Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
Support MFO
Donate through PayPal
Conflict Of Interest Rule Could Save Americans Billions In Retirement
FYI: (This is a follow-up article) When it comes to retirement planning, it's not just about how much you save, but with whom. A new Labor Department rule announced Wednesday will require brokers to put clients' interests ahead of their own when it comes to retirement investments, tightening current industry standards that can incentivize brokers to push high-fee products that prioritize their own profits Regards, Ted http://www.bloomberg.com/news/articles/2016-04-06/conflict-of-interest-rule-could-save-americans-billions-in-retirement
If this were really going to make a change, the B/D, bank, and insurance industry would not be saying they like the new regs. And in fact, as I mentioned in another post, investments that had been targeted for exclusion in earlier versions of the regs have magically been cleared, such as variable annuities, non-traded REITS, and other high-commission products like proprietary mutual funds. Needless to say, there was some financial industry lobbying money that was put to work very successfully. Most folks I know think in the end that consumers will still be at the mercy of salespeople, given all the giveaways to the industry. I think it will be very easy for the sales industry to justify their efforts as being in the best interest of investors. Am I cynical on this topic? You bet.
@BobC - The original regs excluded VAs from PTE 84-24. The final regs exclude VAs from PTE 84-24. The original regs allowed VAs in BICE. The final regs allow VAs in BICE.
I don't disagree that DOL made some changes to accommodate the financial industry. I agree with the cynicism. But I do disagree on some of the facts, and thus the extent of the accommodation. Could you be more specific about the legerdemain?
To put it another way, could you pull back the curtain and show us where VAs were made to vanish and then reappear?
It is a lot to wade through. I get the sense that stories from interested parties are coming from different perspectives, with different reports picking out those parts that confirm their particular perspective. I don't exclude myself in that, which is part of why I'm asking here.
Simple case in point - look at the quote Ted gave. It says that the current rules incentivize brokers to push high profit products. That's nonsense. The high profits provide the incentives. The current rules merely enable this unscrupulous behavior.
One other thought on perspectives. If we had a sane Congress, we'd be hearing Republicans cheering Obama's nomination for Supreme Court justice. In the past, he'd been identified as the best the Republicans could possibly hope for from a Democratic president.
That wouldn't mean that Republicans thought Garland was someone they wanted, but rather that they had dodged a bullet. Saying that you like something (or someone) doesn't necessarily mean that it's what you would have done had you had control.
From the WSJ article referenced there (and in Ted's summary): "The final rule issued by the Labor Department on Wednesday toughens standards for advisers recommending these “indexed annuities” to retirement savers."
From the DOL final regs: "Given the risks and complexities of these investments, the Department has determined that indexed annuities are appropriately subject to the same protective conditions of the Best Interest Contract Exemption that apply to variable annuities."
The indexed annuity rules are being tightened, but those same tight rules when applied to VAs are not a good thing?
The WSJ article goes on to note:
That new best-interest-contract requirement is expected to crimp sales of another type of annuity that has been sold by many advisers—variable annuities ...
[Professor] Bullard of the University of Mississippi applauded the change in the Labor Department’s final rule, saying Wednesday that [variable and indexed] annuities “needed to be under the contract more than any other product because they are not subject to securities regulation and they are extremely complex, costly and often unsuitable.”
Edit: The "change" being referred to in the quote is the new regulation of indexed annuities, which were exempt in the earlier draft. The WSJ text didn't make that clear, because the actual quote was "such annuities" and the immediate textual antecedent in the article was "variable annuities and indexed annuities".
Programmers will recognize the distinction between lexical and dynamic scoping - I scoped lexically, but should have scoped dynamically, referring back to previous quotes of Bullard. He was talking only about indexed annuities.
So @BobC was mostly correct about non-traded REITS. Though the original proposal did not "target" particular investments for exclusion. Rather it explicitly included particular investments, thereby excluding everything else. The original list did allow selling annuities and proprietary products.
