//  3/28/17  //  In-Depth Analysis

If you’re reading this, you must know all about how high-cost retirement investments gobble up workers’ savings while providing inferior returns.[1]  I’m sure you’ve already opted out of your 401(k) provider’s overly complicated, high-cost default fund mix and put your money into an individually directed account, to invest in a highly diversified portfolio of low-cost index funds carefully calibrated to your age and expected retirement date. 

Well, maybe you’ve been meaning to do that, but you need to locate the right phone numbers, find the time to wait on hold for an hour, read some blog posts and get some advice from your college friend who works for a hedge fund.  Maybe you know you’re not going to be in this job much longer and you’re putting the task off for when you roll over your account.  And when you do that, you’re totally going to roll over your accounts from prior jobs and take another look at that IRA you started how many years ago.

Actually, if any of this rings even a faint bell, you’re probably one of the more savvy investors among the many millions of Americans with access to a 401(k) or other similar employer-based retirement plan.  Most have no idea how to manage their retirement savings. And so most tend to rely heavily on the choices and advice offered by their employers’ plans. Usually, large companies (or smaller employers that try to be particularly benevolent to their workers), provide workers some kind of “education” with their 401(k) plans.

If you work for such a company, you might have received this “education.”  It probably felt a lot like “advice” right when you needed it (that is, when you had all the paperwork in front of you and had to make some choices).  Was this information “targeted” at you?  Was it “individualized” if it was presented to lots of people all at the same company, at roughly the same points in their career with similar salaries?  Did you think that the companies offering this information had an obligation to act in your best interest?  Did you know that you were effectively in a timeshare presentation minus the beach and booze?

It’s easy to imagine how the average worker who has access to a retirement account—who is definitely much better off than the average worker overall, but not necessarily a highly educated white-collar worker—would believe that she was receiving targeted advice from someone required to act in her best interests. 

But such a belief would be quite misplaced. The investment advisors providing this advice typically act not in the employees’ best interests, but instead steer them toward expensive, lower-quality investment products which provide the advisors with large commissions. This poor advice has big consequences: given the power of compound interest, choosing a slightly higher-fee (and thus, lower-return) investment early in one’s professional life can cost an employee thousands (and often, tens or hundreds of thousands) by retirement.

To address this problem, in April 2016, the Department of Labor (“DOL”) issued a new rule dramatically expanding which financial professionals would be “fiduciaries” under ERISA.  Once this rule is fully effective, it will mean that nearly all who provide workers with what those workers would interpret as investment advice are fiduciaries obliged to act in those workers’ best interests.  Previously, the only investment advisors held to this high standard were those whose clients paid fees for their advice.  Those receiving commissions based on the products they sell—the vast majority of brokers—were subject to a much less demanding standard.  DOL found that the absence of fiduciary protections caused significant “monetary harm” to retirement investors.

During the comment period after DOL proposed the Rule, financial services companies and their allies opposed the change on many fronts.  But their main argument was that helping workers decide how to invest their savings is a valuable service for which investment professionals deserve to be compensated.  Many industry commenters stressed that brokers tended to be small businesses who needed to receive commissions to avoid pressure to consolidate.  The story goes that most workers (or their benevolent employers) can’t, or won’t, pay an upfront fee for this advice—yet they will happily accept many thousands of dollars less upon retirement (due to lower investment returns over their working lives) to avoid this upfront fee.  DOL was, unsurprisingly, unpersuaded.

The Trump administration, however, has a different view. One of the Administration’s first acts was to issue a Presidential Memorandum ordering DOL to “examine” this rule and make changes if the Rule would, among other things, reduce access to investment advice, cause “dislocations or disruptions within the retirement services industry that may adversely affect investors or retirees,” or increase litigation.  Where the Obama administration prioritized quality advice for workers of all kinds, the Trump administration is eagerly sacrificing quality in the name of (1) improving “access” to advice and (2) protecting small business from the burdens of providing investment advice that would actually be valuable to workers.

  1.      Limiting Litigation, Limiting Accountability

One consequence of making more people subject to the fiduciary rule is that more people stand to be sued for violating their (new) fiduciary obligations.  This is not a bad thing: one way to try to ensure that workers receive retirement advice that is in their best interests is to allow them to pursue brokers who lead them astray.  Lawsuits, whether in court or in arbitration, are an over-inclusive tool—hindsight will inspire many a frivolous action—but increased risk of liability would undoubtedly keep brokers in line at the margins.  This was part of DOL’s reasoning when adopting the Rule and including a provision barring class action waivers in certain arbitration agreements.

The Trump Administration, perhaps unsurprisingly, dislikes this development. Republicans’ enmity for the plaintiffs’ bar is longstanding; any regulation that makes it easier to sue deep pockets is going to draw their ire. 

Moreover, the final rule, by including the class action waiver, unabashedly preferred litigation to arbitration.  There is a lot to dislike in Federal Arbitration Act (“FAA”) jurisprudence, and class action waivers are troubling on many fronts.  Even so, this part of the Rule seems difficult to square with AT&T Mobility LLC v. Concepcion, which held that “[r]equiring the availability of classwide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA.”  Id. at 344.  DOL would be on stronger ground if ERISA contained a substantive right to proceed on a classwide basis or otherwise expressed Congressional intent to override the FAA, but if so it’s hard to see.  In a somewhat analogous situation, the Fifth Circuit held that even the National Labor Relations Act’s protection of workers’ rights to act collectively didn’t authorize the National Labor Relations Board (NLRB) to override the FAA and ban class action waivers. It’s hard to feel confident that the DOL’s ban would survive when the NLRB’s did not.

