Better Markets’ Steve Hall at a U.S. Department of Labor public hearing on proposed rules to protect the retirement savings of millions of Americans. You can learn more about the event here.

You can learn more about our views on these important proposals here.

The video and text of Hall’s remarks are below:

Good morning.  My name is Stephen Hall and I’m the Legal Director and Securities Specialist for Better Markets.  Better Markets is an independent, non-profit organization that advocates for reforms that make our financial markets more stable and more equitable for all Americans seeking to build a better financial future.  We appreciate the opportunity to testify at this important hearing.

We strongly support the DOLs collection of proposed rules and we commend the DOL for taking action to better protect retirement savers from the powerful conflicts of interest among financial advisers that inflict real harm.  We offer three main points in our testimony:

First, adviser conflicts of interest continue to take a huge toll on the financial resources and the quality of life that millions of American workers can sustain in retirement. The damage is on the order of tens of billions of dollars a year.

Second, the DOL proposals, and in particular the updated definition of an investment advice fiduciary, are absolutely necessary to mitigate the harmful impact of conflicted investment advice.  The current definition is nearly 50 years old and it still contains huge loopholes that allow advisers to avoid their fiduciary duties and to place their own interests ahead of their clients’ best interest.   The DOL’s proposed rule would close those gaps.

Third, there are no persuasive arguments being advanced in opposition to the proposals.  For example, contrary to what some opponents claim, neither the SEC’s Regulation Best Interest nor the state insurance regulations are adequate substitutes for the safeguards in ERISA.  In addition, retirement savers with small nest eggs will not lose access to advice once these important rules are in place.  Finally, disclosures alone cannot adequately protect retirement savers.

Now I’ll turn to the harm that conflicted investment advice continues to inflict on retirement savers.

For decades, advisers of many stripes have been allowed to foist investment products, trading strategies, and account types onto retirement investors which cost too much, pose excessive risks, lock up savings in illiquid investments, and provide meager returns.  The advisers increase their profits, win bonuses, or receive lavish non-cash rewards while investors’ retirement savings are eaten away.  This practice inflicts enormous harm on investors, and it is especially acute with respect to rollover transactions.  Those are pivotal moments for retirees, when their entire life savings are often at the mercy of an adviser who may not have the investor’s best interest at heart.  Overall, numerous studies show that adviser conflicts of interest cost tens of billions of dollars a year in lost retirement savings, and these estimates are conservative, as they examine the corrosive impact of conflicts of interest only in relation to certain types of accounts and certain types of investments in those accounts.

This pattern of behavior is uniquely harmful, predatory, and fundamentally at odds with what Congress said and intended in ERISA.  After all, the statute categorically bars advisers from acting on their conflicts of interest or engaging in self-dealing of any kind, subject only to exemptions the DOL is authorized to create.

Yet since 1975, the rule defining investment advice fiduciaries has included huge loopholes that have allowed advisers to avoid the duties imposed by ERISA.  For example, the rule requires that advice be given on a regular basis, thus carving out many rollover recommendations, no matter how much money is at stake.  Second, the rule provides that advice must be rendered pursuant to a mutual agreement or understanding that the advice will serve as a primary basis for the client’s investment decision. Advisers have often exploited this senseless requirement by disavowing it in fine-print contracts, thus avoiding the obligations that ERISA would otherwise impose.  Neither of these elements in the current five-part test is found anywhere in ERISA, which defines a fiduciary simply and broadly as a person who “renders investment advice for a fee or other compensation.”

Now I’ll turn to the proposed reforms.  First and most important is the amended definition of an investment advice fiduciary.  Critically, it closes the regular basis and primary basis loopholes in the 1975 rule, ensuring, for example, that rollover recommendations and advice to plan sponsors will be covered by ERISA.  The amended definition is appropriately broad and protective.  For example, it defines the “compensation” and “recommendation” elements expansively, it expressly negates the impact of evasive disclaimers, and it contains no carve-outs for supposedly sophisticated investors.

