It may surprise you to know that the vast majority of financial professionals and companies are not required to provide you with products or services that are in your best interest. We’ve written many times before about these conflicts, but for those who haven’t been long readers, it is essentially the exception and not the rule, that financial professionals must be fiduciaries to their clients. The rules governing the professional conduct of financial professionals varies from regulator to regulatory, but everyone from your insurance agent to the bank teller essentially avoids professional legal liability for what they provide you with, whether it be loans or insurance. So long as what they sell you is covered in lengthy written disclosures, your thorough understanding, competence to make informed decisions, and basic best interest, are considered irrelevant.
Recently, an update to a specific domain of advice around retirement plans has been proposed, much to the screeching and retching of those many less-than-fiduciary salespeople who occupy the dark corners of caveat emptor. So today, we’re sharing a bit of history on the fiduciary rule, an explanation of the updated proposal, and why thorough due diligence is necessary before you trust someone with your financial needs.
History of “The Fiduciary Rule”
In 2016, the Department of Labor promulgated a rule regarding advice pertaining to rollovers of retirement accounts. This rule came about in part because of a study conducted by the Council of Economic Advisors, a small task force appointed by the President of the United States to address and investigate economic matters. They produced a report in February of 2015 called “The Effects of Conflicted Investment Advice on Retirement Savings”, which surveyed the available research literature on retirement readiness and the financial industry to conclude the following:
- “Conflicted advice leads to lower investment returns. Savers receiving conflicted advice earn returns roughly 1 percentage point lower each year (for example, conflicted advice reduces what would be a 6 percent return to a 5 percent return).
- An estimated $1.7 trillion of IRA assets are invested in products that generally provide payments that generate conflicts of interest. Thus, we estimate the aggregate annual cost of conflicted advice is about $17 billion each year.
- A retiree who receives conflicted advice when rolling over a 401(k) balance to an IRA at retirement will lose an estimated 12 percent of the value of his or her savings if drawn down over 30 years. If a retiree receiving conflicted advice takes withdrawals at the rate possible absent conflicted advice, his or her savings would run out more than 5 years earlier.
- The average IRA rollover for individuals 55 to 64 in 2012 was more than $100,000; losing 12 percent from conflicted advice has the same effect on feasible future withdrawals as if $12,000 was lost in the transfer.”
Naturally, these numbers were quite alarming, and in response, the Department of Labor created the “Fiduciary Rule,” which, among other things, required that recommendations to rollover retirement plans be conducted under a fiduciary duty of care by expanding the definition of fiduciary under the Employee Retirement Income Security Act (ERISA) to encompass rollover recommendations made by financial professionals. Effectively, this meant that these professionals could not recommend the rollover of retirement funds into IRAs unless they could reasonably satisfy a due diligence requirement that it be in the client’s best interest. Seems reasonable, right?
Well, in 2018, the Fifth Circuit overturned the DOL rule in a 2-1 decision on the grounds that it was beyond the scope of the Department of Labor’s authority to regulate IRAs. Never mind that IRAs were created as part of ERISA, which gave the Department of Labor shared regulatory authority over IRAs and other retirement accounts with the IRS and the Department of the Treasury. However, in the time since, the Department of Labor has worked on creating a new rule intended to address the same problems as before. This time, they have proposed a “Definition of an Investment Advice Fiduciary,” which directly updates the regulation under ERISA and its definition of an investment advice fiduciary.
Updating the Definition of an Investment Advice Fiduciary
The proposal requires the following, and is taken directly from the DOL’s website on the proposed rule:
“Many people who give investment advice and get paid for it are currently not considered investment advice fiduciaries under ERISA. Investment advice fiduciaries legally must follow strict rules of conduct.
The proposed rule and related proposed amendments to prohibited transaction exemptions (PTEs) detail when advice providers are acting in a fiduciary role under federal pension laws and explain the conditions they must follow to protect retirement investors.
Under these proposals, investment advice fiduciaries would:
- give advice that is prudent and loyal.
- avoid misleading statements about conflicts of interest, fees, and investments.
- follow policies and procedures designed to ensure the advice given is in an investor’s best interest.
- charge no more than is reasonable for their services.
- give investors basic information about any conflicts of interest.”
Again, does it not seem completely reasonable? Does it not seem appropriate that you should expect anyone giving you advice about your life savings to give advice that is prudent and loyal, avoid misleading statements about their conflicts of interest and the costs you might incur, to charge reasonably, disclose conflicts of interest, and to do so systematically and consistently? Of course it does, right?
