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Can the Department of Labor Clean up Financial Planning?

Sept. 17, 2013
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Planning for retirement is complicated. When planning for retirement, people are oftentimes confused about the difference between brokers and independent investment advisers. But with changes to the Employee Retirement Income Security Act (ERISA) move at a snails pace, it might be a while before consumers are able to easily find advisers who have their interests in mind.

The Department of Labor is hoping to change ERISA’s definition of fiduciary standard. Currently, only financial advisers are bound by “fiduciary standard,” which requires them to keep their clients best interest first. Brokers, on the other hand, are only bound by the “suitability rule,” which merely requires that their recommendations are suitable. Since ERISA was enacted in 1975, the financial system has evolved to blur the lines between brokers and financial advisers. Brokers at big firms are often incentivized to sell consumers the firm’s products.

In response, the DOL has sought to expand ERISA’s fiduciary standards to include brokers. Their proposal, which was expected next month, will probably be delayed further. Texas Tech University Professor Michael Finke believes that the DOL’s proposals would incentivize consumers to shop around.

“There’s a lot of evidence that worker financial security is jeopardized by the high costs of investment options and plan fees within defined contribution plans,” he said.  “The DOL is trying to improve outcomes through legal incentives – in this case by imposing a type of fiduciary standard of care.  They are also trying to improve efficiency by increasing disclosure.  If plan sponsors and employees are more aware of the costs, this should create an incentive to shop around and for providers to lower fees.” 

Critics of the DOL’s efforts have argued that an expanded fiduciary standard would hurt smaller investors.

“Evidence suggests that many smaller employer plans have higher fees and less competitive investment options,” he continued. “But because larger employers have bigger balances, economies of scale in retirement plan administration means that providing a retirement plan costs less per employee.  We either need to find a more efficient way for small employers to access the economies of scale through larger DC plans, or we need to be careful about whether increased regulatory burden will make it difficult for small employers to find a DC provider.  One solution is to give all employees access to a low-fee retirement option that also includes efficient and appropriate investment management like the Harkin proposal. 

“What really needs to be worked out is (hopefully before it is worked out through lawsuits) what types of fees and plan options violate a fiduciary standard of care.  That isn’t easy because small plans are more expensive to administer per employee.  But there is plenty of evidence that many current plans include a limited selection of inefficient products and high fees that would be difficult to defend as being in the best interest of employees.  It’s a tough problem and the DOL deserves credit for trying to improve retirement security despite the many political and practical challenges.”

The Securities and Exchange Commission (SEC) also regulates financial advisers and brokers. One worry is that the SEC’s regulations and the DOL’s regulations will conflict.

“The SEC and DOL are working closely together as they both address the fiduciary obligation for brokers and advisers, and cooperation is vital,” Rutgers Camden School of Law Professor Arthur Laby said. “But timetables vary. The DOL appears poised to act in the relatively short term. By contrast, the SEC is reviewing comments received in response to a recent Request for Data. Before moving forward, the SEC would then propose rules for comment, and the public would presumably have several months to submit comments. Once the SEC reviews those comments, it could then adopt a final rule – but any final rule is presumably months, or over a year, away. Although one agency cannot always wait for another to act, the SEC and DOL should, at a minimum, seek to ensure that rules or standards propounded by each are not in conflict, even if they are not completely consistent.”

The DOL and SEC’s proposals might not be enough to protect investors. To adequately address fiduciary issues, Boston University School of Law Professor Tamar Frankel believes the public needs to change its habits and undergo increased financial education.

“What should happen in the future is that investors must approach investing like they do going to the doctor,” she said. “They wouldn’t get a check up and see someone who wasn’t a doctor. People must get in the habit of asking, ‘Are you a registered adviser?’ People should not talk to brokers who are not registered advisers. This will give the Labor department the rule it had to withdraw because it had so much pushback. There needs to be transparency, so that investors know how much brokers receive and how much investors really pay annually. Some brokers claim that with increased regulation, investors will be lost without brokers’ advice. Frankly, that’s the type of advice that we want to eliminate. There will be advisers from non-profits and other organizations who will be able to fill the gap and offer information.”

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Phyllis C. Borzi Assistant Secretary for Employee Benefits Security testifies to Senate Special Committee on Aging on small Business and Retirement Issues on titled “Opportunities for Savings: Removing Obstacles for Small Business” via Creative Commons