WIth that in mind, here's the original list of permitted investments from the 2015 proposal (Section VIII (c), pdf p. 28):
(c) An ‘‘Asset,’’ for purposes of this exemption, includes only the following investment products: Bank deposits, certificates of deposit (CDs), shares or interests in registered investment companies, bank collective funds, insurance company separate accounts, exchange-traded REITs, exchange-traded funds, corporate bonds offered pursuant to a registration statement under the Securities Act of 1933, agency debt securities as defined in FINRA Rule 6710(l) or its successor, U.S. Treasury securities as defined in FINRA Rule 6710(p) or its successor, insurance and annuity contracts, guaranteed investment contracts, and equity securities within the meaning of 17 CFR 230.405 that are exchange-traded securities within the meaning of 17 CFR 242.600. Excluded from this definition is any equity security that is a security future or a put, call, straddle, or other option or privilege of buying an equity security from or selling an equity security to another without being bound to do so.
That list didn't forbid proprietary products (such as proprietary funds). In fact: "Financial Institution may limit the Assets available for purchase, sale or holding based on whether the Assets are Proprietary Products, generate Third Party Payments, or for other reasons, and still rely on the exemption, provided that ..." (Section IV - Range of Investment Options, pdf p. 26 of original proposal).
Sorry I am getting a little off topic here. But since this is a mutual fund forum, I am curious what effect, if any, this rule will have on the mutual fund distribution methods in the long term. Could it be that the share classes that charge loads, such as A, B, C shares, will eventually disappear?
Right on topic, actually. Both the original proposal and the final rules were designed to allow the current models of compensation to continue. So brokers are still allowed to collect loads. No change when viewed from the mechanical perspective, i.e. you've still got front end loads, trailing fees, etc.
What the regs do is require the fees/loads to be reasonable and disclosed (and for the investor to sign off on this), and for the funds/shares recommended to be in the best interest of the client. That means that the broker can't recommend an inferior (though still suitable) fund just because the fund pays the broker more. In essence, the broker has to ignore the fees when making the recommendation, though the broker is still allowed to collect the fees.
The industry is speculating that this will cause a move away from load funds towards other methods of compensation like wrap fees. IMHO this has been happening for years anyway (see, e.g. the knocks against American Funds as being too "old school" with its load shares).
Could the new rule also cause brokers to stay away from recommending riskier types of mutual funds? Brokers might get nervous given that a fiduciary responsibility could increase scrutiny and make it more likely for them to get sued.
I will post this last comment, since this horse has been beaten to death already. Remember that wirehouses, banks, insurance companies, and independent BDs all seem to be pleased with the final regs. That alone should tell you there is very little change in how the commission folks will continue to do business. So they might have to have clients sign a disclosure. We all know how that works. B and C-Class shares will still be sold, indexed annuities will still be sold, variable annuities will still be sold. The organizations that put every client in the same product will still continue to do that. Just be sure to have clients sign a disclosure form.
Every product and package in BobC's list above was allowed to be sold in the original regs proposal. (Other products, like non-traded REITs had been excluded in the proposal but were not excluded in the final regs; is this what all the cheering is about? [not])
IMHO the broad changes made (or at least the ones that caught my eye) were: - Getting rid of the exclusion list, allowing the "best interests" principle to rule instead of (implicitly) disallowing some investments that might (in rare cases) be in the client's best interest - Significantly reducing the amount of reporting and disclosing that would be required
The latter was a major sticking point, as providers ("wirehouses, banks, insurance companies ...") felt that some of the information originally required, like projected costs, was speculative and difficult/expensive to generate. (See Vanguard link above for Vanguard's comment on this.)
What will be the effect on brokers? Opinions vary. You've got one opinion in the post above this one.
Some quotes (I'm obviously making selections to demonstrate a point):
Securities Industry and Financial Markets Association (sifma): "It remains 'concerned that the DOL’s rule could force significant changes to current relationships, which may leave clients without the help they need to prepare for retirement, at a time when we all agree that more can and should be done.'"
Janus Capital talking about delayed implementation and fewer disclosures: "“the framework remains largely in place. Thematically, the goal was to put clients’ interests ahead of those of advisers and nothing has changed with respect to that.'”
Harold Evensky (oft quoted advisor, advocate of fee-only): "'My attitude is we live in the real world and while perfection would be terrific, I think substantively this is extraordinarily important and powerful' for consumers"
Senator Elizabeth Warren: "'“Sometimes government works for the people and today was one of those days. ... It’s an enormous victory for hardworking Americans.'"
Senator Sherrod Brown: "'It’s clear that the Labor Department considered the comments and input from stakeholders and the public to finalize a rule that protects retirement savers and creates a workable solution.'”
Senator Johnny Isakson: "'For families across the country, this rule is essentially the Obamacare for retirement planning, and I will do everything I can to overturn this rule.'"
