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Protecting retirement savers: The Department of Labor’s proposed conflict of interest rule

Martin Neil Baily and Sarah E. Holmes

Financial advisors offer their clients many advantages, such as setting reasonable savings goals, avoiding fraudulent investments and mistakes like buying high and selling low, and determining the right level of risk for a particular household. However, these same advisors are often incentivized to choose funds that increase their own financial rewards, and the nature and amount of the fees received by advisors may not be transparent to their clients, and small-scale savers may not be able to access affordable advice at all.  What is in the best interest of an individual may not be in the best interest of his or her financial advisor.

To combat this problem, the Department of Labor (DoL) recently proposed a regulation designed to increase consumer protection by treating some investment advisors as fiduciaries under ERISA and the 1986 Internal Revenue Code.  The proposed conflict of interest rule is an important step in the right direction to increasing consumer protections.  It addresses evidence from a February 2015 report by the Council of Economic Advisers suggesting that consumers often receive poor recommendations from their financial advisors and that as a result their investment returns on IRAs are about 1 percentage point lower each year.   Naturally, the proposal is not without its controversies and it has already attracted at least 775 public comments, including one from us .

For us, the DoL’s proposed rule is a significant step in the right direction towards increased consumer protection and retirement security.  It is important to make sure that retirement advisors face the right incentives and place customer interests first.  It is also important make sure savers can access good advice so they can make sound decisions and avoid costly mistakes.  However, some thoughtful revisions are needed to ensure the rule offers a net benefit. 

If the rule causes advisors’ compliance costs to rise, they may abandon clients with small-scale savings, since these clients will no longer be profitable for them.  If these small-scale savers are crowded out of the financial advice market, we might see the retirement savings gap widen.  Therefore we encourage the DoL to consider ways to minimize or manage these costs, perhaps by incentivizing advisors to continue guiding these types of clients.  We also worry that the proposed rule does not adequately clarify the difference between education and advice, and encourage the DoL to close any potential loopholes by standardizing the general educational information that advisors can share without triggering fiduciary responsibility (which DoL is trying to do).  Finally, the proposed rule could encourage some advisors to become excessively risk averse in an overzealous attempt to avoid litigation or other negative consequences.  Extreme risk aversion could decrease market returns for investors and the ‘value-add’ of professional advisors, so we suggest the DoL think carefully about discouraging conflicted advice without also discouraging healthy risk.

The proposed rule addresses an important problem, but in its current form it may open the door to some undesirable or problematic outcomes.  We explore these issues in further detail in our recent paper.

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