Congress: The DOL’s “Conflict of Interest” Rule is Good for American Business

Summary. 

• American corporations, large and small, including business owners, would receive substantial protection from potential liability, as a result of the DOL's proposed Conflicts of Interest Rule. 

• Rather than being hung "out to dry" by their "retirement plan consultants" who largely escape liability for recommendations made to plan sponsors, corporations would be able to hold retirement plan consultants accountable for their recommendations.

• Several recent cases illustrate that American business often suffers, while Wall Street firms and insurance companies escape liability.

• The DOL's rule to remove conflicts of interest, when providing advice to business owners on establishing and maintaining retirement plans, provides important protection for American business. American business, including the U.S. Chamber of Commerce, should support the interests of plan sponsors by supporting the DOL's Conflict of Interest rule.

Introduction.

Congress primarily intended ERISA to be a consumer protection bill. Frank Cummings, ERISA: The Reasonable Expec-tation Bill, 65 Tax Notes 880, 881 (1994). Congress desired employees to have "enhanced protection for their benefits." Metro Life Ins. Co. v. Glenn, 554 U.S. 105, 114, 128 S. Ct. 2343, 171 L. Ed. 2d 299 (2008) (citing Varity Corp. v. Howe, 516 U.S. 489, 497, 116 S. Ct. 1065, 134 L. Ed. 2d 130 (1996)).

To accomplish these goals Congress makes an ERISA fiduciary liable for failing to comply with the strict trust standards codified by ERISA. However, due to a regulation adopted by the U.S. Department of Labor shortly after the enactment of ERISA, and before the beginning of 401(k) plans, many of the insurance companies and broker-dealer firms who currently provide advice to companies (employers, or plan sponsors) escape liability for their recommendations, as they are not found to be “fiduciaries” under the overly permissive language of the 1975 regulation, as interpreted by the courts.

Disputes over defined contribution plan fees and expenses are a common form of recent litigation and raise both duty of disclosure and duty of prudence issues. Fiduciaries have an obligation to administer plan duties with reasonable fees and must attempt to defray unnecessary fees as a part of their prudence obligation. The essence of fee litigation cases is that "the [plan] fiduciaries had an obligation to avoid higher than necessary fees in the mutual fund options offered in a plan menu, and failed to do so." See Stephen D. Rosenberg, Retreat from the High Water Mark: Breach of Fiduciary Duty Claims Involving Excessive Fees After Tibble v. Edison International, J. Pension Benefits, Spring 2011, at 12, 13.

Higher fees and costs associated with investment products result, on average, and pervasively, lower returns for investors in those products. It's that simple. And the academic evidence on this is clear. (For a review of recent academic research on this issue, see my comment letter to the DOL, July 2015.)

In excessive fee litigation, employers are often “on the hook” for claims arising for breach of fiduciary obligations, such as choosing mutual funds and other investment options that possess excessive fees. Yet, the insurance companies and broker-dealer firms, even when they provide “fiduciary warranties” to the employers, largely escape liability in such instances. In essence, employers (plan sponsors) are held liable for following the advice provided to them by insurance companies and broker-dealer firms, yet these firms are not held accountable for such advice. Employers suffer the consequences for the advice provided to them by insurance companies and broker-dealer firms, while these insurance and brokerage firms are “off the hook” through their use of clever disclaimers and other techniques in which they ensure that the courts will not find them to act as "fiduciaries."

To correct this unfair treatment, in which plan participants are harmed, employers (plan sponsors) are often liable, but the real experts (financial services firms) escape liability, the U.S. Department of Labor has proposed to greatly expand the definition of “fiduciary” with its new “Conflict of Interest” proposed regulation. However, Wall Street and the insurance companies are currently spending tens (if not hundreds) of millions of dollars to attempt to stop the U.S. Department of Labor’s proposal to revise its outdated rules. In essence, these financial services firms do not want to be held to account for the advice they provide.

Instead, Wall Street and the insurance companies now propose a new “best interests” standard that, upon closer examination, imposes no new significant duties upon them. While casual disclosure of conflicts of interest (such as “our interests may not be the same as yours”) might be required under this new “best interests” standard, the amount and quality of the disclosures are highly suspect. Even if the disclosures were of sufficient detail, disclosures pose significant problems in their application and effectiveness. While requiring increased disclosures may be a politically expedient solution, they do not provide significant protections for either U.S. business owners nor participants in employer-provided defined contribution plans, such as 401(k) plans.

This memorandum discusses three recent cases in which financial services companies have escaped liability for their advice to plan sponsors. As a result of these and many other cases, the U.S. Department of Labor’s “Conflict of Interest” rule is sorely needed. Otherwise, employers will continue to be misled by many financial services firms into reliance upon their recommendations, and will incur liability, even as those insurance companies and broker-dealer firms usually escape liability for the advice they have provided.

Santomenno v. John Hancock, 768 F.3d 284; 2014 U.S. App. LEXIS 18437; 58 Employee Benefits Cas. (BNA) 2845 (September 26, 2014).

This recent case illustrates how investment providers, such as insurance companies and broker-dealers, who provide advice on investment options to plan sponsors and plan trustees, can escape fiduciary status under current the DOL regulation by inserting provisions in contracts in which they disclaim fiduciary status. Despite the insurance company’s “Fiduciary Standards Warranty” in which the insurance company “warrants and covenants that the investment options” the employer/plan sponsor offers to employees “[w]ill satisfy the prudence requirement of … ERISA,” the courts continue to refuse to hold the insurance companies and broker-dealer firms to account for such representations.