Still, DOL deserves some applause for taking a flyer on the FAA argument, even if the odds of success are low.  Problems with retirement savings accounts present a paradigmatic example of why class actions are needed: The collective harm to employees of poor investment advice is massive.  Yet any single member of a plan might suffer injuries too small to justify litigation, given that establishing the amount of loss in court usually requires paying an expert to explain what alternate investments were available. 

  1.      Access vs. Quality

Historically, it has been progressives who wanted to increase access to financial services. Typically, though, their focus has been on expanding access to the kind of high-quality, low-cost services that the middle and upper-middle classes enjoy.  With payday lending, overdraft fees, and subprime lending, progressives have fought to prohibit services that prey on vulnerable populations and promote financial instability.  Under this worldview, it makes sense to require advice given to workers to be higher-quality, even if that means that advisors would begin charging a fee for advice that these workers currently receive “for free.” 

Industry commenters, by contrast, argued in favor of allowing workers to “choose” to receive free, though biased, advice.  Their argument is that workers understand that an advisor is not their fiduciary; they stress that without this option, many employees would receive no investment advice.  But what is the value that commissioned advisors are providing?  These advisors do provide general financial education—that is, information about the importance of investing, how compound interest works, and other basics that could and should be taught in home economics, civics, or elsewhere in school.

In theory, companies’ HR departments could handle this education in house.  But in practice, many front-line HR professionals lack either the financial literacy or the time to assume this task.  And management is not eager to spend more on the problem. 

And that’s exactly how we ended up with this system in the first place.  By creating the framework for 401(k) plans, Congress delegated responsibility for a key part of the social safety net to employers, who then delegated responsibility to for-profit financial companies.  After all, except for tech firms locked in competition for the most talented workers, companies have little incentive to hire in-house experts on their workers’ post-work financial lives.  By letting financial companies recoup the cost of advice and education through commissions, employers avoid paying for that advice themselves while also appearing to offer workers to access information about their benefits for free. 

There is no reason for employers to care whether the advice workers receive is actually in those workers’ best interests.  All that market forces demand is that the employer to appear to provide competitive benefits.  That is, employers have every incentive to ensure employee access to retirement advice, but little incentive to care about the quality of that advice.  This system lets them pass the buck—just as the buck was passed to them by lawmakers in the first place.

  1.      Dislocations and Disruptions

Access is also nominally at the core of the administration’s concerns about “dislocations or disruptions within the retirement services industry that may adversely affect investors or retirees.”  Retirement advisors are typically small businesses that may or may not be affiliated with larger financial companies.  These small businesses provide investment advice about IRAs and other savings vehicles not tied to employment and can assist workers in managing the numerous employer-linked accounts that they acquire as they move between jobs.  It is debatable whether any significant number of workers could afford to pay an upfront fee that would make the advisors’ time worthwhile, especially if we imagine that, for a variety of reasons, the lowest-income savers need the most advice. 

By forcing investment advisors to act as fiduciaries, DOL’s rule would make it nearly impossible for those advisors to take the large commissions that keep them in business, at least without creating significant litigation risk.  For this reason, the fiduciary rule was poised to force consolidation in the field.  By itself, consolidation may not impact access.  But it certainly could reduce access if large financial services companies decided not to serve lower-income areas or if they set uniformly higher minimum investment amounts. 

Of Trump’s areas for examination, this one seems likeliest to provide a policy basis for undoing the Fiduciary Rule.  It will be easy for the Administration to find some small brokerage exiting the business that is willing to claim the regulatory burdens did them in then while also pointing to some of that firm’s clients who for one reason or another, are not likely to seek advice online or from a larger, but less conveniently located, broker.  But if so, such an anecdote seems like a fairly justification for undoing the Rule, given what are likely significant benefits to employees as a class.

Conclusion

The benefits of the fiduciary rule are straightforward: it requires retirement advisors to offer advice that is actually in their clients’ interests, rather than advice motivated by their own desires to maximize commissions.  It holds them to the standard to which we hold lawyers and the one to which we wish doctors adhered—even if we know that their advice often ends up inadvertently colored by conflicts of interest with drug companies, systemic bias, and other external concerns. 

As straightforward as these benefits are, however, there are some real costs in terms of access to retirement advice.  It’s easy to say that biased advice is not really advice.  But what about all of the workers who might otherwise fail to save at all, or leave all of their savings in cash (or worse, gold and other faddish investments)?  

The best answer is probably that there are some workers who will be harmed by the Rule—but that this harm is small compared to the massive ongoing monetary cost that workers and retirees face from being steered into bad investments by non-fiduciary advisors.  As such, the Administration’s re-examination of the fiduciary rule looks like little more than a gift to the retirement services industry at the expense of workers and retirees. 

So have you called your 401(k) plan administrator yet?

 

[1] For the average worker, without access to the preferred asset classes offered to wealthy individuals and through certain plan sponsors, minimizing fees is the name of the game.  There are lots of resources explaining how this works, but here’s a basic primer: https://financinglife.org/learn-how-to-invest/investing-for-beginners/low-cost-index-funds/#transcript.


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