Holding financial advisers accountable
Dana Muir, the Arthur F. Thurnau Professor of Business Law at the University of Michigan’s Ross School of Business and a noted pensions and retirement funds expert, sheds light on a renewed effort by the U.S. Department of Labor to hold financial advisers more accountable to their clients.
Q: Can investors generally trust their brokers and financial advisers?
Muir: Brokers and many advisers, entrusted with clients’ financial assets, are allowed, like most other businesses, to make recommendations that pay them—not their clients—the most. It is legal for them to recommend an investment that gives them a higher commission or other kind of payment rather than an investment that would be better for their client. That is an undisputed conflict of interest.
People think of those who provide them with investment advice as professionals, similar to doctors and lawyers. So investors expect their advisers to provide advice based on what is best for them as investors. Most people never realize that is not necessarily the kind of advice they receive.
Q: What are these conflicts of interest costing us?
Muir: Direct comparisons are not in the interest of many in the financial services industry. The more complex-sounding the products and terms, the less likely clients can check the long-term price tags. Some research, however, indicates that investors who receive conflicted advice have investment returns that are about 1 percent per year lower than they otherwise would have been. For example, instead of earning 6 percent annually, the investment will earn 5 percent.
My primary interest as someone who focuses on the effectiveness of programs to save for retirement is the effect of these conflicts of interest on the assets in those programs. One recent estimate puts losses due to conflicts of interest at approximately $17 billion a year—and that only includes the losses in mutual funds held in IRAs. It excludes other types of IRA assets, all 401(k) assets and all other kinds of pension plan assets. In short, conflicted advice is costing workers many billions of dollars per year in retirement savings.
Q: What can be done to fix this problem?
Muir: The problem is not financial advisers—at least not all of them. Many excellent advisers do put their clients’ interests first. The problem is the current law. Complex rules make it difficult for clients to differentiate between the various types of advisers and when those advisers are permitted to put their interests first. The good news: the Department of Labor has reproposed rules that would eliminate many of the conflicts of interest when advice is given on assets held in retirement accounts such as 401(k)s and IRAs.
After the DOL first proposed rules on this topic in 2010, portions of the financial services industry mobilized their political power and tremendous financial resources to fight the changes, eventually causing the DOL to withdraw its proposal in 2011. In its revised rules, the DOL has addressed legitimate concerns that were raised about the 2010 proposal. The ideal of those rules, though, remains the same: to reduce the conflicts of interest that provide incentives for those providing investment advice to benefit themselves at significant cost to their clients.
Q. If these rules are finalized, won’t that increase the costs of providing financial advice? And won’t that in turn decrease the ability of investors—particularly small investors—to get advice?
Muir: Yes, there will be costs to advisers to comply with the new rules and potentially costly litigation or other enforcement against advisers who continue to put their best interests before those of their clients who are saving for retirement. But, the compliance costs will be far less than increased investment returns to retirement savers.
As of the end of 2014, Americans held $7.5 trillion in IRAs alone. Assets in all types of public and private retirement plans totaled nearly $25 trillion. The size of the market for advice on retirement investing provides plenty of incentive for advisers to find cost-efficient ways to provide impartial advice in their clients’ best interest. Americans investing for their retirement deserve nothing less.
Contact Dana Muir: 734-763-3091, firstname.lastname@example.org. Bio: myumi.ch/JmnA3