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Firms May Drop Millions of IRA Savers on Rule, Sifma Says

Phyllis Borzi, Assist. Secretary of Labor, U.S.
Phyllis Borzi, the U.S. Assistant Secretary of Labor, in an undated photo provided to Bloomberg News by the U.S. Dept. of Labor in March, 2010.

Brokerage firms may drop millions of individual retirement account holders if a proposed U.S. Labor Department rule takes effect, a lobbying group said today.

The Labor Department wants to expand the scope of fiduciary responsibility to protect those saving for retirement from conflicts of interest, such as recommending investments with higher fees. The rule would require investment professionals who advise employers and workers with retirement savings plans such as 401(k)s or IRAs to act in the best interest of their clients.

The change may cause financial firms to offer fewer investment options in retirement accounts and shift to a fee-based model used by investment advisers, which will raise costs, Kenneth Bentsen, executive vice president for public policy and advocacy at the Securities Industry and Financial Markets Association, said at a Washington hearing before the House Subcommittee on Health, Employment, Labor and Pensions.

“Most firms require a minimum account balance for advisory accounts that could result in millions of IRA account holders being dropped,” Bentsen said in written testimony. There are more than 7 million IRA accounts with balances under $25,000 that are commission-based, according to Sifma, a lobbying group for banks and brokerages. The rule may force a number of small account holders “to go looking for services somewhere else and at a higher cost,” Bentsen said at the hearing.

“The broker concern is perhaps due to misunderstanding,” Assistant Secretary of Labor Phyllis Borzi said at the hearing. “We’re not intending to overturn a commission-based system.”

Exemptions Exist

Exemptions already exist in Labor Department rules that would allow brokers to continue to provide securities, mutual funds and annuities to IRA owners, Borzi said. “We’re very concerned about closing off advice to small investors.”

Employers generally are held responsible for making sure their retirement plans operate in the best interest of employees. The proposed Labor Department regulation would apply a fiduciary standard to firms that advise plan sponsors and investors about investments even if they don’t give that advice regularly.

“It’s not about raising the standard, it’s about turning off whole lines of business,” Jim McCarthy, managing director of wealth advisory solutions at Morgan Stanley Smith Barney in Purchase, New York, said in a telephone interview.

If firms are considered fiduciaries by the Labor Department, selling investors bonds from a brokerage’s inventory or recommending a trade that would generate a commission may be considered a conflict of interest and a “prohibited transaction,” said McCarthy. Morgan Stanley Smith Barney manages about $430 billion in retirement assets, he said.

No Exaggeration

“I think the industry is not exaggerating when they say they will abandon this business,” Barbara Roper, director of investor protection for the Consumer Federation of America in Washington, said in a telephone interview.

Improved regulation of retirement plans is needed because employers and participants may not understand that the person educating them about their investments may have a financial stake in the choices they make, the U.S. Government Accountability Office said in a report released in February.

U.S. retirement assets totaled $18 trillion as of March 31, according to the Investment Company Institute in Washington. Savings in IRAs were $4.9 trillion at the end of the first quarter, while assets in 401(k)-type plans were $4.7 trillion, ICI data show.

Selling Product

The Labor Department should clarify which actions would be exempted and wouldn’t trigger prohibited transaction penalties, said Roper of the Consumer Federation. The agency also should close a loophole in the regulation that “you could drive a truck through,” which exempts investment professionals who only sell a product, Roper said.

Investment professionals who are only selling products rather than giving advice won’t be considered fiduciaries, Borzi said.

“They are putting their entire rule at risk in their rush to finalize this,” Roper said. The Labor Department has said it plans to make the rule final by the end of this year.

“We’re not rushing ahead,” Borzi said at today’s hearing. “It’s more important for us to get it right rather than meet that regulatory agenda.”

Slow Down

“Everyone wants them to take the foot off the gas,” Representative Phil Roe, a Tennessee Republican and chairman of the subcommittee, said after the hearing. The industry won’t move forward because they don’t know what the final rules will be including which transactions would be exempted, Roe said.

As part of the Dodd-Frank financial-services overhaul law enacted last July, Congress asked the Securities and Exchange Commission to study existing standards for registered investment advisers and broker-dealers. In January, the SEC recommended a common standard for those who provide personalized investment advice.

The agencies are working together to make sure the final rules don’t conflict, Borzi said at the hearing.

The Labor Department rule also may apply to advice given to savers when they are leaving a job and trying to decide whether to roll their money into IRAs. Fees on IRAs typically are 25 basis points to 30 basis points higher than fees on 401(k)s, and can be as much as 65 basis points higher, the GAO study said. A basis point is 0.01 percentage point.

Worker Responsibility

The shift by employers to 401(k)s from traditional pension plans has meant that workers have more responsibility for how they invest their retirement savings, said Norman Stein, who testified on behalf of the Pension Rights Center, a consumer advocacy group in Washington. Savers are “highly dependent” on the advice they receive, which may be subject to conflicts of interest, said Stein, who is a professor of law at the Earle Mack School of Law at Drexel University in Philadelphia.

“Some investment advisers receive revenue-sharing and other payments from the vendors of the products they recommend,” he said.

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