Posted by on Aug 12, 2013 in Blog, Columns, Featured |

By Jason Zweig | 8:23 pm ET  Aug. 9, 2013
Image Credit: Christophe Vorlet

In the next few weeks, the way investors get advice could change forever.

By law, a fiduciary—like a doctor or a lawyer—must act in the best interests of his client and seek to avoid all material conflicts of interest. Investment advisers are required to act as fiduciaries, but stockbrokers and insurance agents generally aren’t—yet.

As early as October, the U.S. Department of Labor is expected to propose new rules that would ensure that brokers and other securities professionals would act solely for the benefit of their clients when advising on individual retirement accounts. Those assets are a giant honey pot, with $5.41 trillion in IRAs, according to the Federal Reserve.

The Dodd-Frank financial-regulation law of 2010 authorize the Securities and Exchange Commission to establish a “no less stringent” fiduciary standard for brokers than the duties that investment advisers must follow. How that will play out may depend largely on the ferocious lobbying battle raging over the Labor Department’s plan.

The period for public comment on what an SEC rule should look like officially ended in July.

The SEC staff, a spokesman says, is “carefully considering the comments we received and will coordinate with the commissioners on next steps.” The SEC won’t say how long that might take.

Meanwhile, the Labor Department is charging full speed ahead—and raising hackles in the brokerage industry.

“The DOL is clearly moving forward on a track that’s inconsistent with where the policy should end up,” Judd Gregg, the former Republican U.S. Senator from New Hampshire who serves as chief executive of the Securities Industry and Financial Markets Association, Wall Street’s main trade group, told me. “It’s a dangerously large expansion that will chill all kinds of activity.”

Mr. Gregg says it “would be a disaster, a nightmare,” if the DOL sets a separate fiduciary standard for IRAs.

“We don’t think the DOL is moving forward in a way that’s going to be constructive at all; it’s going to be destructive,” adds Mr. Gregg. “The folks with small accounts are going to lose the ability to get advice, and their costs will go up.”

The heart of the matter: Fiduciaries should avoid conflicts, but brokers are generally required only to disclose them.

“Having a completely conflict-free relationship doesn’t work in practice” across most of the brokerage industry, says John Taft, head of RBC Wealth Management in the U.S., which manages $250 billion.

For example, when your broker’s firm underwrites an initial public offering of stock, he and the firm earn far more by selling some of those shares to you than selling you something else. When your broker buys you a bond out of his firm’s inventory of your broker’s firm, rather than on the open market, the firm also tends to make more money.

Industry groups have argued that if brokers can’t have any conflicts, like earning higher fees on some investments than on others, then they no longer will be able to afford handling small accounts.

“The [brokerage] industry is saying, in effect, ‘If you don’t allow us to continue to give conflicted advice, we won’t be able to give any,'” Assistant Secretary of Labor Phyllis Borzi, who oversees retirement benefits, told me. “But there are lots of people out there who are already acting as fiduciaries, and they’re not bankrupt. They’re making money.”

Labor Department officials can’t comment on the details of the pending rule proposal, but Ms. Borzi says the agency and the SEC are “working very closely” to ensure that their agendas don’t clash.

There are several possibilities, say legal experts.

Advisers could be restricted from enticing retirees to sell one investment they already hold in order to buy another, says Tamar Frankel, a professor at Boston University who specializes in fiduciary law.

Arthur Laby, a securities-law professor at Rutgers University, suggests that brokers could be permitted to fill orders for individual investors from their firms’ own inventory only for “readily marketable, highly liquid securities” and that firms could be prevented from paying their advisers more for selling in-house products.

“There’s no mileage in it for anybody to come up with a rule that is unduly burdensome,” Ms. Borzi says. “But when people rely on experts for advice on what is probably the biggest chunk of money they’ve ever had in their life, the advisers have a responsibility to work for the clients’ best interests and not their own.”

Meanwhile, ask your adviser: Do you or your firm earn more money for recommending this investment? Can you suggest a simpler, cheaper way of accomplishing the same goal?

Investors can always act as their own fiduciaries—just in case their advisers aren’t.


Source: The Wall Street Journal