) Rule - rolling out programs to serve clients both large and small with reduced-fees-and-cost, largely conflict-free platform offerings.

• Some firms started to adapt even before the release of the Final Rule in early April 2016.

• Many brokerage firms have already lowered, or are in the process of lowering, the fees of their advisory platforms.

• Many brokerage firms are reducing their account minimums, so that they can serve even smaller clients.

• It is clear that the Rule will benefit business owners (plan sponsors), by substantially reducing the risks they face in excessive fee litigation cases. Expect more 401(k) plans to be offered.

• Business owners currently possess little or no recourse against their "retirement plan consultants," most of whom escape liability under the weak "suitability standard" that largely protects brokerage firms and insurance companies from liability for the advice they provide. As a result of the DOL fiduciary rule, business owners won't be "left hanging and out to dry" for relying upon the recommendations made by these "retirement plan consultants."

• Both large and small business owners should be entitled to rely upon the advice they receive, as to the investment options to include in their company's retirement plan.

• The fiduciary standard operates as a constraint on greed. "Bad choices" - i.e., expensive, inappropriate, rent-seeking investments - will be done away with under the fiduciary standard.

• With the ability to trust the investment adviser to the plan, and with reduced risks, more business owners are likely to start and maintain qualified retirement plans.

• Because the level of trust in financial services will rise, and lower fees and costs will mean greater returns for investors, a new era of increased capital formation will occur. This, in turn, will accelerate the growth of the U.S. economy over the long run, further boosting prosperity for all Americans.

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Dear Members of the U.S. Congress:

In the ongoing battles over the U.S. Department of Labor's enactment of its "Conflicts of Interest" (fiduciary) rule, over and over again I have observed Wall Street firms, insurance companies, and their lobbying organizations (SIFMA, FSI, and NAIFA) spout various misleading and often downright false statements.

In this blog post I point to many of the sources in which Wall Street's lies are unmasked, and their double-talk is revealed.

I hope you will do your own review of the evidence, and ascertain that - once again - Wall Street is intentionally misleading you.

Prior to examining Wall Street's statements in more detail, please permit me to dispel any misconceptions you may possess about the SEC and the DOL working together - they intensively engaged in meaningful, cordial discussions, and their dialogue led to a better rule.

I've scanned the 2,500+ pages of emails and correspondence between the two agencies. My scan reveals two agencies working together well, offering thoughtful insights and suggestions to each other.

• The fiduciary standard under ERISA is a "sole interests" standard, augmented by ERISA's prohibited transaction rules. The fiduciary standard under the Investment Advisers Act of 1940 is a "best interests standard." While similar in most respect, differences exist. Hence, absent major Congressional action that changes either ERISA or the Advisers Act, the U.S. Department of Labor's application of the fiduciary standard will be different from that of the U.S. Securities and Exchange Commission.

• Despite these differences, the DOL and SEC have conferred on the DOL's rule-making, extensively. While the Majority Staff of the U.S. Senate Committee on Homeland Security and Governmental Affairs issued a 40-page critical of the extent of communication, one need only review the over 2,500 pages of e-mails, drafts circulated between the DOL and SEC (and comments thereon), attendee lists of joint meetings of the DOL and SEC staff, and much more, to ascertain both the huge breadth and depth of the communications between the two agencies over several years time. 

• Furthermore, while the Majority Staff report was critical of a dialogue between two economists, who has never known two economists to not disagree? Additionally, from the perspective of this writer (a professor of finance and financial planning), the DOL's economist's statements in the two economist's written exchanges were correct, while the SEC economist appeared to lack knowledge of how the financial services industry works, the huge body of academic research relating to the behavioral traits of consumers, and much more.

Let's More Closely Examine Wall Street's Many Misleading and False Statements about Fiduciary Rule-making.

