By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends much of her time in Asia and is currently working on a book about textile artisans.
The Wall Street Journal reported last week in Who Is Winning With the Fiduciary Rule? Wall Street that the fiercely-resisted fiduciary rule has proven to be a boon thus far to Wall Street– contrary to the idea that its implementation would spell the end of Western civilisation as we know it:
The brokerage business fiercely fought the new retirement advice rule. But so far for Wall Street, it has been a gift.
The rule requires brokers to act in the best interests of retirement savers, rather than sell products that are merely suitable but could make brokers more money. Financial firms decried the restriction, which began to take effect in June, as limiting consumer choice while raising their compliance costs and potential liability.
But adherence is proving a positive. Firms are pushing customers toward accounts that charge an annual fee on their assets, rather than commissions which can violate the rule, and such fee-based accounts have long been more lucrative for the industry. In earnings calls, executives are citing the Department of Labor rule, known varyingly as the DOL or fiduciary rule, as a boon.
Now, taking my tongue out of my cheek for a moment. As I’ve written before, it’s no surprise that implementation of the fiduciary rule had more or less proceeded as planned– despite Trumpian sturm und drang to the contrary– given that Wall Street firms had taken steps necessary to comply given the rule’s planned implementation date before Trump was elected as President (as I wrote in this February post, Fourth Federal District Court Looks Likely to Uphold Fiduciary Rule). Notwithstanding Trump’s February memorandum directing the Department of Labour to revisit the rule–especially given the dubious legal significance of that action– firms were not going to roll back these arrangements.
Yet now it turns out that the new rule actually helps, rather than hurts, the bottom line of financial firms. Well, strike me pink and call me Rosy, as my high school English teacher, Mr. Gordon Muir, was known to say. According to the WSJ:
Primarily because of DOL and market appreciation, assets are growing in fee-based accounts, said Stifel Financial Corp. Chief Executive Ronald Kruszewski, on a call in July. In an interview, he said such accounts can be twice as costly for clients.
For some consumers, a fee-based account could make economic sense. Such accounts can also come with more services, and they theoretically align a broker’s interest with that of the client. Some customers are negotiating discounts on the fees they pay, and some are moving to lower-cost firms, data suggests and industry executives say.
“Whether it’s in clients’ best interest is unclear,” said Steven Chubak, an analyst at Nomura Instinet. But the fiduciary rule is ”incentivizing firms to accelerate conversions“ to fees from commissions, he said, and “certainly the amount charged on a fee-based account versus a [commission-based] brokerage account is higher.” The push is speeding up an industry trend toward fees, which offer more predictable revenue than commission-based accounts.
If it Helps Wall Street, Does that Mean that It Hurts the Retail Investors It allegedly Promulgated to Protect?
Given the WSJ’s reporting– which I have no reason to doubt per se, the obvious thought arose: if this helps Wall Street, doesn’t that come at the expense of account holders.
To which I have three responses.
First, we have no good idea what the actual cost or benefit of the current rule is to account holders. There were some estimates bandied about by the previous administration– the most widely cited being that the previous system cost investors 1% in returns or about 17 billion dollars in total per year. I’d like to see some better figures here. And given that the rule only took effect in June, and only partially– with the Labor Department now proposing to push off full implementation until January 2019– I wouldn’t be surprised that the evidence might be highly inconclusive.
Second, let’s suppose that the WSJ is correct– and that financial firms are even now reaping higher returns from their new, fee-based compensation than under the previous commission-based system. Is that necessarily bad?
Well, I would say, no, not necessarily– because under the previous system, firms had huge incentives– based on the expected commissions they would earn– to steer investors into at minimum unsuitable and in the worst case, outright dodgy investments. Even if investors are paying nominally higher fees to for their brokerage accounts, overall, they might be better off when the full cost of being directed to loser investments is considered. In other words, under the previous system, they may have paid Wall Street less for the privilege of investing, but overall, lost more on loser investments to which they were directed under the previous commission-based system. The fees/commissions paid may only have been a minor percentage of total losses.
And, I’d like to make a third point. It seems to me that a fee-based system is more transparent, and makes it easier for investors to shop around– and shift their business to other brokerages– if their present arrangements seems to be unduly expensive. So, that if even at the moment– after less than a couple of months of the new rule being partially in place– the still-developing fee-based system has investors shelling out more in fees, as this system is fully implemented, that won’t necessarily be the case (assuming that the Labor Department doesn’t gut the rule entirely– more on that below).
What Comes Next?
Does this mean the fiduciary rule is here to stay? Well, not so fast. The WSj also reported last week in Labor Department Seeks 18-Month Delay in Fiduciary Rule:
The Labor Department is proposing to delay the fiduciary rule’s compliance deadline by 18 months, a move that experts say suggests the retirement-savings rule will emerge from a re-evaluation with significant revisions.
The agency, which has been reassessing the Obama-era rule’s economic impact, said Wednesday in a court document that it submitted a proposal to push the Jan. 1, 2018, compliance date to July 1, 2019. The document, filed as part of a lawsuit in the U.S. District Court for the District of Minnesota, also says the Labor Department is considering loosening restrictions on the types of transactions that are prohibited under the rule, including insurance products and rollovers of individual retirement accounts.
The fiduciary rule “is likely here to stay, but its impact could be significantly reduced over the next few years if exemptions from the rule are significantly expanded,” said Jamie Hopkins, a professor at the American College of Financial Services.
The details on what the Labor Department will do are vague, according to the New York Times in Labor Dept. Seeks Delay of Consumer Protection Rule for Financial Advisers. For the moment, the Labor Department is not expected to tamper with the basic standard that brokerages are expected to follow in their handling of client accounts. But over the longer run, reconsideration of other elements appear again to be in play, such as the rule’s legal liability standards, which allow consumers to sue investment advisers and the financial firms with which consumers hold their retirement accounts for breach of the new fiduciary standards. As I discussed in this earlier post, Goodbye Fiduciary Rule? Department of Labor Delays Implementation Until June. the Trump administration has proven to be an assiduous opponent of expanding legal liability, and I see no reason for an exception to be made here.
What I fear may happen is that the Labor Department will now act to neuter elements of the rule that are not business-friendly. But that’s only an intuition on my part, and it will be necessary to wait and see just what the agency comes up with in this regard.