J&H Berge, Inc. (“Berge”), the employer and “plan sponsor” of a 401(k) plan, entered into a group annuity contract with John Hancock under which John Hancock, assembled for the 401(k) a variety of investment options. From these investment options, the trustees of the 401(k) plan chose which investment options to offer to plan participants. The plan participants (employees) could then select from the more limited menu of options where to invest their funds.

As part of its agreement with the Plans, John Hancock offered a product feature called the Fiduciary Standards Warranty ("FSW"). Plan trustees received this feature if they selected for their Small Menus at least nineteen funds offered by John Hancock, rather than independent funds. Under the FSW, John Hancock "warrants and covenants that the investment options Plan fiduciaries select to offer to Plan participants: Will satisfy the prudence requirement of . . . ERISA." However, In the FSW, John Hancock stated that it was "not a fiduciary," and that the FSW "does not guarantee that any particular Investment option is suited to the needs of any individual plan participant and, thus, does not cover any claims by any Individual participant based on the needs of, or suitability for, such participant."

When the plan participants (employees) sued John Hancock alleging that John Hancock rendered investment advice to the plans for a fee, and that it charged excessive fees by selecting its own funds and funds of other companies that had high fees, John Hancock’s moved to dismiss the complaint on the basis that it was not a fiduciary under ERISA, and hence owed no duties of care, loyalty and utmost good faith to the plan participants (employees).

ERISA provides that a person is a fiduciary to a plan if the plan identifies them as such. See 29 U.S.C. ß 1102(a). It also provides that:

[A] person is a fiduciary with respect to a plan to the extent

(i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets,

(ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or

(iii) he has any discretionary authority or discretionary responsibility in the administration of such plan. Such term includes any person designated under section 1105(c)(1)(B) of this title.

29 U.S.C. ß 1002(21)(A).

On appeal from the trial court’s grant of John Hancock’s Motion to Dismiss, the appellate court held that John Hancock’s fund selections – including funds with high expense ratios – were mere "product design" features do not give rise to a fiduciary duty, in and of themselves. Additionally, the appellate court, while acknowledging that the U.S. Department of Labor (DOL) had re-proposed a new definition of “fiduciary,” held that the current DOL regulation remained binding. Under the existing regulation, adopted in 1975 and even before 401(k) plans came into existence, a five-factor test exists for determining whether an entity has rendered "investment advice" for purposes of ERISA fiduciary status. An entity is an investment advice fiduciary if it: [1] [R]ender[ed] advice to the plan as to the value of securities or other property, or makes recommendation as to the advisability of investing in, purchasing, or selling securities or other property . . . [2] on a regular basis . . . [3] pursuant to a mutual agreement, arrangement or understanding, written or otherwise, between such person and the plan or a fiduciary with respect to the plan, [4] that such services will serve as a primary basis for investment decisions with respect to plan assets, and [5] that such person will render individualized investment advice to the plan based on the particular needs of the plan. 29 C.F.R. ò 2510.3-21(c)(1). "All five factors are necessary to support a finding of fiduciary status." Thomas, Head & Griesen Emps. Trust v. Buster, 24 F.3d 1114, 1117 (9th Cir. 1994).

While noting the arguments of the employees that the existing DOL regulation “engrafts additional requirements for establishing fiduciary status under 29 U.S.C. ß 1002(21)(A)(ii) that narrow the plain language of this subsection,” the appellate court held that John Hancock was not an investment adviser to the plan, as any advice rendered as to the selection of mutual funds was not “pursuant to a mutual agreement, arrangement or understanding.” Because John Hancock expressly disclaimed taking on any fiduciary relationship, there was no “mutual assent” by John Hancock.

ERISA precludes fiduciaries from contracting away their responsibilities. See 29 U.S.C. ß 1110(a) ("[A]ny provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under this part shall be void as against public policy.") But the appellate court that this provision of ERISA did not prevent John Hancock from disclaiming, in the contract, the existence of fiduciary status.

McCaffree Financial Corp. v. Principal Life Ins. Company, 65 F. Supp. 3d 653; 2014 U.S. Dist. LEXIS 172626; 59 Employee Benefits Cas. (BNA) 2233 (December 10, 2014).

This recent court decision illustrates how employers acting as plan sponsors, who are fiduciaries under ERISA, cannot hold to account many of the insurance companies and broker-dealer firms. Despite the fact that employers are lured into such reliance by representations that the insurance companies and broker-dealer firms “undertake a rigorous due diligence process” in selecting investments and that the investment options offered are “designed to be appropriate for” 401(k) plans, these providers of investment advice continue to escape liability for their recommendations.

McCaffree Financial Corp. (McCaffree) sponsored a 401(k) plan for its employees. McCaffree entered into a group annuity contract with Principal Life Insurance Company (“Principal”) under which Principal offered investment options for the participants of the 401(k) plan and provided other services for the plan. The life insurance company offered a number of “separate accounts” – against which are charged “management fees” and “operating expenses.” For participants in McCaffree’s 401(k) plan, Principal selected and offered 29 separate account options. Each of these separate accounts corresponds with a Principal mutual fund that was otherwise available to retail and institutional investors. For the for the separate accounts fees were layered on top of the fees charged by the Principal mutual funds in which the separate accounts exclusively invest, thereby enabling Principal to reap substantial fees on top of the fees charged by its own mutual funds.

