Last week President Obama directed the Department of Labor to move ahead with a proposal that would raise investment-advice standards for brokers handling retirement accounts. His proposal would require more brokers to abide by a fiduciary standard and put the best interest of their clients above their own when advising on retirement saving. Of course you want the best interests of investors protected, but some argue this new red tape would actually cut some of their choices.
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Chris Carosa, a financial advisor and author of “Hey! What’s My Number? How To Improve The Odds You Will Retire In Comfort,” offered his insight and opinion as to what this new red tape could mean for brokers and investors:
Boomer: How does an investor know whether or not their broker is putting their financial interests first?
Carosa: All sorts of financial service providers claim to offer “advice.” At issue is the requirement that all advisors act as fiduciaries, that is, they must always put their clients’ interests first. Currently, only Registered Investment Advisers are required to do so. That means brokers, insurance agents, and many others can legally offer advice without obeying the fiduciary standard. That being said, one need not be a fiduciary to always put their clients’ interests first. Furthermore, being a fiduciary isn’t a sure thing for clients. After all, Bernie Madoff theoretically worked as a fiduciary, and look how that turned out. The bottom-line: As with any professional service provider, you need to look out for yourself.
Boomer: Are brokers legally allowed to skirt their fiduciary responsibilities to their clients? How? In what instances?
Carosa: Brokers are not legally bound to adhere to the fiduciary standard; therefore, they have no fiduciary responsibilities. As a practical matter, they can “recommend” mutual funds that are affiliated with their companies and/or funds that pay them what the president called “kick-backs” or “backdoor fees.” These are considered “prohibited transactions” and not allowed under the fiduciary standard. The best way to protect yourself is to make sure the only person who is paying your advisor is you. When engaging a professional, ask them whether or not they or their company are receiving any compensation from the investment products they recommend.
Boomer: Will this new proposed rule close these “loopholes”?
Carosa: First, the proposal offers no “new” regulations. It merely asks that every provider offering investment advice play by the same set of rules. These refer to the rules already being followed by Registered Investment Advisers. The proposal seeks to expand those rules to brokers, insurance agents, and any others who provide investment advice. At least in theory. In practice, the existing Department of Labor rules currently exempt certain self-dealing transactions that are normally prohibited under prevailing trust and fiduciary law. So there’s no guarantee all the loopholes will be closed.
Boomer: Are brokers pushing back against Obama’s new legislation? Why?
Carosa: Infamous bank robber Willie Sutton was once asked why he robbed banks. “Because that’s where the money is,” was his incredulous response. Brokers oppose the idea of following the same rules as Registered Investment Advisers because not following those rules gives them a tremendous marketing advantage in the investment advice arena. And, needless to say, that’s where the money is.Boomer: Are 401ks at the center of this new rule? Why?
Carosa: To a small extent yes, but recent court rulings have made 401k plan sponsors aware of the personal risks they take if they don’t hire a fiduciary. The real target of expanding the existing rules is the IRA market. With 401k plans, at least retirement savers have an objective fiduciary (i.e., the plan sponsor) looking out for their best interests. Once retirement savers leave the cocoon of the 401k and rollover their assets into an IRA, well, then they’re entering what might best be called the Wild West of finance. They have only themselves to look out for their own best interests (again, remember Madoff). That’s why I always recommend that people pick a team of independent service providers – investment adviser, custodian, accountant, attorney – so that their assets are seen by multiple parties.
That way they can always count on getting a second opinion.