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(Bloomberg View) — Wall Street is wasting no time revving up its lobbying machine now that President Barack Obama has said his administration soon will propose a rule to require brokers to act as fiduciaries when advising clients on their retirement savings.  Asking brokers to put clients’ interests ahead of their own seems like a good idea, yet industry trade groups argue the rule will make investment advice and retirement planning too expensive for low- to middle-income families. If that happened, the argument goes, those families would save less for retirement and, down the road, could be a burden on taxpayers.
One industry group, the National Association of Plan Advisors, which represents professional retirement-plan advisers, goes so far as to call the proposal the “No Advice” rule.  This sounds alarming! Is Obama about to make worse the very problem — too little retirement savings — he says he wants to fix?  That’s the thrust of a memo written by the law firm Debevoise & Plimpton for the Financial Services Roundtable, which represents the chief executive officers of banks, insurers and asset managers. The main evidence comes from a 2011 study by consulting firm Oliver Wyman, which has come to represent the core of the industry’s argument.  That study says lower-income investors prefer to work with brokers (who don’t have a fiduciary duty and are paid through sales commissions, revenue-sharing deals and other fees) over registered investment advisers (who are paid directly out of a client’s pocket and already must put client interests ahead of their own).  The report, which the main Wall Street trade group, the Securities Industry and Financial Markets Association, also cites, isn’t a scientific study. It was paid for by 12 financial-services companies. It doesn’t use statistical measures, such as random sampling, but relies on data the 12 companies aggregated from customer accounts. And it doesn’t actually ask savers what they prefer. Oliver Wyman didn’t respond to requests for comment. Yet the study concludes that lower-income savers prefer brokers who have no fiduciary duty, because the majority of the companies’ savers used a broker when they invested in an individual retirement account.
That circular argument overlooks the fact that many investors use brokers simply because they think it’s cost-free. Studies show investors don’t understand that there are hidden costs associated with brokers, eroding savings over time.
The biggest indirect cost is the conflict of interest brokers can face. Mutual-fund sponsors reward brokers who send client money their way. But the performance of broker-sold funds, many of them actively managed, on average is lower than that of the low-cost index funds that many investment advisers recommend.  A White House report estimates the cost to investors from conflicted advice at $17 billion a year in forgone retirement savings — even before counting the broker payments. In other words, underperformance is the price of brokers’ advice.  Lisa Bleier, an associate general counsel at SIFMA, says the White House misinterpreted the studies it relied on to reach the $17 billion loss figure. She said SIFMA will soon issue a rebuttal.
Broker payments can range from sales loads (fees charged when investors purchase or sell shares in a fund) to revenue- sharing arrangements (such as payment for shelf space, in which a brokerage is paid to give priority to a fund on the brokerage’s platform). Sometimes brokers receive multiple forms of payment — and with them, multiple incentives that may conflict with the client’s interests.  Why can’t brokers just become fiduciaries? That would require training and licensing of the 37,000 U.S. investment professionals, or 36 percent of the total, who aren’t registered investment advisers. Instead, they are salespeople who make “suitable” recommendations to clients, meaning the product fits the customer’s age, income, investment goals and tolerance for risk. But because brokers can choose from dozens of investment products, all of them “suitable” for their clients, they are free to recommend the one that pays them the most — and often do. Another problem, as SIFMA puts it, is that “millions of investors’ primary source of financial education and advice is being threatened.” The Wyman study is also the source for this claim. “Brokerages,” the study says, “would no longer have an economic incentive to develop relationships with investors” with small balances.  In other words, if brokerages aren’t able to collect fees from revenue-sharing deals, sales loads and the rest, there isn’t enough profit in selling investments to lower-income people with small balances.
It’s true that many brokerages couldn’t just switch customers to fee-based advisory accounts, which often require minimum balances, usually $25,000 to $50,000. More than 7 million retail customers of the 12 companies in the study would be left in the lurch because their balances fall below the minimum. But for the industry to say that savers would be at sea without brokers is a stretch. It isn’t clear why investment firms can’t lower the account-minimum bar for lower-income savers. The study, moreover, only compares brokers with advisers who take a percentage of a customer’s assets annually as payment. It doesn’t mention that advisers who charge by the hour or charge a flat fee are readily available.  Better yet, savers could avoid brokers and investment advisers altogether by investing in low-cost index mutual funds, most of which have better returns than the higher-cost managed funds brokers seem to prefer. What the Wyman study is really saying is that a fiduciary duty would destroy the brokerage business model, which has grown up around the back-door payments that induce brokers to place client money in underperforming funds. Without those payments, it would be too costly to provide non-conflicted advice. That’s different from saying Obama’s fiduciary rule would harm lower- income savers.  Investment advice isn’t cheap, and it most certainly isn’t free. One way or another, savers pay for advice, directly out of their pockets or indirectly through lower returns if the advice is conflicted.

To contact the author on this story: Paula Dwyer at pdwyer11@bloomberg.net To contact the editor on this story: Christopher Flavelle at cflavelle@bloomberg.net
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