Apparently, we would be wrong. The proposed rule garnered 18,368 comments from the public, with a fairly clear division. The CFP Board, the Financial Planning Association, the National Association of Personal Financial Advisors, and others representing professionals who already operate as fiduciaries for their clients in clear favor. Those representing the securities brokerage and insurance industries in vehement opposition and even conjuring a fascia of victimhood into existence via op-eds in industry publications.
Why such vehement opposition? Well, like most things, it simply isn’t as black and white as we’d like to believe. The side in favor of a fiduciary requirement would make the argument along the lines I’ve already articulated: People advising clients on what to do with their retirement savings, and often their entire life savings, should be required to do so with a fiduciary duty of loyalty and care, disclose their compensation and conflicts of interest, and do so with systematic commitment. I happen to agree with that, but let’s give the other side of the argument a fair hearing.
On the side of not wanting to expand the definition of investment advice fiduciary is an uncomfortable truth: fee-compensated professionals tend to work with higher income and affluence clientele: those typically around the 90th percentile of income and assets compared to the general population. Those who work on commission, on average, tend to work with a lower income and lower net worth demographic population (citation for both datapoints). Consequently, the argument they make is that by requiring commission-based salespeople to act with a fiduciary obligation to their clients, they will end up serving less people, and therefore, access to professional advice around retirement issues will be decreased.
Now, that argument is reasonable on its face. However, there is a snuck premise in the argument: That consumers are better off with non-fiduciary advice from these salespeople than they are without it. Yet, remember the Council of Economic Advisors report above: Compensation conflicted advice is costing consumers 1% annually in their returns, amounting to an estimated $17 billion dollars annually. There is a cause-and-effect statement here: Consumers are expected to have had $17 billion dollars more wealth had they not been exposed to compensation-conflicted advice. So, while the claim that requiring salespeople to be fiduciaries would reduce access to retirement advice is true, the economic data would suggest that the consumers not accessing compensation-conflicted retirement advice would be better off for it.
No One Identifies as a Villain
Ask Darth Vader if he was a villain, and until his redemption on the second Death Star, he’d say, “I have brought peace, freedom, justice, and security…” While Star Wars is admittedly a bit of a dramatic example, it’s a classic case of a simple fact: no one identifies as a villain. They’re simply doing bad things with what they perceive to be good reasons. When discussing topics such as access to retirement advice, everyone in the business of giving retirement advice thinks they are doing so competently and with good reasons. However, the financial industry as a whole suffers from a serious Maslow’s Hammer problem. Let me explain.
Financial planning and the CFP® Certification were born out of a recognition in the late 60s by a group of stockbrokers and insurance agents that, while they were very competent in their respective domains, they were limited by the tools available to them (mutual funds, stock trading, life insurance, etc.) Consequently, in the decades since, financial planning has emerged as a separate activity and service, held aside from any form of product-based transaction, though a product-based transaction may occur as part of the activity and may be entirely how the financial planning engagement is paid for. Yet, in a country with 902,500 life insurance agents, 637,669 assorted securities licensed individuals, and a menagerie of uncounted adjacent professionals, a simple problem arises: How you get paid affects the advice you give, and therein is the Maslow’s Hammer problem: “For someone whose only tool is a hammer, all problems look like nails.”
If you are a life insurance agent and you’re being asked for retirement advice, you have a conflict of interest. The conflict is simple: You will get paid if the person asking for advice buys an annuity or life insurance policy from you, and you won’t get paid if you don’t.
If you are a general securities representative or investment company and variable contracts products representative, you have a conflict of interest. The conflict is simple: You will get paid if the person asking for advice buys an investment product or gives you money to trade, and you won’t get paid if they don’t.
If you are an investment adviser representative, you have a conflict of interest. The conflict is simple: You will get paid if the person asking for advice hires you by the hour, for a project fee, for a percentage of the assets you might manage for them, for a percentage of their income, for a subscription fee, or even for a percentage of their net worth; And you won’t get paid if they don’t.
Everyone involved in the business of giving financial advice to clients, whether solely incidental to the sale of a financial product or with a fiduciary duty of loyalty and care, have conflicts of interest. Yet, no one is in any of these roles or offers any of these products or services thinking that they’re hurting their clients when offering them. Everyone involved believes they’re a good person, providing a valuable service or product that can help their client or customer.