In particular, the Separate Investment Account Rider which formed part of the group annuity contract disclosed that each separate account could be subject to a Management Fee of up to 3% plus another fee on the underlying mutual fund. And Rider disclosed that, on top of the other two fees, each separate account is assessed an Operating Expense charge "which must be paid in order to operate a Separate Account."

Principal’s website stated in part: “The Principal understands the fiduciary responsibilities plan sponsors face in developing and monitoring an investment lineup appropriate to help meet the diverse needs of retirement plan participants. We undertake a rigorous due diligence process as a direct response to this challenge, resulting in a key differentiator -- our Sub-Advised Investment Options.”

Principal also stated in its materials that its Sub-Advised Investment Options are "designed to be appropriate for retirement savings under employer-sponsored plans" and that it has "fiduciary oversight and the ability to oversee the investment manager selection and ongoing monitoring process."

McCaffree filed a class action lawsuit against Principal, alleging that Principal violated ERISA by charging grossly excessive investment management and other fees to the participants in the McCaffree 401(k) plan and to participants in other defined-contribution retirement plans subject to ERISA. McCaffree contended that this conduct violated ERISA's duties of loyalty and prudence and involves self-dealing transactions prohibited by ERISA. In response, Principal contended that “a service provider neither acts as a fiduciary nor breaches any duty when it charges fees that are approved by a plan fiduciary--here, [McCaffree].”

The trial court rejected McCaffree’s arguments that Principal was a fiduciary under ERISA, even though Principal selected the separate accounts that will be available to plan participants. The trial court held that there was no nexus between the selection of the accounts and/or the ability to change the investment options and the excessive fees. Even though the selection of the accounts affected the fees charged to plan participants. The trial court also held that Principal was not a fiduciary as an “investment advisor” under ERISA, for if excessive fees were charged they bore no relation to the investment advice provided.

Tussey vs. ABB, Inc., Case No. 2:06-CV-04305-NKL, United States District Court for the Western District Of Missouri, Central Division, 2012 U.S. Dist. LEXIS 45240; 52 Employee Benefits Cas. (BNA) 2826 (March 31, 2012)

This case illustrates that, even when a financial services provider provides investment recommendations that result in greater income to it, and even when the new investments underperform the replaced investments, the financial services provider can still be “off the hook” – as it is not a fiduciary with respect to the investment decisions undertaken.

This case is relatively famous as a result of a later appellate decision, in which the U.S. Eighth Circuit Court of Appeals addressed the intersection between “float” income and plan assets and held that Fidelity did not breach any fiduciary duties by retaining float income. Additionally, the Eighth Circuit upheld a $13.4 million judgment against ABB (the employer), holding that “ABB used revenue sharing to benefit ABB and Fidelity at the Plan’s expense.”

Subsequently, in July 2015, the trial court, in spite of concluding that ABB was acting in breach of ERISA’s self-dealing prohibitions, held that the employees “failed to satisfy their burden of proof on the issue of damages” with respect to the choice of investments claim. This is despite the trial court’s conclusion that, “as a result of the mapping of the assets of the Wellington Fund into the [Fidelity] Freedom Funds, the [401(k) plan] sustained a loss because the Wellington Fund consistently outperformed the Freedom Funds after the mapping occurred until the six year statute of limitation ran.”

But, prior to the appellate case and the subsequent trial court proceedings, arguments in the original court case were made as to whether Fidelity was liable in connection with the investment advice it provided to ABB (and to ABB’s Pension Review Committee).

ABB, Inc. (“ABB”) offered a 401(k) plan to its employees. The Pension Review Committee of ABB was the named fiduciary of the Plan and is responsible for selecting and monitoring the Plan's investment options. The Plan included mutual funds offered by Fidelity Investments. A Fidelity Investments affiliated company, Fidelity Research, served as the investment adviser to the Fidelity mutual funds which were offered by the 401(k) Plan and invested the balances of bank accounts, which held plan contributions in overnight securities. Another affiliated company, Fidelity Trust, served as the record keeper for the 401(k) plan and, as such, provided educational information, bookkeeping, and other services to the plan participants.

In 2000, Fidelity proposed a substantial reduction in its recordkeeping fees if the assets in the Wellington Fund were mapped, or transferred to Fidelity’s Freedom Funds. At the time, the Wellington Fund, an actively managed balanced mutual fund invested in both stocks and bonds, had a 70-year track record and an annual performance exceeding Morningstar’s benchmark by 4 percent, according to the ruling. In 2000, Fidelity’s three Freedom Funds had been in existence for less than five years. Fees for the Wellington fund were lower than fees for the Freedom Funds, and the Wellington Fund contributed less in revenue sharing fees to Fidelity than the Freedom Funds.

