The Fiduciary Train’s a Comin’; It’s a Comin’ for the Cash

(“Folsom Prison Blues” by Johnny Cash)

In the investment world, the proverbial train “rollin’ ‘round the bend” has been the Department of Labor’s fiduciary rule. The DOL’s famous fiduciary rule is still on track, and it will be rumbling into the station starting June 9, 2017 (yes, this Friday!). Additional input and review will be ongoing throughout the year as we approach the January 1, 2018, full implementation date. There could possibly be changes and even further delays, depending on the new administration’s involvement and understanding of the issues. Further, it looks as though the Securities & Exchange Commission (SEC), which already regulates registered investment advisors in accordance with a fiduciary standard, has been invited by the Department of Labor to join the conversation more prominently through a joint effort. (See “SEC Rethinking its Own Fiduciary Rule,” Financial Advisor IQ, June 2, 2017).

According to David Lenok of WealthManagement.com, the new DOL Secretary, Alexander Acosta, will not further delay the June 9 effective date for rule implementation, as some financial advisors and brokerage houses would like him to do. (See “Acosta Won’t Extend DOL Rule Delay” at wealthmanagement.com/industry/acosta-wont-extend-dol-rule-delay.)

Secretary Acosta chose to not delay the rule as a matter of principle in following the rule of law. We can assume that since the rule was developed and debated and rewritten over a five-year period, most people involved with the rule at the Department of Labor agree with its purpose and utility for helping middle-class workers save more efficiently without conflicts of interest that benefit financial advisors. However, the reason and decision to not delay the rule’s implementation is stated to be jurisdictional. Secretary Acosta does not believe he has the authority within the statutes to enact a further delay.

The fiduciary rule essentially states that any financial agent giving advice or providing investment instruments for retirement accounts (including IRAs, pensions, 401ks, etc.) must be a fiduciary. Simply stated, a fiduciary must act as if the funds were his or her own. As a fiduciary, one’s obligation is to the client first. Thus, for any retirement-related account, the burden is now on the advisors to show and to transparently prove that their actions are aligned with the best interests of the client. Until now, the rule has essentially been caveat emptor (let the buyer beware) within certain bands of broad suitability. With the new rule, some transactions where the client and the financial advisor have a long-term, contented business relationship will no longer be permitted. That, of course, is an unintended consequence of the rule. The rule tilts the retirement investment advice business in favor of a fee-only, fiduciary relationship rather than a transactional or dealer model. Essentially, the rule aims to assure that financial advisors and their clients are more tightly aligned for the long-term benefit of the clients.

Many opponents of the fiduciary rule had hoped that the Trump Administration would derail the DOL’s fiduciary rule as part of a combined move to also take out the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010. So far that has not happened, and the fiduciary rule does not (yet) seem to have been successfully combined with Dodd–Frank in the public discussion as a duo for deregulation.

The DOL fiduciary rule was designed to eliminate conflicts of interest that cost IRA retirement investors an estimated $17 billion in underperformance. Non-fiduciary financial advisors have been steering people into higher-fee investment options, mostly mutual funds. The $17-billion figure is based on a 2015 Council of Economic Advisers report that estimates that of the $7.9 trillion in IRA accounts, the owners of $1.7 trillion are receiving conflicted advice. As they say in economic theory, there is a principal-agent problem going on in the investment advice business. As a conservative estimate, underperformance of approximately 1% is the result.

Further, the direct contribution (DC) retirement market, with $7 trillion in assets, has its own conflicts of interest and principal-agent problems, particularly in the less-than-$20-million plan space used by smaller businesses. The workers who use the products there do not even have any say over the options available in their retirement plans. The financial industrial complex that provides conflicted investment products in that space does so in an opaque way through revenue-sharing payments that are disclosed but not commonly known. Most of the financial agents involved are therefore not fiduciaries, for obvious reasons. One study in 2014 (Chalmers and Reuter) of an Oregon workplace retirement plan reveals the embedded conflicts in that market. Quoting the CEA report on this case:

“In the authors’ words, ‘brokers significantly increased annual fees, significantly decreased annual after-fee returns, and slightly increased risk-taking relative to the counterfactual portfolio’ (that is, the default investment option). The estimated magnitude of underperformance in this study is large: 298 basis points relative to the plan’s default investment option.” (page 11)

That is almost 3% underperformance for conflicted advice in this particular Oregon retirement plan – an egregious finding. That is real cash money, certainly when annualized over decades. Even if the cost of conflicted advice is closer to 1% for Defined Contribution, or “DC”, retirement plans – that is, similar to the CEA’s estimate for the IRA market – that is still a lot of cash. If half of the defined-contribution money in retirement plans is in high-fee, non-fiduciary, conflicted arrangements, that could be another $35 billion per year in underperformance on top of the $17 billion per year in the IRA business. That’s about $50 billion a year in underperforming investments purchased as high-fee investment products in just those two markets alone. On its face, this state of affairs does not seem like a good deal for the workers saving in their retirement plans or for other investors in their IRA accounts. The money at issue becomes a legitimate social and ethical question at these levels. Many retirees who have not saved enough and who have received conflicted financial advice are left singing the blues.

The CEA report is very thorough and thoughtful regarding the status quo in the retirement savings and investing arena. Readers – regardless of where they find themselves in the current debate, either as financial advisors/brokers or as investors – may find the report to be necessary reading for context and background. (See Council of Economic Advisers, “The Effects of Conflicted Investment Advice on Retirement Saving,” February, 2015, at  permanent.access.gpo.gov/gpo55500/cea_coi_report_final.pdf.)

With such large amounts of money and fees in question, many large financial companies oppose the new fiduciary rule, since it requires them to change business models and practices and may cost them a lot of revenue. In fact, Eugene Scalia, son of the late Supreme Court Justice Antonin Scalia, has been retained by clients who are fighting the fiduciary rule. The arguments against the rule tend to lean toward procedural issues rather than the essence of the conflicts of interest being targeted. (See “Godzilla (the Fiduciary Rule) Ate the Rule of Law” in the Wall Street Journal, June 1, 2017.)

Cumberland Advisors is a fee-for-service fiduciary advisor operating with a three-silo approach (separate custodian bank, separate advisor, separate brokerage) with full disclosure and transparency. The problems recounted above are among the reasons we have existed as a fiduciary investment advisor from the founding of our firm in 1973. We work with clients and other financial agents across the spectrum of the investment business. We find most business partners to be people of high standards and integrity. The fiduciary rule, however, will have impacts across the board, certainly on non-fiduciary agents giving advice on retirement-related accounts. With any change, there will be angst.

But whether the fiduciary rule is successfully delayed in the future or even changed, it seems clear that most people and most investors agree with the basic premise of the rule. You do not need an act of Congress or any statutory, bureaucratic regime to force the silent hand of the market. Increased fairness and transparency are where the investment business seems to be headed. All financial advice in the future will most likely be given in accordance with a non-conflicted fiduciary model. It’s only a matter of time.

As such, it probably does not matter if the fiduciary rule can be delayed or changed at the present time. Most consumers and the investing public want their investment advisors to be aligned with them in their compensation. They want to know that when a person in a position of professional trust gives advice, that the advice proffered is the best possible without conflicts of interest.

The fiduciary train’s a comin’; it’s a comin’ for the cash,
Has already left the station and not likely lookin’ back
The ole’ train barrels onward, and there seems no delays
So take it on in from here, Johnny, and blow my blues away…
Johnny Cash - Folsom Prison Blues (Live)

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