Redundant tax protections reveal flaws in the Department of Labor's fiduciary rule.
The Department of Labor's fiduciary standard-unveiled in April 2015-was intended to prevent brokers from selling unnecessary high-fee products. A nice thought! Unless, we guess, you are a variable annuity salesperson. Some predicted these annuities-famously fee-heavy-would take a hit once the rule took effect (it hasn't fully yet). But annuity factories are adapting in anticipation. They're finding ways to keep targeting retirees-for example, by offering new products they expect to better fit the fiduciary standard, though they aren't fundamentally different otherwise. In our view, this is a great example of the issues with the DoL's rule-and a reminder for investors to always do their due diligence on any investment product or service before jumping in.
The DoL's fiduciary rule is supposed to protect investors by requiring brokers and advisers working with retirement accounts to act in their clients' best interest; disclose all conflicts of interest in writing and on a dedicated website; and inform clients how they are working to mitigate those conflicts. Most of the rule is on ice until July 2019 while regulators decide how to apply it, but many brokers and insurers are preparing now for its eventual implementation via new annuity offerings for use in IRAs and 401(k)s.
There is a basic problem here: Simply, annuity marketing promises funds that grow tax-free until withdrawal, when the assets can be converted into a "guaranteed" stream of income payments. But most retirement accounts already grow tax-free-and that annuity shell will still cost much more than a comparable non-annuity option. Adding another tax shell in your IRA or 401(k) is redundant. The SEC has had warnings on its website for about a decade regarding this practice.
Now, you would think this is the sort of thing a well-designed rule mandating brokers act in clients' best interest would prevent. A deferred annuity in an IRA is expensive and may benefit the broker or selling firm more than the client, as there are generally lower-cost, less restrictive ways to generate cash flow. But it's fine under DoL fiduciary standard, as long as the client signs disclosure forms saying they aren't putting the annuity in the IRA for tax deferral purposes. To be fair, this was the requirement before the fiduciary rule, too-but that's sort of our point. If a rule seeking to improve the quality of recommendations retirement investors receive can't even limit this expensive, redundant tactic-one regulators have long discouraged-we can't help but wonder what good it truly does.
This isn't the only trouble with the DoL's rule. As our founder, Ken Fisher, discussed a while back in USA Today, the rule has a get-out clause known as the Best Interest Contract Exemption (BICE) that pretty much guts its core aims. Brokers can keep pushing products like always as long as the client signs on the dotted line.
So, with that in mind, the DoL rule and BICE effectively mean the US has three (or four!) different standards of care in the financial advice industry. There is the SEC's fiduciary standard, which Registered Investments Advisers (including Fisher Investments) are held to. There is the suitability standard that brokers have traditionally operated under. The DoL rule adds two more, a watered-down fiduciary rule for retirement accounts and an even more watered-down version under BICE. One client dealing with one financial professional may have accounts held to all four. Confusing!
Plus, a lot of this stuff is subjective. We happen to think deferred annuities are really bad options for the vast majority of investors, but we're well aware others disagree. It doesn't take much rationalization to comply with the letter of the law. Likewise, well-intentioned advisers doing what they think is best for their clients still make mistakes. A broker or adviser could have all the scruples in the world and still make awful recommendations out of sheer ineptitude, or they might not have adequate resources to properly serve clients.
This is why, whether or not the DoL's rule ultimately takes effect, the onus remains on investors to do their due diligence-not just about regulatory standards, but about the values and resources the financial professional uses to uphold those standards and put clients first. Plenty of honorable professionals work in this industry, regardless of the standard of care. To know whether you're talking to one requires digging deeper. Get to know your adviser's investment philosophy, process, expertise, values, resources, history, conflicts of interest, compensation structure and costs (including hidden) on various products and services. Time-consuming? Maybe. Important? Absolutely.
As for what the future holds, the DoL's rule isn't the only game in town. 2010's Dodd-Frank ordered the SEC to ponder a uniform fiduciary standard for all brokers and advisers, and the agency is reportedly taking up the issue again. It's impossible to know today how it'll shake out, but it would be great if investors had the simpler, clearer-cut standards they did for much of the 20th century. One of the biggest benefits of the Investment Adviser's Act of 1940-which established the original fiduciary standard-is the line it drew between investment sales (brokers) and service (advisers). It didn't fully eradicate charlatans from this industry,[i] as Bernie Madoff and others show, but it did give investors a clear view of what they were paying for (transactions or advice/service) and which side of the table their guy was on. However, as investors flocked to advisers, the brokerage industry tried to compete by recasting itself as the realm of "financial advisors,"[ii] with nothing preventing brokers from "recommending" products that paid them a handsome commission.
Hence our main beef with the DoL's rule: In our view, it blurs the line between sales and service even further-rather than redrawing it-while adding paperwork. If the SEC redraws the line and makes it easier to discern sales from service, we think investors big and small would be better off. Clients who opt for financial advisers would still need to weigh their options in that arena and find the right one for them, but having clear rules would help them narrow that funnel considerably.
[i] Nothing will. And that is true of every industry everywhere.
[ii] Subtle, huh?
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.