October 25, 2015
Wagner vs. Obama: Are investors being soaked?
St. Louis Post-Dispatch, by Jim Gallagher
The Labor Department rule would turn advisers — read stock, bond and insurance brokers — into “fiduciaries” when they give advice on retirement accounts. That means they must place their clients’ interest above their own when advising people on 401(k)s, IRAs and the like. Many clients expect their advisers to do that anyway. But legally, most don’t have to. … A fact about the investment advice business: Conflicts of interest are rife. Investments that are best for the client don’t always bring the biggest payoffs for brokers or their bosses. This can put good advisers in an ethical pickle: They want to do right by their clients, but financial forces tempt them toward the dark side. For instance, a broker selling stock on commission makes money when you trade a lot, but that is rarely good strategy. A broker might make a 4 percent commission on putting you in load mutual funds. But there’s often a 7 percent commission on choosing a deferred annuity or 10 percent on non-traded real estate investment trusts. Many of these conflicts, such as that annuity commission, are invisible to the client. Brokerages often sell bonds out of their own portfolio. So, the brokerage makes more profit if you pay a high price for the bond. Mutual fund companies often pay brokerages extra if they put a lot of clients’ money in their funds. The system gives the broker an incentive to sell the funds that pay the brokerages. The money for these payouts comes out of the fund investor’s hide. Some brokers are urged to beat the drums for their own company’s branded mutual funds, because the brokerage makes money managing them. Some conflicts are visible if the client knows where to look. For instance, funds sold by brokers usually have higher expenses than no-load funds that clients could buy on their own. But clients don’t know where to look. They come to advisers because they don’t understand investing. Under the law, most brokers aren’t required to give clients their best advice. Their recommendations must only be “suitable.” A broker can’t put a 90-year-old life’s savings into a couple of high-risk stocks. That’s not suitable. But he can recommend a mutual fund that pays a fat commission, knowing that a cheaper choice would be best for the client. Along comes the Labor Department with a proposal to solve that. It would make brokers fiduciaries, and give them two ways to get paid when dealing with retirement accounts. They can charge investors a fee for advice and forsake the conflicts of interest. Or, they can keep the current commission model, with all the conflicts, but sign a contract with their clients promising to put the client first. Brokers would have to tell clients what they’re actually paying — exposing those behind-the-scenes payouts. They’ll have to set up websites showing how each investment product compensates the brokerage.
Read full St. Louis Post-Dispatch article by Jim Gallagher here.