At the same time, the proposal incorporates reasonable limits.  For example, in an accommodation to the Fifth Circuit’s 2018 opinion, it applies only where it is reasonable to conclude that the advice is individualized and that the investor may trust and rely upon that advice. Moreover, it leaves all business models intact, including commission-based sales. And the DOL has sought to harmonize the elements of the definition with the provisions in the SEC’s Reg BI and the standards under the Investment Advisers Act, all with an eye to minimizing compliance costs.

The proposal also makes beneficial adjustments to the prohibited transaction exemptions, or PTEs.  I’ll note that with respect to PTE 2020-02, we have previously expressed concerns that in its 2020 iteration, it did not actually go far enough to protect retirement savers.  We will continue to consider those issues as we comment on the proposal.  However, it is clear to us that in conjunction with the new definitional rule, PTE 2020-02 will do an enormous amount to safeguard retirement savers from adviser conflicts of interest.

Finally, I’ll briefly address some of the most common arguments in opposition to these reforms.  None of them are persuasive.

First, contrary to some claims, there is no other regulatory regime that adequately protects retirement savers from conflicted investment advice.  The SEC’s Reg BI only applies to recommendations regarding securities.  Yet retirement savers are often advised to purchase a wide array of non-securities products, including fixed indexed annuities, real estate, cryptocurrencies, precious metals, CDs, and derivatives such as futures and options.  In addition, Reg BI only applies to individual retail customers.  That means, for example, that advice to an employer seeking to create a menu of high-quality investment options for their employees remains vulnerable to conflicted investment advice under Reg BI.

Nor can state insurance regulation come close to filling the current regulatory gaps in the DOL rules.  The model regulation governing annuity transactions adopted by the National Association of Insurance Commissioners is a “best interest” standard in name only. It nowhere prohibits producers or insurers from placing their interests ahead of their customer’s interests.  Instead, it feebly provides that an insurance producer “has met” their best interest obligation if they simply have “a reasonable basis to believe the recommended option effectively addresses the consumer’s financial situation and insurance needs.”  In addition, the NAIC Model Rule remarkably excludes both cash and non-cash compensation from its definition of “material conflict of interest,” even though such forms of compensation obviously create the most intense conflicts of interest.  Moreover, like Reg BI, the NAIC Model Rule does not cover advice to plan sponsors.

Second, small account savers won’t lose access to advice. Claims to the contrary are scare tactics that find no credible support in theory or in practice.  In the first instance, the proposal is designed to leave current advisory models intact, from fee-based to commission-based accounts.  Firms of all types are essentially free to continue operating as they have been, provided they act in their clients’ best interest when dispensing advice.

Experience in the investment advice marketplace also belies fears about loss of access. Many financial professionals, including the certified financial planners, already successfully operate under a fiduciary standard while serving clients all along the income spectrum. In addition, the proposal broadly aligns with the SEC’s Reg. BI, and there is no evidence that it has reduced small savers’ access to investment recommendations. And in those states where broker-dealers are subject to a fiduciary duty under state law, no evidence has emerged that lower income retirement savers have been denied access to quality advice.  Far from harming small savers, the proposal would provide them with important protections, as they are most vulnerable to the losses attributable to adviser conflicts of interest.

Third and finally, while disclosure is an important element of any investor protection regime, it cannot by itself adequately protect investors against abuses by financial professionals.  Based on experience and expert studies, we know that disclosure is subject to numerous failings.  Often, investors don’t read them, don’t receive them in a timely fashion, or don’t understand them.  Even when effective disclosures are imparted, investors often remain uncertain about what course of action to take in light of the disclosures.  Moreover, disclosures can readily be overridden by assurances from advisers that the disclosures are merely technical boilerplate.  Above all, it is clear that reliance on disclosure is not what Congress intended in ERISA, which imposes the most stringent affirmative obligations and restrictions on those who provide investment recommendations to retirement savers.

That concludes my testimony, and I look forward to questions.