But the data simply doesn’t bear that out: in some cases, whether it be the fee for the service offered, or the commission paid to the sales representative, the advice wasn’t good, and it hurts their client or customer. The conflict of interest has gotten in the way of their professional judgment and caused harm to their client. The key distinction at the heart of the proposed rule regarding access to retirement advice is that anyone giving the advice, regardless of how they get paid, should be doing so as a fiduciary. Some professionals, the fee-only financial planners, and investment adviser representatives, already do so. The effect of such regulation is obvious: the rate of client complaints and disputes for those with only securities licenses and without sales licenses is substantially lower than those with such licenses, and the rate of complaints and disputes by clients of salespersons is several orders of magnitude greater (source).
The proposed rule for access to retirement advice by modifying the definition of an investment advice fiduciary directly serves to help protect consumers not just from deliberately malicious and unscrupulous salespeople, but provides some legal teeth to redress potential harms by even well-meaning professionals that simply let their conflicts of interest get in the way, where those teeth presently resemble far less effective gums.
And remember, no one identifies as a villain. No one providing compensation-conflicted advice is going to recognize that their advice is compensation-conflicted when they’re giving it. They may even go so far as to convince themselves that their compensation is actually less conflicted, and that even though they’re not held to a fiduciary standard, they would never do the wrong thing for their clients and customers. No one is doing any of this maliciously, but as the expression goes: “You will know them by their words and deeds.” If a professional, their business, or their lobbyists are militantly fighting being held to the same standards as more well-regulated professionals, believe them when they tell you who they are with their words and deeds, not by how charmingly or politely they convey their advice that you purchase products or services from them.
How do you protect yourself?
This rule is not presently in place. Moreover, even if the proposed rule takes effect, it is very likely that the same lobbyist groups that overturned the last DOL rule will spend millions of dollars to do so again. So not only are retirement savers not presently protected by wildly different legal standards based on who they work with, but it may be the case going forward that they remain unprotected or are only protected for a limited period of enforcement, pending the almost inevitable lawsuits to overturn the rule.
So, in the interest of protecting yourself, there are a couple of important activities you can undertake:
1) Militantly and explicitly ask for full written disclosure of fees or commissions that will be paid by you or by product companies for the sale of products you are sold. Do not accept verbal explanations or promises of future disclosure. Do not accept any advice or participate in any transaction without these written disclosures. Further, ask that the chief compliance officer of the firm you’re working with sign off on the disclosures, and finally, ensure that you get both a physical and digital copy sent to you.
2) Ask tough questions. Examples of tough questions are provided by Jason Zweig and the National Association of Personal Financial Advisors, among many others that are out there. Just google “questions to ask a financial advisor” and you’ll get hundreds of results.
3) Talk to multiple professionals before hiring one and get second opinions from other professionals. Compare the answers they’re giving you and be skeptical. And, sad to say it, but just because someone is your brother-in-law, cousin, or friend doesn’t mean that they’re free of conflicts of interest.
That said, this is the end of “the article.” There’s one more section you can read after this, but it’s for those of you who are curious about our model and how we think about our conflicts of interest, in light of having just spent a few thousand words telling you to be skeptical and careful.
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MY Wealth Planners® Conflicts of Interest
MY Wealth Planners offers four services with four distinct compensation models, all of which have conflicts of interest, and all of which are fully disclosed in our form ADV 2A filed with the State of Colorado and the Securities and Exchange Commission no less than annually and provided to all clients before agreeing to engage in our services or paying us. The four models are as follows, and we’ll discuss the conflicts therein:
- Comprehensive financial planning and investment management for an annual fee of 0.5% of net worth, calculated as a flat fee and billed in monthly increments in arrears. This arrangement has a $4,200 minimum annual fee and a minimum commitment of one year.
- Standalone investment management for a 1% annual fee, billed in monthly increments in arrears. This arrangement has no minimum but is reserved for specific cases where comprehensive financial planning isn’t appropriate, e.g., management of trust assets, management of small business retirement plan individual accounts, etc.
- Employee Compensation Consulting in two forms:
- 3(38) Fiduciary Services for ERISA retirement plans billed from 0.12% to 0.50% of asset balances, based on specific breakpoints.
- Project-based one-time fees for specific engagements for consulting outside of retirement plans for topics like employee salaries, bonus structures, and recruitment and retention programs.