The Amended Complaint noted that the 401(k) plan included approximately sixteen (16) retail mutual funds as investment options in 2005 as well as ABB stock and five (5) custom blended funds charging above average fees. The Amended Complaint also noted that In the financial and investments industry, a large institutional investor with billions of dollars, like the 401(k) plan, routinely can obtain lower prices for investment management and other services than can a retail investor with only thousands, or even a few million, dollars. Yet, the plan participants alleged that the plan sponsor and Fidelity subjected the plan participants “to the high costs of retail/publicly-traded mutual funds and failing to provide investment options with significantly lower costs.”

Fidelity Trust was paid two different ways for its services. Originally, Fidelity Trust was selected by a competitive bid process and was paid a per-participant, hard-dollar fee. But, over time, Fidelity Trust was primarily paid with "revenue sharing." The revenue sharing came from some of the investment companies whose products were selected by ABB to be on the 401(k) platform. Those investment companies gave Fidelity Trust a certain percentage of the income they received from PRISM participants who selected their company's investment option. Fidelity Trust also derived revenue sharing from an internal allocation within the interrelated Fidelity companies. For example, Fidelity's Magellan Fund, was one of the mutual funds placed on the 401(k) platform by ABB. When plan participants invested in Magellan, a set number of basis points (i.e., a percentage) was transferred internally from Fidelity Research, which managed the Magellan Fund, to Fidelity Trust; this was been described by Fidelity and others as internal revenue sharing.

When revenue sharing was used to pay Fidelity Trust, its fee grew as the assets of the Plan that provided revenue sharing grew, even if Fidelity Trust provided no additional services to the Plan. The trial court found that the 401(k) plan overpaid for the recordkeeping services provided by Fidelity Trust, as the revenue sharing generated for Fidelity by the funds in the 401(k) plan assets far exceeded the market value for recordkeeping and other administrative services provided by Fidelity Trust.

In essence, Fidelity (collectively, as to all of its affiliates) was the record keeper of the 401(k) plan and had its investment products in the ABB 401(k) plan. According to the plantiff’s legal counsel, Fidelity was very intimately involved with the plan sponsor, ABB, in making recommendations about investment options. In fact, Fidelity told ABB that any changes had to be “revenue neutral” to Fidelity, even though changes were subsequently made that resulted in greater compensation to Fidelity.

The plan participants alleged that Fidelity Trust and Fidelity Management breached their fiduciary duties to the plan participants by providing investment options whose fees and expenses are excessive and not properly disclosed. The trial court’s order in connection with a Motion to Dismiss noted that “the weighted average expense ratio was high compared to peer plans.”

The plan participants also alleged that Fidelity Trust “plays a central role in the selection of the investment options the Plan makes available to participants,” because Fidelity Trust “does the first-cut screening of investment options, and has veto authority over the inclusion of investment options available in the Plan ” (Am. Compl. ¶¶ 15 -16); (Doc. 110, 4). “The Trust Agreement provides that ABB’s Pension Review Committee may select “only (i) securities issued by the investment companies advised by Fidelity Management & Research Co. . . , (ii) securities issued by the investment companies not advised by Fidelity Management & Research Company” as long as Fidelity Trust approves those elections.” (Fidelity Brief Ex. 1-A, Trust Agreement Between Asea Brown Boveri Inc. and Fidelity Management Trust Company).
However, when sued, Fidelity stated that they were not responsible for any decisions of the company because they (Fidelity) were not a fiduciary. And, after trial and appeal, Fidelity was let off the hook – again.

In Conclusion.

The Committee on Investment of Employee Benefit Assets (CIEBA) has, as its members, the chief investment officers of more than 100 of the Fortune 500 companies who individually manage and administer ERISA-governed corporate retirement  plan assets. In its July 21, 2015 comment letter to the U.S. Department of Labor regarding the DOL's proposed "Conflict of Interest" rule, CIEBA stated: "CIEBA believes that participants deserve thorough, prudent, and unbiased advice from all providers involved in the management of [401(k) plan] assets ... the average 401(k) participant needs safeguards from conflicted advice. Anyone advising participants about their 401(k) assets should be held to the same fiduciary standards as plan sponsors."

I agree. Any firm providing recommendations about which investments to include, or not include, in a 401(k) plans line-up is providing advice. Firms should not escape liability for their recommendations by hiding behind the "suitability doctrine" - which is an inappropriate abrogation of the standard of care to which nearly all other service providers are held.

Since the DOL's regulations were enacted in 1975, defined contribution plans (including 401(k) plans) have arisen and now dominate the retirement plan space. Yet, the regulations failed to keep pace. The result was, over time, the use of these out-dated regulations by insurance companies and broker-dealer firms to escape liability for their investment advice, in most instances.

Employers - American businesses - desire to offer retirement plans for their employees. Not being experts in the complex field of investments, they are often duped by "fiduciary warranties" and "due diligence" recommendations made by insurance companies and broker-dealer firms. Yet, when the s**t hits the fan, only the plan sponsor (employer) is held liable in most instances, and the insurance companies and broker-dealer firms - upon whom they were encouraged to rely - are left off the hook. This is gravely unjust and an inherently unfair result.

It is time to protect American business from these misdeeds. The DOL's proposed Conflict of Interest should be permitted to move forward, toward its final adoption.

Congress, especially the Republicans who have long been advocates for American business interests, should wake up and recognize the substantial harm resulting to both plan sponsors (American corporations) and to retirement plan participants (employees) by the numerous conflicts of interest currently present in much of the financial services industry.


