Administration support for new conflict of interest rule

March 12, 2015

On February 23, 2015, the Department of Labor sent to the Office of Management and Budget a proposal for a "new conflict of interest rule." At the same time, the White House released a report by the Council of Economic Advisors (CEA) on The Effects Of Conflicted Investment Advice On Retirement Savings and a Fact Sheet titled Middle Class Economics: Strengthening Retirement Security by Cracking Down on Backdoor Payments and Hidden Fees; DOL released a set of Frequently Asked Questions titled Protecting Retirement Savings; and the President made the soon-to-be-proposed regulation the highlight of a speech to the American Association of Retired Persons (AARP).

The new rule is the successor to DOL's proposed re-definition of fiduciary regulation. That regulation was proposed in 2010 and then, amidst criticism from service providers, employers and members of Congress from both parties, was withdrawn in 2011.

The new proposal is not publicly available and won't be until OMB completes its review. But the statements, reports, FAQs, fact sheets, and the President's speech do tell us a number of things. In this article, based on that information, we discuss (1) the Administration's view of the importance of this proposal, (2) how it intends to support its adoption and (3) what (in bare outline) the proposal may look like.

The Administration's view of the importance of the new proposal

Clearly, the Administration takes the new proposal very seriously. The comprehensive information blitz that accompanied sending the proposal to OMB is, in retirement plan regulation at least, unprecedented. The purpose of this strategy is to vigorously confront anticipated opposition – opposition that, with respect to the 2010 proposal, forced its withdrawal. In his speech to the AARP, the President said:

Just because we put forward a new rule doesn’t mean that it becomes law. There are a lot of financial advisors who support these basic safeguards to prevent abuse, but there are also some special interests that are going to fight it with everything they’ve got, saying that these costs will skyrocket or services are going to be lost. ... [W]e welcome different perspectives and ideas on how to move forward. That's what the comment period for the rule is all about. What I won’t accept is the notion that there’s nothing we can do to make sure that hardworking, responsible Americans who scrimp and save somehow end up losing some of those savings to less than scrupulous practices.

In its FAQs, DOL, confronting the challenges raised with respect to the 2010 proposal, stated:

FAQ 7.Is this proposal the same as the Department's 2010 proposed fiduciary rule?

No. In September 2011, the Department announced that it would withdraw its 2010 proposal in order to review the public input received and publish a new and improved proposal to expand the consumer protections for retirement savers. We've taken the time since then to carefully consider the hundreds of comments we received, including the testimony we heard at two days of public hearings. Furthermore we have continued to listen to all perspectives, including those of the financial services industry, consumer groups, employers, Members of Congress, and academics.

As a result, the new proposal will reflect careful consideration of all that input and address key concerns raised about the 2010 rule. For example, the new proposal will include a robust economic analysis, which will detail the costs of conflicts of interest and the expected impact of the rule.

Bottom line: the Administration and DOL are pulling out all the stops to make sure that this proposal does not suffer the same fate as the 2010 proposal.

The CEA report

The talking point – highlighted in the President's speech and in the other key documents released on February 23 – is the CEA's finding that "[o]n average, conflicts of interest in retirement advice results in annual losses of 1 percentage point for affected persons… And all told, bad advice that results from conflicts of interest costs middle-class and working families about $17 billion a year – $17 billion every year." (Quoting the President's speech to AARP.)

We can expect both the 1% and $17 billion numbers to be headlined in Administration and DOL communications about the new proposal and in the preamble to the proposed regulation. It is that cost which justifies a fundamental revision of what the President, CEA and DOL describe as "outdated regulations.”

Those numbers come from the CEA report released on February 23, The Effects Of Conflicted Investment Advice On Retirement Savings. That report reviews "relevant academic literature" and concludes:

CEA's survey of the evidence suggests that conflicted advice reduces investment returns by roughly 1 percentage point for savers receiving that advice. In the aggregate, such savers hold about $1.7 trillion of IRA assets. Thus, we estimate the aggregate annual cost of conflicted advice is about $17 billion each year.

The conclusions of this report are based on a careful review of the relevant academic literature but, as with any such analysis, are subject to uncertainty. However, this uncertainty should not mask the essential finding of this report: conflicted advice leads to large and economically meaningful costs for Americans’ retirement savings.

CEA rejected the common argument that the current system is the only way for Americans with modest savings to obtain advice, finding that:

With appropriate resources advisers can provide non-conflicted advice "at the same cost as an advisor receiving conflicted payments, as long as the inputs in time and infrastructure are equal.”