Each of these models serves a specific type of client and has its own material conflicts of interest that we not only disclose to potential clients and clients but must be mindful of continuously over time as we continue to serve them.
Comprehensive Financial Planning and Investment Management: This service is suitable for the individual or family that wants to delegate elements of their finances on an ongoing basis and wants regular and consistent support throughout the year on the various elements of their finances. It’s not suitable for those with a very limited suite of financial questions or concerns, nor is it appropriate for those seeking a short-term financial engagement. Our choice of a net worth-based fee was made to assist in two areas: one, the scope of the service and the potential complexity of the client’s circumstances, and two, to mitigate conflicts of interest around how and where clients placed their money or made their investments. A net worth-based fee has allowed us to serve many clients who might otherwise be priced out of a higher flat fee service provider but also ensures that we are not underpricing the scope of service and work required to provide a comprehensive and ongoing financial planning service for clients of varying circumstances and means. Because of the nature of our service and compensation model, we regularly turn away clients for whom the minimum fee could represent more than 1% of their net worth or 2% of their income. While some people can be insistent that we work with them despite these limitations, we want to ensure that we are never harming our clients by charging them more than is reasonable for their resources and means.
Standalone Investment Management: This service is only appropriate in cases where comprehensive financial planning simply doesn’t make sense. The circumstances where this is suitable is for things like the management of a non-profit endowment, a family trust, or in limited instances where we assist small business owners in operating a company retirement such as a SEP IRA or a SIMPLE IRA, where charging a minimum annual fee of $4,200 per client (or employee, as the case would be) could be substantially more than even the regular contributions to such plans. We are so firm in our standard that we do not take clients on for standalone investment management in cases where comprehensive financial planning could and should apply, that we turned away several million dollars in new business in just the last year because some consumers are simply looking for an investment manager. There are some limited cases where legacy clients who came to us years prior to the decision to offer a comprehensive bundled financial planning and investment management service are presently on standalone investment management. In each of these cases, we assessed and notified them when we began offering the combined financial planning service whether it would increase or decrease their costs to adopt it, and ensured that we directed clients to say on the better-priced of the two options for their unique situation. Naturally, there is an obvious conflict of interest in cases where clients might pay more as comprehensive financial planning clients or as standalone investment management clients. However, we are very direct in ensuring that we only onboard clients into services that are materially in their best interest and refuse business in cases where we might be overcompensated while providing less service.
Employee Compensation Consulting: These services are limited to businesses only. In the case of the ERISA plan services, this is priced lower than net worth or standalone investment management fees because our role with this service is very different. Rather than advising clients on their comprehensive financial planning needs or performing delegated portfolio management, this service involves regularly reviewing and performing due diligence on retirement plan assets and advising the business’ management on the appropriate availability of investment options for their employees, along with providing counseling and guidance to participants in the plans on an as-needed basis. These plans are often startup 401(k) plans and can take literal years to reach a point where they’re profitable to serve, but we want to encourage people to save for retirement and build wealth, so while these are seldom “money makers”, we offer this service to all business-owning and managing clients for whom a business retirement plan is appropriate. In cases where business owners or managers need assistance in matters outside of ongoing investment due diligence and 3(38) fiduciary services, we offer a la carte projects to assist in the other dimensions of their employee compensation plans and quote a fixed one-time fee for these projects. Naturally, we have a conflict of interest in the recommendation of ERISA plans versus other retirement plans where our services as a 3(38) fiduciary might result in greater current or future income; we help mitigate this through a breakpoint schedule that steadily reduces the percentage of our fee as the plan grows in asset size. In cases where we’re asked to provide consulting on a project basis, the conflict is less about the fee we might charge than the scope of work performed. In those cases, we hold ourselves accountable for delivering by not asking for payment until the project is completed to the client’s satisfaction.
Conflicts unrelated to what we do but what we don’t do: As a fee-only service provider, we are not in the business of selling investment or insurance products or any other form of financial product. While this seems like the absence of a conflict of interest, I would argue that there’s a different conflict to address here: indifference. For all the faults of sales-based compensation and its conflicts of interest, there is an incentive to solve a problem with the application of one product or another. Consequently, we address the “indifference” conflict of interest by analyzing financial needs such as life insurance, tax preparation, or financing annually and offering to shop on our client’s behalf, ultimately either putting them in touch with the appropriate brokers or providers for their needs or identifying that they don’t have a need or can’t fulfill a need reasonably given their circumstances.