Norman Stein calls for an end to conflicts of interest in investment advice (September 13, 2013)

Norman Stein calls for an end to conflicts of interest in investment advice (September 13, 2013)


At a briefing for Senate staff on the importance of unconflicted investment advice, PRC Senior Policy Advisor Norman Stein discussed the history of fiduciary regulations and why they need to apply to 401(k)s and other retirement savings plans.

I’m speaking today both as an academic—I teach law at Drexel University—and as a policy advisor to the Pension Rights Center—a 37-year-old consumer advocacy organization, which probably makes it older than some of you here today.

You’ve just heard from Marcus about some of the differences between the SEC’s role in protecting the integrity of the retail market place for securities and the Department of Labor’s separate mission in assuring that retirement plans are run for the sole purpose of assuring that their participants will have financial resources to support themselves in retirement.

My comments will focus on ERISA and the anachronistic 1975 fiduciary regulation that the Department of Labor is trying to adapt to the current world in order to ensure that the millions of people who save in retirement plans and individual retirement accounts get good rather than conflict-ridden investment advice.

Our nation is facing an impending retirement crisis.  The Center for Retirement Research at Boston College estimates that we have a $6.6 trillion retirement savings gap—the difference between what people have already saved for retirement and what they already should have saved.  

This is an enormous savings shortfall and it is compounded by permitting salespeople with serious conflicts of interest to advise people on how to invest their 401(k) and IRA money.  This tainted advice robs regular people of a substantial part of their retirement savings. 

So the issue is not just academic. It’s about protecting real workers, real retirees, and their families from real harm.

To understand why investment advisors are currently permitted to give retirement advice despite serious conflicts of interest we need to go back in history a bit.

For those of you who may be new to these issues, ERISA is the pension reform law that Congress enacted in 1974. It sets high standards for the people who run retirement plans and for the people who give investment advice that affects retirement savings.

ERISA says unambiguously that people and firms that give investment advice to people in retirement plans are fiduciaries and that fiduciaries cannot generally have disabling conflicts of interest. This is not a new idea. It has been the law for close to half a century. 

But in 1975 the Department of Labor adopted a regulation that artificially constricted the meaning of investment advice. That regulation said that ERISA only makes an investment advisor a fiduciary if the advice is continuous and there is mutual agreement that the investment advice will be the primary basis for making investment decisions. 

So under this narrow definition, an investment advisor can shed his fiduciary status simply by saying that any advice I give you is not intended to serve as the primary basis for your investment decisions. 

Why was the definition of investment advisor so narrowly constructed? 

Well, the world in 1975 was a very different world than it is today.  Steven Jobs was still tinkering in his dad’s garage, gasoline cost 44 cents per gallon, Jennifer Anniston was in the first grade, and more pertinent, the 401(k) plan had not yet been invented and only a few thousand individual retirement accounts had been opened.

Few plans gave individual participants the responsibility of making investment decisions—instead, plan assets were generally managed by professional money managers and they were the ones who received investment recommendations from brokers and others. These money managers had the experience and sophistication to evaluate investment recommendations and to identify the conflicts of interest of those people who made the recommendations. 

The world has changed in the intervening decades. Today, some 60 million workers participate in 401(k) plans and assets in IRAs exceed $5 trillion dollars, with the majority of the IRA money flowing from roll-overs from employer-sponsored retirement plans.

The people participating in 401(k) plans and IRAs are, for the most part, everyday people without extensive investment training or experience. As a result, they are highly dependent on the advice offered to them by the investment industry.

Unfortunately the recommendations they receive are sometimes infected by serious conflicts of interest. Some brokers, hiding in the shadows of the 1975 regulation, guide their clients toward investments that maximize the broker’s commissions and other compensation, regardless of whether the client might be better served by other investment options. 

And here this gets a bit personal for me.  Last summer, my brother and I went over my 85-year-old mother’s investment portfolio with her. Her investment adviser had her primarily in a mutual fund invested 46 percent in stock and 35 percent in junk bonds, a ridiculous level of risk for an octogenarian. So why was my mother in this risky fund? Well, it paid her broker an extremely high sales fee (a 4.5% load) and continued to pay his firm fees for each year my mother remained in the fund. I suspect that these payments may have clouded the broker’s judgment. 

It is thus good, necessary, and fitting that the Department of Labor is looking to update its 38-year-old rule to address current reality. 

Of course, no one yet knows what a new regulation will say, but we do know that representatives of the investment industry and consumer advocates, such as the Pension Rights Center, and others will have ample opportunity to review and comment and engage in dialog with the Department of Labor when it does propose new rules.  In the meantime, the Department should be allowed to complete its important work of protecting the retirement savings of American working men and women.  Our nation’s collective retirement security depends on it.

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