• A STATEMENT COMPLETELY UNTRUE AND THE REVERSE OF WHAT WILL ACTUALLY HAPPEN: "SMALL BUSINESS OWNERS WILL BE HARMED." Yet, all logic dictates otherwise, as I've explained here and here). The reality is that business owners both large and small are exposed to excessive fee litigation lawsuits, often with no recourse against their "retirement plan consultant" who hide behind the "suitability shield" and who do not possess fiduciary obligations to the plan sponsor (i.e., business owner). The DOL's Conflicts of Interest Rule corrects this situation, so that plan sponsors are not "hung out to dry" for relying upon the recommendations of a "retirement plan consultant." I predict that more 401(k) plans will be formed by small businesses, not less, given the greatly reduced liability exposure of plan sponsors when such plan sponsors (small business owners, generally) receive advice as to investment selections for the plan under a fiduciary standard.

• A GROSSLY FALSE ASSERTION: "FEES AND COSTS WILL RISE FOR INVESTORS." This is exactly the opposite of what will actually occur, as explained by numerous economic studies. This is also confirmed by my own personal observations, from observing hundreds and hundreds of clients over the past 15 years. I observe that clients' total fees and costs fall usually in the range of 30% to 70%. Fees and costs matter to the returns investors secure, as I've explained here. Under the fiduciary standard, the adviser becomes the steward of the client's wealth, with the obligation to incur only reasonable fees and costs. (See also the discussion below, where new fee structures have already emerged under the fiduciary standard from broker-dealer firms, in which fees have been lowered.)

• A STATEMENT CONTRARY TO ALL THE EVIDENCE! "SMALL INVESTORS WON'T BE SERVED." Yet, I provide insights into entire networks of fiduciary, fee-only advisers that already serve small investors, in "How to Choose A Financial/Investment Adviser: A Checklist for Consumers." In addition to these networks, as well as newer online investment advice platforms that have emerged, we have seen many existing firms already adopt new platforms to serve smaller clients:

• The Wall Street Journal reported on March 16, 2016, that brokerage firms are actually LOWERING their minimums, and LOWERING their fees, for SMALL CLIENTS! 

• "The brokerages are trying to avoid losing small-balance, commission-based retirement accounts because of the rule, while also positioning themselves to gather more fee-based revenue. LPL Financial Holdings Inc., based in Boston, said ... that it would lower its minimum for certain fee-based accounts by $5,000, to $10,000, this year, while also cutting some of the costs associated with those accounts."

• "Edward Jones plans to roll out new low-cost accounts that charge an annual fee to investors with as little as $5,000, according to Jim Weddle, the firm’s top executive. D.A. Davidson & Co. of Great Falls, Mont., is in the process of developing a similar product, according to an executive."

• Ladenburg Thalmann, one of the country's largest independent broker-dealers, is rolling out $ymbil, its new digital advice platform. The self-service portfolio account will be made available to its advisor network and will require a minimum  of only $500 investment to open an account.

• Margarida Corral of Financial Planning magazine reported on March 31, 2016: "CUSO Financial Services and Infinex Financial Group are planning to not only lower minimums and adjust pricing on advisory accounts but are making arrangements to partner with digital advice providers – all in an effort to serve the widest range of customers in the new regulatory environment, including small investors with modest savings." 

• Further evidence of the adjustments already taking place at broker-dealer firms can be discerned from a May 15, 2016 article from GlobeNewswire, where it was noted: "FolioDynamix offers a solution that can help firms transition their commission-based business into advisory accounts. There are even options for smaller-balance accounts that might not normally meet managed account thresholds. Key firms have already begun taking advantage of this solution ...."

• Industry consultant Cerulli Associates "anticipates large broker/dealers (B/Ds) will use developing technology to serve smaller accounts on a flat-fee basis, and insurance companies will be forced to lower variable annuity expenses and commissions to be in line with other financial products."

• Financial Planning magazine reported on March 31, 2016:

• "CUSO Financial Services  and Infinex Financial Group are planning to not only lower minimums and adjust pricing on advisory accounts but are making arrangements to partner with digital advice providers – all in an effort to serve the widest range of customers in the new regulatory environment, including small investors with modest savings.

• With the expected shift to fee-based advisory business, firms want to make sure that their advisory offerings are competitive in terms of both their account fees and minimums.

• Infinex, for instance, is in the process of lowering its minimum balance requirements on all of its advisory products so that it "can offer advisory products to a wider audience," says Stephen Amarante, president and CEO of the broker-dealer.  He noted that Infinex is rolling out more tiered pricing to appeal to a broader range of clients, despite the fact that the firm's pricing is already extremely competitive, especially on the lower end.

