The battle over who will be legally obligated to protect investors’ assets continues to rage in a knock-down, drag-out exercise that is now in its third year back in Washington. So what else is new? What the financial services industry is fighting is the requirement that all brokers working with retirement accounts including IRA’s become “deemed fiduciaries.” A “fiduciary,” by definition, is charged with making all recommendations in the sole interest of the beneficiary of the recommendations.
In other words, if there are two identical investments with the only difference being that one charges more than the other, a fiduciary is required, by law, to recommend the cheaper alternative. Some mutual funds, for example, have as many as five different share classes for the same fund. Each share class, ranging from “R1 to R5 charges successively less in annual commissions with R1 being a full 1 percent and then grading down by a quarter percent until, at R5, there is no commission charged. Brokers or financial planners recommending R5 shares just bill the client a negotiated fee for management. Someone recommending R5 shares today could be a fiduciary. The rest would fall under the vague requirement that the recommendation is “suitable” and they would not be held to any fiduciary standard.
Also back in Washington, the Supreme Court has stepped into the fray by its finding in the case of Tibble v. Edison whereby the company’s 401(k) trustees elected to use three mutual funds that charged higher annual expense rations when cheaper institutional shares were available. The ruling was unanimous --- 9 to 0 which helps to illustrate how obvious some things can be. It doesn’t say who the brokers were, but they could care less. They were not fiduciaries. The hapless fiduciaries responsible for what is now the cost of the company making up the years of lost, compound earnings going back to 1999 are the company management’s decision-makers who played any role in choosing the broker or advisor and accepting poor advice.
For many in the brokerage and insurance industries, conflicts of interest are built into the business model. I’m all, “Where are the Customers’ Yachts?” In the meantime, efforts to stall the proposed regulations forcing them all to adhere to the fiduciary standard has unleashed a desperate struggle to slow and then throttle the Labor Department’s rule-making process. If that fails, they will try to introduce opposing legislation to maintain the status quo.
But the need for reform is so obvious, hopefully, that its momentum will beat back any efforts to stand in its way. Brokers may still be able to charge commissions through revenue sharing arrangements with fund families, but they will be obligated to disclose any conflicts and detail how, and by how much, they are being paid. Preliminary language in the proposed rules states that they must charge “reasonable” compensation which, of course, is subject to interpretation, but at least buyer and seller can have the tools for reaching an informed agreement. Also, mutual fund companies will be allowed to pay more to gain “shelf space” on the list of a brokerage firm’s recommended products. Schwab’s so-called “No-transaction-fee” (“NTF) list of mutual funds costs those funds an additional half percent per year which is passed on to investors --- an annual fee for a service the buy-and-hold investor may never need after the original purchase. This, along with hundreds of specious revenue-generating techniques will have to be fully disclosed under the new rules.
Conflicted advice and excessive fees are said to cost investors about 1 percent per year or $17 billion in total. Unfortunately for investors, the compound interest on that missing annual one percent over time is more like several trillion. For a single investor, the damage of earning just 9 percent instead of what could have been an average of 10 percent over time is eye opening. On a $10,000 annual investment, the missing one percent costs $8,600 in ten years, $75,000 in twenty years (almost half of all your contributions) and about $400,000 in 30 years. A $10,000 per year investor who might have had about $1.9 million in thirty years has about $1.5 million instead. The rest went to the industry that has enlisted lawmakers to block the Labor Department from adopting all these proposed accountability standards.