Congress should permit the DOL to proceed with its rules, which will minimize those conflicts of interest. In so doing, American business will be encouraged to offer retirement plans for employees, and American business can hold all providers of investment advice to plan sponsors to account for their recommendations. It is just to do so. It is fair to do so.

Act Now! In The Battle for the Future of the U.S. Economy & Americans' Retirement Security

We have great needs in this country. Greater investments in infrastructure, education, and renewable energy, to provide the foundations for our great country's economic growth.

But these and other needs require capital - and lots of it.

We are blessed with innovation - driven in large part by our great research universities, but also in independent labs and offices throughout the country.

We are blessed with entrepreneurs - risk-takers who, with perseverance and finely honed business skills, can take innovative ideas and bring them to the marketplace.

What we need, to propel our economy forward, is capital.

While Americans invest, primarily in qualified retirement plans and IRAs, in stock and bond mutual funds, which in turn provide capital to fuel American business forward, much more in needed. More savings. More capital investment. Much more accumulations of capital over time.

Yet, a force has emerged, over the past few decades, that has stalled U.S. economic growth. It is Wall Street, and the insurance companies. Acting together they have effected a dramatic extraction of rents from the retirement savings accounts of tens of millions of our fellow citizens. By some estimates, 20% to 40% of all of the returns of the capital markets flow to Wall Street and the insurance companies, rather than to individual investors.

The result? Less capital accumulation, in the retirement savings accounts of our country.

The DOL's Conflict of Interest proposed rule would correct, to a large degree, this wrong. The DOL is due out, within the next few months, with a final rule. Implementation of the rule is expected about 7-9 months later.

This rule will mean more of the returns of the capital markets will flow to our fellow citizens. They, in turn, will accumulate that capital. This, in turn, will greatly assist to fuel future U.S. economic expansion.

But ... Wall Street and the insurance companies don't want this rule. It would affect their ability to extract huge amounts out of the system, and into their pockets. And they are fighting HARD to stop or delay the rule.

Wall Street and the insurance companies are pouring TENS OF MILLIONS (and some estimate HUNDREDS OF MILLIONS) of dollars into Congressional campaign coffers to influence members of Congress to stop the rule.

Wall Street and the insurance companies have funded a multi-million-dollar media campaign, with misleading ads - reminiscent of the tobacco company ads of a couple of decades ago.

CEOs and paid lobbyists from Wall Street firms and the insurance companies are visiting Washington, DC, each and every day, to do everything in their power to stop this rule.

Some in Washington, DC says this campaign by Wall Street and the insurance companies, to protect their own profits and to continue their greedy practices, is the most coordinated, aggressive intensive lobbying effort they have ever seen.

What's at stake?

The retirement security of our fellow Americans. They will possess far greater in retirement if conflicts of interest are largely removed from the "financial advice" and "investment advice" provided to U.S. employees and savers.

The need to protect business owners, who sponsor retirement plans. Currently many get sued, as plan sponsors (and fiduciaries), for providing inappropriate (i.e., costly) investment options to their employees. If the DOL's rules go forward, business owners will receive "retirement consulting" advice not from highly conflicted Wall Street brokers and insurance agents (who nearly always escape liability due to the shield of "suitability"), but rather from trusted advisors who undertake due diligence to identify the best investment products.

Also at stake - the future of the U.S. economy. The IMF in 2015 estimated that excessive financialization of the U.S. economy is costing U.S. economic growth 2% a year!

Moreover, with less capital accumulating, the effect is cumulative. Instead of retirees having larger retirement plan balances, and more capital to invest in the U.S. economy, far less amounts are accumulated. U.S. business becomes starved of capital.

We need to put an end to the archaic system of product sales by those who claim to be "financial advisors" and "wealth managers" and "financial planners" - while in truth they are but product salespeople with incentives to sell the highest cost (and hence, worst) products. We need, instead, to expand the number of financial advisors who possess fiduciary duties of due care, loyalty, and utmost good faith to their clients.

Contact your Senators and U.S. Representative today. Let them know that the DOL's proposed Conflict of Interest rule should go forward. For the sake of our fellow Americans. For the sake of America's future economic prosperity.

Use this simple tool to contact your member of Congress: found at www.SaveOurRetirement.org. The organizations supporting this web site, and its tool, and this effort include AARP, Better Markets, NAACP, Certified Financial Planner Board of Standards, Inc., Consumers Union, Consumer Federation of America, and many more. This is a non-partisan issue, of importance to all Americans.

The battle with Wall Street and the insurance companies is in full swing. Protect our fellow individual Americans and enable their retirement nest eggs to expand and grow much larger, for the sake of their own financial security in retirement. Protect U.S. business owners (plan sponsors) from the liabilities which arise when they are told to use high-cost, expensive and inappropriate investments in their 401(k) plans and other qualified retirement plans. Most importantly, empower future U.S. economic growth - for the good of us all. ACT TODAY! 

The Exceptional Financial Adviser: An Expert, Trustworthy, Candid Life Coach

Being a professor of finance, and chair of the Financial Planning Program at Western Kentucky University, and also serving on many professional associations over the years, has afforded me the opportunity to visit with practitioners - during conferences, at luncheons, and in their own offices. I have greatly benefitted from the insights gathered from those I meet - they serve to help me improve my own practice, as well as our university's financial planning undergraduate program.