• CUSO Financial is also looking into changes to its advisory offering with a view to helping smaller clients who don't have assets to meet program minimums. "We have been looking at tweaking programs and developing new programs that will have lower minimums and lower fees to work best with this segment of our clients," says Peter Vonk, CUSO's chief compliance officer and executive vice president of business services. 

• For the smallest customers, both CUSO and Infinex are planning to use robo technology platforms.  An investor who is adding just $50 a month to his 401(k), for example, might be better served under a digital platform, Amarante notes. While these smaller accounts would be served using automated technology, they would still be managed by an advisor, he says.

• CUSO is in discussions with several digital advice providers and anticipates having a platform implemented long before the final rule becomes effective. "We expect to have solutions to continue to meet everyone from the ultrahigh-net-worth to the folks who are just starting out on their investment journey," Vonk says."

• Large Wall Street Firms Have Already Transitioned Much of Their Business to Fee-Based Accounts! The Wall Street Journal's columnist, Jason Zweig, wrote on April 4, 2016: "Giants like Morgan Stanley and Bank of America Corp.’s Merrill Lynch are already moving away from commissions, because fee-based revenue is more stable and less tied to market swings. Morgan Stanley’s wealth-management division, for example, already has 40% of client assets in accounts that charge an annual fee. That helped it generate $8.5 billion in fee-based revenue last year, or 70% of its total. In January, Morgan Stanley projected a 5% to 13% increase in pretax profitability at its wealth unit in 2017, partly as a result of its continuing shift to fee-based accounts."

• DOL fiduciary rule will impact less than 10% of Bank of America wealth assets, CFO says http://www.investmentnews.com/article/20160414/FREE/160419953/dol-fiduciary-rule-will-impact-less-than-10-of-bank-of-america (Investment News)

• ANOTHER MISLEADING STATEMENT: "CHOICE IS ELIMINATED." Only bad choices will be limited. At its core, the fiduciary standard operates as a restraint on greed, as I've explained here. Even Adam Smith recognized the need for standards of conduct! And, the fact of the matter is that new, lower-cost products will emerge for investors - as has already occurred both before and after the announcement of the DOL Final Rule!

• A MISLEADING STATEMENT. IN FACT, IF "COMPLEXITY" IS A PROBLEM, IT'S ONE OF WALL STREET'S OWN MAKING! - "THE RULE IS TOO COMPLEX." At its core, the application of the fiduciary standard to retirement accounts (qualified plans and IRAs) is done through a principles-based standard grounded in centuries of legal precedent. The core rule is simple, straightforward, and elegant.

• The "Best Interests Contract Exemption" (BICE) - which Wall Street and the insurance companies complain about as being "too complex" - only exists because of the DOL's effort to accommodate Wall Street's business practices. Even then, the core of BICE - found in its Impartial Conduct Standards - remains a straightforward, elegant elicitation of the core fiduciary standards of conduct. Wall Street decries BICE, however, for its "complexity" and the requirement of "more disclosures." Yet, if Wall Street does not desire to operate under BICE, all they need to do is operate under ERISA's principles-based standard, with no additional exemption required - as thousands and thousands of investment advisers already do, every single day!

• AN UTTERLY FALSE STATEMENT: "THE RULE DETERS CAPITAL FORMATION." Wall Street argues that capital formation will be deterred. But, the opposite occurs, as more wealth is accumulated as excessive rent-taking is reigned in, thereby accelerating the retention and growth of capital. This in turn provides the fuel for future U.S. economic growth, as I've explained here). An added bonus is that the capital markets become more efficient in allocating capital, as greater due diligence is undertaken among various investments by expert advisers.

Wall Street's hypocrisy gets even worse. Let's examine conflicting statements from ICI.

