Five years ago, the Obama administration proposed a regulation to force brokers to prioritize clients’ best interests when counseling them on investments. The idea behind the so-called fiduciary rule was to reduce hidden conflicts of interest that can incentivize commission-based brokers to steer clients into investments that generate higher fees for financial firms but worse returns for customers.
When Donald Trump took office, he and Republican lawmakers helped the financial industry block the rule from being implemented. And now new research shows exactly why they wanted to kill it: It was doing too good a job of preventing Americans from being fleeced.
Rampant Conflicts of Interest That Harm Savers
The new study by Harvard and New York University researchers examined sales of variable annuities, which regulators have said are among the investments that receive the most consumer complaints. The researchers looked at whether the market for those products changed after the rule began moving forward and the industry began taking steps to deal with it.
Here are the three key finding from the report, which was published by the National Bureau of Economic Research:
1. Financial conflicts of interest are real: “While investor incentives matter, broker incentives play a more important role in determining sales. Moreover, brokers’ incentives conflict with their clients’: Brokers earn higher commissions for selling inferior annuities that have higher expenses, as well as fewer and worse-performing investment options...brokerage firms that sell higher-expense products have higher rates of customer complaints and regulatory offenses.”
2. Conflicts of interest steer customers into sketchier investments: “Variable annuities have been criticized for having high expenses and are the commonly cited financial product in brokerage customer complaints...A one standard deviation increase in brokerage commissions is associated with a 17 percent increase in variable annuities.”
2. The fiduciary rule was actually working to stop this: “In response to the proposal of the rule, brokers began complying with the rule by placing greater weight on investor interests…The rule helped reduce conflicts of interest. In response to the rule, annuity sales flows became twice as sensitive to expenses and the sale of high-expense annuities fell by 52 percent. Moreover, the relative availability of high-expense products declined following the rule...the proposed rule change increased the risk-adjusted returns of investors by up to 86 basis points per annum.”
So, to reiterate: parts of the financial industry are plagued by hidden conflicts of interest that can end up pushing customers into investments that are good for the finance industry but bad for the customers — and a new rule actually started having some success in addressing the problem.
This Is Why Wall Street Worked So Hard to Kill The Fiduciary Rule
Now we see exactly why Wall Street and its front groups spent millions to block the fiduciary rule. It wasn’t about the new regulation being too complex and burdensome, and it wasn’t because they actually cared about mom and pop investors, as they insisted with a straight face.
The data suggest that the opposition was really all about profits: financial firms didn’t want their lucrative scheme to end -- and so they convinced Trump to eviscerate the rule the moment he took office.
Of course, Trump appointees tell a different tale: they would have us believe that the administration has been replacing the fiduciary rule with other regulations that better protect workers’ and retirees’ savings. But the new initiatives at both the Labor Department and Securities and Exchange Commission seem primarily designed to protect the financial industry’s power to preserve the conflicts of interest that perpetuate the grift.
“It is hardly surprising that the Labor Department under Secretary Eugene Scalia has proposed a new advice rule that is designed to benefit the same financial firms who once kept Secretary Scalia busy challenging rules they found too worker- or investor-friendly,” wrote the Consumer Federation of America’s Barbara Roper, referring to Scalia’s previous work for Wall Street firms. “But appearances must be maintained, so the Department is now out selling its proposal as benefiting the very workers it puts at risk...It reinstates a 1975 regulatory definition of fiduciary investment advice that is so rife with loopholes that financial firms can rest assured that they will only be regulated as fiduciaries when they choose to be (and they don’t often choose to be).”
The 2020 Democratic platform says the party will try to throw out Trump’s initiatives and reinstate the Obama fiduciary rule, but it is important to understand the context of GOP’s effort to eviscerate that rule.
This isn’t happenstance and it isn’t some one-off move — the Republican initiative is a key pillar of a larger plan to create an architecture of legalized theft. That plan is being hatched at precisely the moment the Trump administration is also aiming to allow financial managers to funnel workers’ and retirees’ savings to the private equity industry, as that industry bankrolls Republicans’ 2020 campaigns.
SEC regulators recently noted that private equity is plagued by rampant conflicts of interest and rapacious fees — and now that the Obama-era fiduciary rule is dead, Wall Street is free to make those conflicts of interest and fees even worse.
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