As these conversations over many years have progressed, I have learned that financial planning, at its core, is all about assisting clients with achieving their lifetime goals. Because the accumulation of wealth is not an ends, but a means.

The exceptional financial planners I meet are:

• First and foremost, experts. The body of knowledge required of a financial planner is both broad and relatively deep. A commitment to lifelong learning is absolutely essential. The best financial planners attend professional association conferences - gaining insights not just from the presenters but also from their fellow practitioners. And - they read, read, and read some more. They have good habits ... eschewing watching t.v. every evening and instead devoting time to family, friends, and their own education.

• Second, trustworthy. The best financial planners realize that the allure of additional compensation, in whatever form it takes place, can distort the advice given to clients. Conflicts of interest are minimized - and avoided altogether when possible. These financial planners enjoy the expert professional-level compensation they receive, and they enjoy being on the "same side of the table" as their clients.

• Third, candid with their clients. Never pulling punches. Dedicated to assisting their clients overcome obstacles, with often frank advice, even at the risk of losing the relationship. Clients don't just want to be surrounded by "yes" advisors.

Lastly, and most importantly, the exceptional financial planners focus on assisting clients to identify, further development, and work toward the attainment of lifetime goals. Financial planners are "counselors" in a sense, but from another perspective financial planners are more like "life coaches."

Life only happens once. Our clients deserve our expert guidance to empower them to suck all the marrow out of life, to live their lives with passion, to gain the rewards they themselves can receive from assisting others and expressing gratitude, and to live such a life that - near the end of life - they will have no regrets.

Being a financial planner is a gift, in and of itself. It is and can be the most enjoyable of professions. But it requires the commitment to be an expert, the intellectual honesty to maintain the client's interests as paramount at all times, and courage to be candid, and the focus on helping each and every client lead a highly successful life, in all of its many aspects.

Financial planning. A most rewarding profession.

Let us continue to progress toward that goal - a true profession.

Let us achieve, each and every one of us, the esteemed honor that flows from when a client refers to her or his financial planner as "my trusted financial advisor and life coach."

A Call to Action re: The DOL Conflict of Interest Rule

As the U.S. Department of Labor seeks to pour through all of the comment letters received, in an attempt to finalize its "Conflicts of Interest" rule by early 2016 (with a later effective date), Wall Street and the insurance companies are pouring hundreds of millions of dollars at lobbying efforts, and misleading television ads, to stop this very important development. Permit me to share some stories, and some thoughts:

The "Suitability" of a Replacement Annuity. Ms. Grange (not her real name) was a 74-year old retiree. In her IRA account - her sole source of funding for her retirement needs other than her social security check - she had previously been sold a variable annuity. She desired to "annuitize" this investment - i.e., turn it into a lifetime income stream. She went back to her broker (i.e., registered representative of a broker-dealer firm, also registered as an insurance agent). Her broker advised her to roll it into a new immediate annuity, to generate the income stream. Later Ms. Grange came to see me. I discerned that the effective rate of return, assuming she lived to age 95, was only 1%. But her prior annuity would have provided a rate of return of 4.5%, with the same assumption. And, a little analysis would have revealed that her rate of return would be even high had she waited until age 75 to annuitize her prior annuity, under the annuity contract's provisions. Both annuities were from strong insurance companies. In essence, Ms. Grange was getting a lesser monthly check from the new annuity than from the one she already had. The new annuity had no benefit to her. Why did the broker do this? To generate a new commission for himself. Plain and simple. I had a securities law attorney analyze the case, to see if a complaint in arbitration made sense. "Little chance of recovery," he replied. The new investment was "suitable." The broker had no fiduciary duty to the client.

The Plan Sponsor: Hung Out to Dry. An employer established a 401(k) plan for his employees. Not well-versed in the intricacies of such plans, he sought advice from a "retirement plan consulting firm." The firm, not a fiduciary (despite their use of the term "consultant") recommended a selection of high-cost funds for the plan, from their affiliated insurance company. Years later the employer (plan sponsor) was sued by his employees for breach of the plan sponsor's fiduciary duty of due care. The employees prevailed, and the plan sponsor / employer was forced to come up with a huge sum to reimburse the plan (in addition to paying substantial legal fees). What happened to the retirement plan consultant? Nothing! Because the "consultant" was not a fiduciary, and the investments recommended - while high-cost - were "suitable." Why had such high-cost funds been recommended? Because they paid the consultant, and its affiliates, greater compensation.

The Retiree and the Illiquid, Mis-valued Non-Publicly Traded REIT. Another prospective client approached me. Age 68, she was advised by her broker to place all $800,000 of her savings and investments (held in both IRA and non-IRA accounts) into non-publicly traded REITs (all with the same REIT sponsor). I grew suspect. Aside from obvious lack of portfolio diversification this strategy entailed, her statements still reflected a $11 per share price for the REIT shares - the same as the original offering price a few years before. Yet, during this time commercial real estate prices had fallen substantially. Moreover, there was a 10% commission paid to the broker by the REIT upon the sale of this product, in addition to "marketing reimbursements" paid to the broker-dealer firm. It was obvious that the REIT shares were not valued correctly on the brokerage statements. My due diligence uncovered other problems with the REIT. (See this article.) Shortly thereafter, FINRA required the REIT to restate their per share valuations. Later the brokerage firm was fined. Why did the broker sell such an illiquid investment, when many other investments (including publicly traded REITs) were available? To generate higher commissions and fees. Plain and simple.

