New Rule Would Crack Down on How Brokers Handle Retirement Savings

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Photographer: Ron Antonelli/Bloomberg

Brokers and insurance agents providing retirement-savings advice would have to put clients’ interests ahead of their own under an Obama administration plan that will face stiff opposition from Wall Street and Republican lawmakers.

The Labor Department proposal announced Tuesday is a win for Democrats and consumer advocates, and a setback for bankers who had angled for a standard to be set by the Securities and Exchange Commission, which oversees a broader range of investment activities. Adoption of a final rule could take six months or longer, according to RBC Capital Markets, providing plenty of time for congressional scrutiny and industry lobbying.

Under the plan, brokers would have a legal duty to put clients’ interests first, a shift that could reshape how they steer clients and collect fees, and potentially create winners and losers among mutual funds and other products. The changes would extend protections to the $7.4 trillion held in IRA accounts, a common vehicle for retirement savings that barely existed when the original rules were issued 40 years ago.

“This rule is intended to provide guardrails, but not straitjackets, so we know consumers are getting advice that is in their best interest,” Labor Secretary Thomas Perez told reporters on a conference call.

President Barack Obama endorsed Labor’s plan in February, putting new momentum behind the effort to revise rules that affect tens of millions of baby boomers nearing retirement age and workers who don’t have pension plans. It’s also backed by Senator Elizabeth Warren, the Massachusetts Democrat who has scolded banks over their treatment of consumers.

Lobbying Effort

Wall Street has spent more than four years lobbying against Labor’s effort. Led by banks such as Morgan Stanley and Wells Fargo Advisors, the industry has argued that costlier regulations could take away options for smaller investors.

Brokers won concessions, including a framework that would let them continue selling bonds out of their own inventory. Morgan Stanley questioned whether an earlier version of the plan, issued in 2010, would have barred such transactions.

Trade groups such as the Securities Industry and Financial Markets Association are expected to focus during the 75-day public comment period on the rule’s 250-page economic analysis, which outlines its costs and benefits.

“This is a voluminous rule where the fine print matters,” said Kenneth Bentsen, Sifma’s chief executive officer. “We want to ensure it protects investor choice and doesn’t unnecessarily reduce access to education or raise costs, particularly for low-and middle-income savers.”

Compliance Costs

Compliance costs for the industry would be $2.4 billion to $5.7 billion over 10 years, according to the Labor Department.

Shares of companies that offer 401(k) plans, including Principal Financial Group and Ameriprise Financial Inc., reversed losses Tuesday after the proposal was released.

Banks with large brokerage arms, including Bank of America Corp., Wells Fargo & Co., and UBS Group AG stand to be affected by the changes, according to RBC.

Brokers who pitch retirement plans to large employers may be exempt from the higher standards because the employers have experts who are obligated to look out for their workers’ best interest, according to a fact sheet distributed by the Labor Department. The exemption wouldn’t apply in cases where brokers sell 401(k) plans to smaller employers that lack the expertise to judge offerings, according to the fact sheet.

Sub-Par Advice

Perez has said that current rules allow brokers to get away with providing sub-par advice. The new protections would save investors $40 billion in avoided fees over 10 years, according to the Labor Department.

Instead of the current suitability standard -- a requirement that investments fit a client’s needs and risk tolerance -- brokers would have a fiduciary duty to recommend products that are in the best interest of customers.

Brokers could earn sales commissions and other fees that create conflicts of interest if they sign a “best-interest” contract with investors, Perez said. The contract would have to disclose fees or other incentives that might influence recommendations, he said.

IRA account holders would have a new right to sue financial advisers who don’t adhere to the best-interest standard, the Labor Department said.

The ability to sue advisers creates a “class-action right” that “will have a huge chilling effect on the willingness of people to be in this business,” said Kent Mason, a partner at Davis & Harman LLP who represents industry clients fighting the rule.

The proposed changes would cover the roughly $11 trillion held in 401(k) plans and IRAs. Labor’s existing rules don’t cover rollovers from 401(k)s to IRAs, which can result in higher fees for investors and the need to sell assets, according to regulators.

‘Attractive Targets’

“This is the single most important financial decision many people will ever make, and it’s a point when investors become attractive targets for sometimes predatory practices,” said Barbara Roper, director of investor protection for the Consumer Federation of America. “So covering rollovers was a must for us.”

Sweeping criticism from brokerage firms and lawmakers including Democratic stalwarts such as Barney Frank led the Labor Department to scrap an earlier draft of the rule in 2011. Leading House Democrats say the agency’s new effort is better.

“I applaud the DOL for today proposing to close the loopholes and gaps in our current regulatory structure, and for addressing concerns I and many of my colleagues had with the prior proposal’s impact on low-income and minority retirees,” said Representative Maxine Waters, a California Democrat.

The brokerage industry would prefer that the SEC devise the fiduciary rules, fearing that the Labor Department’s version would make it impossible to charge commissions.

SEC Chair Mary Jo White said last month that she favors imposing a fiduciary standard on all types of retail-investment transactions. The SEC is far behind the Labor Department’s progress, however, and White warned the effort would be complex.

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