Insights can be gleaned from the Investment Company Institute (ICI) in its Nov. 15, 2013 letter in opposition to the California Secure Choice Retirement Savings Program. ICI represents large asset managers, many of whom will see their revenues fall as a result of the rule and the shift to lower-cost investment products. While ICI now opposes the DOL's fiduciary rule, and its application of ERISA's fiduciary standards to 401(k), certain other qualified retirement accounts, and IRAs, just look at what ICI stated in 2013 regarding the benefits of ERISA:

• "ERISA's purpose is to protect the benefits of private sector workers and we see no justifiable reason to deny these fiduciary protections to workers ....";

• "Many financial services providers .... offer low-cost 401(k), 403(b) and IRA-based plans to employers large and small";

• "We question whether denying Program participants the fiduciary protections or ERISA would benefit private-sector workers"; and

• "In our view, to essentially give workers participating in the Program no recourse to hold any party responsible for the decisions made and actions taken with respect to their retirement savings would be unfathomable" [yet, this is what occurs, de facto, under the current extremely low "suitability" standard of conduct, which lowers the standard of care of brokers and permits them to sell often-high-cost and inappropriate products to consumers, as I explained here].

Many Others are Pointing out Wall Street's Misleading Statements and False Assertions.

• fi360 and ThinkAdvisor have for several years conducted a survey of financial advisors. The survey summarizes its findings: "The fiduciary model works for advice and money management – registered investment advisers have been profitably providing advice that’s in the best interest of their clients since 1940. However opponents of the fiduciary standard say some brokers would leave the industry, or charge investors more for advice, or wouldn’t work with small investors if regulators extended the fiduciary standard. Findings of the fi360 Fiduciary Standard Survey do not substantiate those fears."

• Senator Warren and Representative Cummings blasted the insurance companies in theIr Feb. 11, 2016 letter to the DOL and OMB. Pointing out the insurance companies' contradictory statements,  Sen. Warren and Rep. Cummings stated: "In contrast to their public doomsday predictions, industry leaders have told their own investors that they 'don't see this as a significant hurdle,' 'will once again respond to marketplace or regulatory changes effectively,' and that they are well-positioned to 'adapt to any regulatory framework that emerges.'"

• "Senator Warren Calls for SEC Investigation Into Financial Services Providers Over Contradictory Statements on the DOL Conflict of Interest Rule": Senator Warren, in a March 31, 2016 letter to the SEC, questioned whether insurance companies (who also act as broker-dealer firms, through a subsidiary) were violating federal securities laws by making misleading statements to shareholders. Senator Warren pointed out that, in one instance, a firm "saying almost simultaneously [to the DOL] that the rule would be 'unworkable' and [to its shareholders] that the rule would not be "a significant hurdle." Senator Warren's letter further set forth these examples:

• In July 2015, Dennis Glass, the president and CEO of Lincoln National said in his comment letter that the proposed rule was "immensely burdensome" and "extremely intrusive," and would be "so burdensome and unworkable that financial advisors and firms will not be able to use it."; while two months earlier, Mr. Glass told investors that he didn't "see [the proposed rule] as a significant hurdle for continuing to grow that business."

• In July 2015, the president of Jackson National Life Insurance Company said in his DOL comment letter that the proposed rule would "be very difficult, if not impossible for financial professional and firms to comply" with; then, in August 2015, the president of Jackson's parent company told investors that a similar rule in the United Kingdom actually led to an increase in retail sales and that the company was positioned to "build whatever product is appropriate under that set and adapt faster and more effectively than competitors."

• In July 2015, the president and CEO of Transamerica' s Investment and Retirement Division said in a comment letter that the proposed rule was "unworkable"; then, a month later, the president of Transamerica's parent company told investors that the company had "shown ... flexibility and ... expect[ed], with that flexibility, [to] remain very strongly positioned in a market that is providing products that millions of customers in the U.S. continue to need."

• In July 2015, Prudential Financial's Executive Vice President and General Counsel wrote in a comment letter that some of the proposed rule's provisions posed a "significant challenge" that "will significantly increase" the firm's servicing expenses; that same month, another Prudential Financial official told investors that the proposed rule would not stop the company from "mak[ing] these offerings available on terms that work for everybody." 

• Industry commentator Bob Clark recently unveiled how Wall Street speaks double-talk about commissions resulting in lower fees to investors, when in reality commissions (and other revenue-sharing arrangements, in addition to commissions) result in far greater compensation to brokers (and, as a result, less returns to investors).

• Anthony Isola recently unmasked the high fees resulting from many annuity sales.