Consumer Federation of America: "'From our point of view, a rule that preserves the core protections but is easier for industry to implement is a win for everyone.'"
My final comment, after listening to several attorneys "interpret" the new regs: Advisors will have to jump through a few more hoops and defend recommendations/decisions as being in "the best interest" of consumer. A few advisors will have to drastically change their business models. That is positive change. A local firm that spends a fortune on fancy TV advertising (of course never disclosing that they sell almost everyone an indexed annuity) has told colleagues the extra paperwork and documentation is worth it, since they can essentially continue business as usual. In truth, it will be some time before we really know how much positive change results from the DOL regs. Having been in this business for 30 years, I trust you will forgive my initial cynicism.
@BobC - That sounds like a much more nuanced appraisal. Thanks!
A change from the original regs was to reduce the number of hoops to jump through, but not to eliminate them (i.e. a compromise).
The core - fiduciary duty - remains, and is what requires advisors to be able to defend their recommendations. They won't actually have to defend the recommendations unless challenged by their clients. This goes to @Alban 's question of how the rule changes will affect recommendations - will advisors make suboptimal recommendations simply because they're less likely to be challenged?
The "business as usual" problem supports my cynicism (and yours) about the dubious value of disclosures. I keep scratching my head trying to figure out when a deferred variable or indexed annuity in an IRA would ever be in the client's best interest.
That's because you can get the equivalent without the annuity wrapper more cheaply (mutual funds and structured notes). Later you can buy an immediate annuity if you want to annuitize. Fixed deferred annuities are a little different because there you're getting a "CD" except that instead of FDIC insurance it's backed by a private lender (the insurance company) with somewhat higher yield. A justifiable risk/reward tradeoff.
Comments
I don't disagree that DOL made some changes to accommodate the financial industry. I agree with the cynicism. But I do disagree on some of the facts, and thus the extent of the accommodation. Could you be more specific about the legerdemain?
To put it another way, could you pull back the curtain and show us where VAs were made to vanish and then reappear?
All the docs, both current and original, can be found at the DOL:
http://www.dol.gov/ebsa/regs/conflictsofinterest.html
It is a lot to wade through. I get the sense that stories from interested parties are coming from different perspectives, with different reports picking out those parts that confirm their particular perspective. I don't exclude myself in that, which is part of why I'm asking here.
Simple case in point - look at the quote Ted gave. It says that the current rules incentivize brokers to push high profit products. That's nonsense. The high profits provide the incentives. The current rules merely enable this unscrupulous behavior.
That wouldn't mean that Republicans thought Garland was someone they wanted, but rather that they had dodged a bullet. Saying that you like something (or someone) doesn't necessarily mean that it's what you would have done had you had control.
http://www.mutualfundobserver.com/discuss/discussion/26891/rules-for-indexed-annuities-face-an-unexpected-tightening
From the WSJ article referenced there (and in Ted's summary):
"The final rule issued by the Labor Department on Wednesday toughens standards for advisers recommending these “indexed annuities” to retirement savers."
From the DOL final regs:
"Given the risks and complexities of these investments, the Department has determined
that indexed annuities are appropriately subject to the same protective conditions of the Best Interest Contract Exemption that apply to variable annuities."
The indexed annuity rules are being tightened, but those same tight rules when applied to VAs are not a good thing?
The WSJ article goes on to note: Edit: The "change" being referred to in the quote is the new regulation of indexed annuities, which were exempt in the earlier draft. The WSJ text didn't make that clear, because the actual quote was "such annuities" and the immediate textual antecedent in the article was "variable annuities and indexed annuities".
Programmers will recognize the distinction between lexical and dynamic scoping - I scoped lexically, but should have scoped dynamically, referring back to previous quotes of Bullard. He was talking only about indexed annuities.
Here's an Investment News article talking (correctly) about how non-traded REITs magically appeared in the final regs.
So @BobC was mostly correct about non-traded REITS. Though the original proposal did not "target" particular investments for exclusion. Rather it explicitly included particular investments, thereby excluding everything else. The original list did allow selling annuities and proprietary products.