The Call Center Employee, the Inappropriate IRA Rollover, and the New Retiree. A gentleman, upon his retirement, called the "retirement consultant" to his current 401(k) plan (a large mutual fund complex), seeking guidance on how to commence distributions from the 401(k) plan. The call center employee "advised" the gentleman to roll over his 401(k) plan into an IRA with the same mutual fund complex. The call center employee also "recommended" an asset allocation, including specific funds. Only problem was, the retiree could have stayed in the plan and received the same asset allocation at far lower cost, using the "institutional shares," rather than the higher-fee "retail shares."

Additionally, the retiree had some employer stock in his 401(k) and no advice was provided on the potential to save a substantial amount in taxes. The employer stock had been rolled over into the IRA (and then sold therein) without any consideration given to the Net Unrealized Appreciation (NUA) strategy.

Also, the new retiree was age 57; under the 401(k) plan he could take distributions without early retirement penalties (as the plan offered this provision, which is available under §72(t)(2)(A)(v) of the Internal Revenue Code. Now this gentlemen approached me, to assist him to get money out of his IRA. To avoid the pre-age 59.5 penalty, we set up substantially equal periodic payments. But this was much less flexible than what had existed under the 401(k) plan.

There are major planning issues present when a rollover from a 401(k) to an IRA takes place. See Section XI of my DOL comment letter.

But, simply put, the call center employee was only trained to encourage IRA rollovers - into more expensive mutual funds at that. The advice provided was not as a "fiduciary" - it was neither expert nor done under a duty of due care. Why was this advice given? Simple - it paid the for-profit mutual fund company more money.

The Retiree, the IRA, and the Variable Annuity. A couple came to me, perplexed. They had invested their IRAs in variable annuities, some ten years before. Despite their relatively even allocation between stock funds and bond funds in the various sub-accounts they were advised to invest in, and despite a substantial increase in the stock market over the past five years, their variable annuity's value had only gone up a little. I reviewed the contract. Not surprising, with the riders attached, the variable annuities had total annual fees and costs well in excess of 4% annually.

The clients were perplexed. What about the 7% "guarantee" they had been promised. I explained that this guaranteed rate of return was only effective if they annualized the annuity. But, if they did that, the annuitization rate offered in the variable annuity contract was far below that which was available today.

Why had their broker recommended this variable annuity, rather than mutual funds which were far less costly? Probably because this variable annuity did not mandate any break-point discounts (which reduces the commission charges). (Many variable annuities still don't do this, creating a perverse incentive for brokers to recommend variable annuities rather than mutual funds, to avoid lower commissions.)

Under a proper due diligence analysis, this variable annuity was inappropriate for their IRA accounts. So why had it been recommended? Simple - it resulted in higher commissions to the broker and the brokerage firm.

Economic incentives matter, and they matter a great deal. When a salesperson has the opportunity to receive much higher compensation from the sale of one product, compared to another, the allure of the investment product with the higher compensation (and higher fees to the client) nearly always win.

These insidious conflicts of interest cause great harm to the financial and retirement security of our fellow Americans. The academic research in this area is compelling – higher-cost investments lead, on average, to lower returns. In fact, there is a strong negative correlation between the total fees and costs of an investment product and the returns of that product over the long term, relative to similar investments.

Conflicts of Interest Lead to Poor Investment Recommendations. Conflicts of interest are insidious. The incentivize bad advice to be given.

Disclosures of conflicts of interest are insufficient to protect investors. Indeed, disclosures may actually cause even worse advice to be given. According to Prof. Dalian Cain, Yale School of Management, in “The Dirt on Coming Clean: The Perverse Effects of Disclosing Conflicts of Interest,” “Conflicts of interest can lead experts to give biased and corrupt advice. Although disclosure is often proposed as a potential solution to these problems, we show that it can have perverse effects. First, people generally do not discount advice from biased advisors as much as they should, even when advisors’ conflicts of interest are disclosed. Second, disclosure can increase the bias in advice because it leads advisors to feel morally licensed and strategically encouraged to exaggerate their advice even further. As a result, disclosure may fail to solve the problems created by conflicts of interest and may sometimes even make matters worse.”

The Necessity of the Fiduciary Standard for Providers of Investment Advice. Fiduciary duties are imposed by law when public policy encourages specialization in particular services, such as investment management or law, in recognition of the value such services provide to our society.  For example, the provision of investment consulting services under fiduciary duties of loyalty and due care encourages participation by investors in our capital markets system. Hence, in order to promote public policy goals, the law requires the imposition of fiduciary status upon the party in the dominant position. Through the imposition of such fiduciary status the client is thereby afforded various protections. These protections serve to reduce the risks to the client that relate to the service, and encourage the client to utilize the service. Accordingly, the imposition of fiduciary status thereby furthers the public interest.

Some might opine that financial literacy efforts can fulfill this role. Yet, the body of academic research, and my own experience in dealing with thousands of clients, reveals that financial literacy efforts only significantly assist consumers with basic personal finance training, such as in expenditures budgeting and saving for future needs. However, the complexity of the financial markets, and the limits of time each consumer possesses to devote to training in finance, renders the vast majority of consumers unable to become investment experts or to understand the many terms and concepts required, even with the aid of a multitude of disclosures. We are just as likely to turn a consumer of financial services into a highly knowledgeable designer and manager of her or his investment portfolio as we are to turn a patient needing a brain operation into a neurosurgeon. 