• Josh Brown, a former broker - now a fiduciary - unveils "The Most Horrendous Lie on Wall Street"- stating in part: "The incentives paid by fund companies to brokerage firm sales forces across the country are a cancer that must be rooted out."

• Barry Ritholtz, another former broker turned fiduciary, also effectively refutes Wall Street's main threats about the fiduciary standard in his March 20, 2016 piece: The enlightened view on managing other people’s money

CONGRESS - IT'S TIME TO DO THE RIGHT THING!

The fact of the matter, the rule is good for individual consumers, and good for the future economic growth of America, and the prosperity of all Americans.

This is an example of prudent regulation that possesses huge benefits for Americans and America, far in excess of the one-time costs associated with its implementation.

The DOL's rule may possess an impact on some broker-dealer firms, some insurance companies, and some asset managers - but only if they don't change their conflict-ridden business models. Those firms that embrace change and react proactively to the rule will likely gain market share, attain a more stable stream of revenue, and thereby increase the value of their business entities.

• [By way of explanation, brokerage firms charging commissions, predominately, are typically valued at 1x gross revenue. But firms charging primarily fees, such as annual asset-under-management fees, because of the stability of the income stream and the greater depth of relationships with their clients, typically are valued at 2x-5x gross revenues. Brokerage firms can actually increase the price of their shares, and benefit their shareholders, by moving to fee-based accounts.]

As discussed above, the fact of the matter is that many broker-dealer firms and insurance companies are already adjusting to the new rules. Some are even lowering minimums for new clients - as well as lowering fees!

In summary, the DOL's Conflict of Interest Rule will:

• restore the trust of Americans in their financial and investment adviser;

• reduce the excessive rent-taking by Wall Street from individual investors;

• benefit business owners, both large and small, by reducing the risks they face in connection with qualified retirement plan accounts;

• lead to substantially better retirement outcomes for our many friends and neighbors as the reduced fees and costs result in higher returns for individual investors; and

• result in greater capital accumulation, fueling an explosion of economic growth in the United States over the long term.

Members of the U.S. Congress - Do The Right Thing! ... Support the DOL's Conflict of Interest Rule.
Support a government action that is long overdue, and that fosters a hugely positive and beneficial result for your fellow Americans.

Support an elegant rule that will promote America's future economic growth. 

Ron's past speaking engagements, webinars and articles/posts since the DOL Final Rule was announced:

• Financial Planning magazine, webinar with other participants

• Garrett Planning Network, webinar (April 2016) (membership in GPN required)

• AICPA - podcasts and white paper (April 2016) (registration required)

• The Wall Street Journal - Ron answers questions with other experts about the DOL's Final Rule in this series of articles:

• Karen Damato, "Ask the Experts - Fiduciary Q&A: Must Conflicts Be Avoided or Just Disclosed?" (WSJ, 4/27/2016)

• Karen Damato, "Ask the Experts - Fiduciary Q&A: Will the New Rule Bleed Over to Nonretirement Accounts?" (WSJ, 4/27/2016)

• Karen Damato, "Ask the Experts - Fiduciary Q&A: The New Fiduciary Rule (5 Questions)" (WSJ, 4/15/2016)

Please note the upcoming speaking engagements by Professor Ron A. Rhoades. Attend these presentations to learn more about the DOL Conflicts of Interest (Fiduciary) Rule and its impact on financial services and business practices:

• FPA Kentuckiana, Louisville, KY - Sept. 2016 (date tentative)

• FPA of Portland and SW Washington - Sept. 2016 (date tentative)

• FPA of Southwest Florida - Estero Country Club - Oct. 20, 2016 presentation

[If your organization is interested in having Professor Rhoades speak about the rule, please contact Ron at: Ron.Rhoades@wku.edu. Thank you.]


Dr. Ron A. Rhoades is an Assistant Professor of Finance and Director of the Financial Planning Program, Gordon Ford College of Business, Western Kentucky University, in Bowling Green, Kentucky. Over the past decade he has undertaken substantial legal research and writing regarding the fiduciary standard of conduct, as applied to investment and financial advisors. Dr. Rhoades is a frequent speaker on the fiduciary standard at financial planning and investment industry conferences.

(This blog represents the personal views of the author, and not necessarily the views of any institution, organization or firm with whom the author may be associated.)