WIth that in mind, here's the original list of permitted investments from the 2015 proposal (Section VIII (c), pdf p. 28): That list didn't forbid proprietary products (such as proprietary funds). In fact: "Financial Institution may limit the Assets available for purchase, sale or holding based on whether the Assets are Proprietary Products, generate Third Party Payments, or for other reasons, and still rely on the exemption, provided that ..." (Section IV - Range of Investment Options, pdf p. 26 of original proposal).
What the regs do is require the fees/loads to be reasonable and disclosed (and for the investor to sign off on this), and for the funds/shares recommended to be in the best interest of the client. That means that the broker can't recommend an inferior (though still suitable) fund just because the fund pays the broker more. In essence, the broker has to ignore the fees when making the recommendation, though the broker is still allowed to collect the fees.
The industry is speculating that this will cause a move away from load funds towards other methods of compensation like wrap fees. IMHO this has been happening for years anyway (see, e.g. the knocks against American Funds as being too "old school" with its load shares).
Every product and package in BobC's list above was allowed to be sold in the original regs proposal. (Other products, like non-traded REITs had been excluded in the proposal but were not excluded in the final regs; is this what all the cheering is about? [not])
As someone pointed out in another thread, even Vanguard had issues with the original proposal; my response then and now was that this had to do with details. If Vanguard is now happy, what does this mean?
http://www.reuters.com/article/us-usa-brokers-fiduciary-vanguard-idUSKCN0X42OY
Vanguard perspective on final rule: Moving in the right direction (emphasis in original)
https://personal.vanguard.com/us/insights/article/DOL-fiduciary-rule-perspective-042016
IMHO the broad changes made (or at least the ones that caught my eye) were:
- Getting rid of the exclusion list, allowing the "best interests" principle to rule instead of (implicitly) disallowing some investments that might (in rare cases) be in the client's best interest
- Significantly reducing the amount of reporting and disclosing that would be required
The latter was a major sticking point, as providers ("wirehouses, banks, insurance companies ...") felt that some of the information originally required, like projected costs, was speculative and difficult/expensive to generate. (See Vanguard link above for Vanguard's comment on this.)
What will be the effect on brokers? Opinions vary. You've got one opinion in the post above this one.
https://www.google.com/search?q=Reactions+to+the+Labor+Department’s+Fiduciary+Rule&ie=utf-8&oe=utf-8 (top link)
Some quotes (I'm obviously making selections to demonstrate a point):
Securities Industry and Financial Markets Association (sifma): "It remains 'concerned that the DOL’s rule could force significant changes to current relationships, which may leave clients without the help they need to prepare for retirement, at a time when we all agree that more can and should be done.'"
Janus Capital talking about delayed implementation and fewer disclosures: "“the framework remains largely in place. Thematically, the goal was to put clients’ interests ahead of those of advisers and nothing has changed with respect to that.'”
Harold Evensky (oft quoted advisor, advocate of fee-only): "'My attitude is we live in the real world and while perfection would be terrific, I think substantively this is extraordinarily important and powerful' for consumers"
Senator Elizabeth Warren: "'“Sometimes government works for the people and today was one of those days. ... It’s an enormous victory for hardworking Americans.'"
Senator Sherrod Brown: "'It’s clear that the Labor Department considered the comments and input from stakeholders and the public to finalize a rule that protects retirement savers and creates a workable solution.'”
Senator Johnny Isakson: "'For families across the country, this rule is essentially the Obamacare for retirement planning, and I will do everything I can to overturn this rule.'"
Consumer Federation of America: "'From our point of view, a rule that preserves the core protections but is easier for industry to implement is a win for everyone.'"
A change from the original regs was to reduce the number of hoops to jump through, but not to eliminate them (i.e. a compromise).
The core - fiduciary duty - remains, and is what requires advisors to be able to defend their recommendations. They won't actually have to defend the recommendations unless challenged by their clients. This goes to @Alban 's question of how the rule changes will affect recommendations - will advisors make suboptimal recommendations simply because they're less likely to be challenged?
The "business as usual" problem supports my cynicism (and yours) about the dubious value of disclosures. I keep scratching my head trying to figure out when a deferred variable or indexed annuity in an IRA would ever be in the client's best interest.
That's because you can get the equivalent without the annuity wrapper more cheaply (mutual funds and structured notes). Later you can buy an immediate annuity if you want to annuitize. Fixed deferred annuities are a little different because there you're getting a "CD" except that instead of FDIC insurance it's backed by a private lender (the insurance company) with somewhat higher yield. A justifiable risk/reward tradeoff.