We must recognize that the combination of specialization and interdependence found today is essential to the progress of our society. This combination fosters both the development of new knowledge and expertise. It provides great benefits to consumers, provided the advice is delivered with a high degree of due care and in the consumers’ best interests. It enables consumers to place the fruits of their hard-earned labor to work in the capital markets, with the expectation that the returns offered by the markets will be returned to the consumer, less a reasonable amount for professional-level compensation to the specialist.

America Itself Needs the Fiduciary Standard, to Promote U.S. Economic Growth. In my nearly 30 years as an estate planning and tax attorney, and in my nearly 15 years as a fiduciary investment adviser, I have possessed the opportunity to review hundreds of clients’ investment portfolios. When the clients’ investment portfolios were advised upon by either broker-dealer firms, by dual registrants (firms and individuals with both securities broker/dealer licensure and registered investment adviser licensure), or by insurance agents, the allure of high-fee investment and insurance products was nearly always too strong to resist. Over 95% of the time, in my reviews of hundreds of clients’ portfolios, I discerned high-cost investments, tax-inefficient portfolios, or both.

The high costs of Wall Street’s services and products not only engender the retirement security of individual Americans, but also impair the American economy. As the role of finance has grown ever larger, instead of providing the oil that ensures the American economic engine churns efficiently, the peddling of expensive investment products to Americans has led to a sludge that impairs the vitality and threatens the future of not only our fellow Americans, but Americans itself.

The growth of the financial services industry has grown to an extraordinary proportion of the overall U.S. economy. As stated in a recent article by Gautam Mukunda appearing in the Harvard Business Review: "In 1970 the finance and insurance industries accounted for 4.2% of U.S. GDP, up from 2.8% in 1950. By 2012 they represented 6.6%. The story with profits is similar: In 1970 the profits of the finance and insurance industries were equal to 24% of the profits of all other sectors combined. In 2013 that number had grown to 37%, despite the after effects of the financial crisis. These figures actually understate finance’s true dominance, because many nonfinancial firms have important financial units. The assets of such units began to increase sharply in the early 1980s. By 2000 they were as large as or larger than nonfinancial corporations’ tangible assets …. " Gautam Mukunda, “The Price of Wall Street’s Power,” Harvard Business Review (June 2014).

The result of this excessive rent extraction by Wall Street is impairment of the growth of the U.S. economy. As Steve Denning recently noted in Forbes:

The excessive financialization of the U.S. economy reduces GDP growth by 2% every year, according to a new study by International Monetary Fund. That’s a massive drag on the economy–some $320 billion per year. Wall Street has thus become, not just a moral problem with rampant illegality and outlandish compensation of executives and traders: Wall Street is a macro-economic problem of the first order … Throughout history, periods of excessive financialization have coincided with periods of national economic setbacks, such as Spain in the 14th century, The Netherlands in the late 18th century and Britain in the late 19th and early 20th centuries. The focus by elites on “making money out of money” rather than making real goods and services has led to wealth for the few, and overall national economic decline. ‘In a financialized economy, the financial tail is wagging the economic dog.’

Steve Denning, “Wall Street Costs The Economy 2% Of GDP Each Year,” Forbes (May 31, 2015).  

Wall Street’s lack of legal and ethical constraints have been opined by many as the root cause of the financial crisis of 2008-9 and the resulting recession in the United States, from which we still have not fully recovered. As Jack Bogle, founder of Vanguard, observed: “Self-interest, unchecked, is a powerful force, but a force that, if it is to protect the interests of the community of all of our citizens, must ultimately be checked by society. The recent crisis—which has been called ‘a crisis of ethic proportions’ – makes it clear how serious that damage can become.” John Bogle, “The Fiduciary Principle,” ETF.com (June 22, 2009), adopted from a speech given to the Columbia University School of Business, New York City, NY, April 1, 2009.

A CALL TO ACTION!

Wall Street's large broker-dealer firms, and the insurance companies, are currently contributing tens of millions (if not hundreds of millions) of dollars to attempt to get the U.S. Congress to stop the DOL's efforts to protect plan sponsors (employers), individual Americans, and to restore U.S. economic growth. Literally, each week dozens of their lobbyists descend upon Capitol Hill. National television ads, of a very deceptive nature, have been expensively produced and now run.

Again and again, I hear ... those who advocate for the fiduciary standard of conduct, and the reduction of conflicts of interest that so pervade are simply outgunned.

BUT ... each of us can help. Please contact your U.S. Representative and U.S. Senators today. Tell them you support the DOL's Conflict of Interest Rule, and that Congress should NOT intervene, at the behest of Wall Street and the insurance companies. Tell them the DOL rule to substantially reduce the conflicts of interest in financial services is right for plan sponsors, right for individual Americans, and right for America itself.

Call, fax or e-mail your U.S. Representative and U.S. Senators today. Get your colleagues, friends, family members, and clients to also contact them. TODAY. Because tomorrow may be too late.

For more information, please visit Save Our Retirement.

Thank you. - Ron