Conflicted advice may actually hinder the development of efficient, non-conflicted advice. Quoting: "Ongoing developments in the financial industry are sharply reducing the cost of advice, but it may be difficult for new entrants providing quality, unconflicted, low-cost advice to compete on price when other advice erroneously appears to be free.”

"[S]avers with modest balances today tend to become savers with larger balances tomorrow.”

It also rejected arguments that the underperformance of the portfolios of retirement savers who receive conflicted advice can be explained by either (1) the intangible benefits that an adviser provides or (2) the characteristics of households receiving conflicted advice.

Finally, it rejected the argument that mandated disclosures, rather than a substantive fiduciary rule, is all that is needed to fix the problem. It found that: (1) disclosures are generally too opaque (existing in fine print and in legalese) for participants to understand; (2) even a lucid description of the issues could not do justice to the complexity of the information necessary for the saver's decision; and (3) disclosures may actually make the problem worse by making advisors "more willing to pursue their own interest" and advisees overconfident in the honesty of the adviser.

Limits to the CEA's findings

We note that the CEA report focused on the impact of conflicted advice on IRA owners and not on 401(k) plans. In this regard, one of the issues it considered at length was the effect on returns of investors being "steered" by intermediaries to front- or back-loaded mutual funds. That is not generally a typical investment option in larger 401(k) plans.

One of DOL's key concerns, however, is "steering" by, e.g., call center operators of participants, typically on termination of employment or retirement, into IRAs, rather than, e.g., encouraging them to roll their distribution over to a new employer's plan or to simply leave their balance in the old employer's plan. In that context, the line between plan-related issues and IRA-related issues blurs.

What we know about the proposal

We still have very little information on what the new proposal will look like. As we understand it, the proposal will greatly expand the definition of fiduciary, presumably to include the ‘conflicted advisers’ that are targeted in the February 23 publications and the President's speech. It will deal with the resulting disruption of standard industry compensation practices by providing targeted exemptions. The Administration is confident that those exemptions will ‘thread the needle’ – allowing non-problematic practices while preventing abuse.

The following are some excerpts from the DOL FAQs describing the proposal:

We are looking for a balanced approach that improves protections for retirement savers, ensures that advisers provide advice in their client's best interest, and also minimizes any potential disruptions to all the good advice in the market.

[T]he proposal ... will not prohibit common compensation practices, such as commissions and revenue sharing. It will include new proposed exemptions from ERISA's and the Internal Revenue Code's restrictions on fiduciaries receiving conflicted compensation, and will request public input on the final design of the exemptions. These exemptions will include a new type of exemption that is more principles-based, providing businesses with the flexibility to adopt practices that work for them and adapt those practices to changes we may not anticipate, while ensuring that they put their client's best interest first and disclose any conflicts that may prevent them from doing so. It will not cover Employee Stock Ownership Plan (ESOP) valuations. It will also continue to allow financial advisors to provide general education on retirement saving. The rule will not eliminate conflicts of interest, but it will mitigate them to protect consumers' interests.

* * *

Many anticipate that, given the high level of support the Administration is demonstrating for the new proposal, OMB will accelerate its review and that the proposal will be published in the relatively near future.

At this point, the takeaway is that the Administration and DOL are doing everything they can to avoid the problems they had with the 2010 proposal.

We will continue to follow this issue.

October Three Consulting, LLC is a full service actuarial, consulting and technology firm that is a leading force behind the reemergence of defined benefit plans across the country. A primary focus of the consultants at October Three is the design and administration of comprehensive retirement benefits to employees that minimize the financial risks and volatility concerns employers face.

Through effective plan design strategies October Three believes successful financial outcomes are achievable for employers and employees alike. A critical element of those strategies is the ReDB® plan design. The ReDefined Benefit Plan® represents an entirely new, design-based approach to retirement and to the management of both the employer’s and the employee’s financial risk, focusing on maximizing financial efficiency and employee value.

For more information:

233 South Wacker Drive, Suite 8350
Chicago, IL 60606-7147
info@octoberthree.com
Phone: 312-878-2440
Fax: 866-945-9676
Contact Us

 

Share this with your Colleagues:

Latest News:

  • 2018 Increases for Retirement Plans, Social Security - Read More
  • Republican Tax Reform proposal – effect on retirement savings policy - Read More
  • September 2017 Pension Finance Update - Read More
  • September 2017 fiduciary rule update - Read More
  • Update on IRS 2018 Mortality Table Guidance - Read More
  • Cash Balance Plan Design - Read More
  • ReDefined Benefit Plan™ - Read More