Debevoise fiduciary duty regulatory memo to fsr 17 february 2015

February 17, 2015

MEMORANDUM CONCERNING EXPECTED DEPARTMENT OF LABOR CONFLICT OF INTEREST RULE

KEY POINTS 1.

The interests of retirement savers are served by enhancing access to professional retirement planning and guidance at an affordable price rather than imposing barriers to access.

2.

Americans currently have choices about how to work with a financial professional. These choices have increased workers’ confidence and retirement savings.

3.

Any change to the current rules under ERISA that would limit access to professional retirement planning, guidance and investment products would potentially reduce workers’ overall level of retirement savings.

4.

Experience in the United Kingdom and Australia does not support adoption of similar regulations in the United States.

TABLE OF CONTENTS Page Executive Summary ............................................................................................................ 3 Introduction......................................................................................................................... 4 I.

Any change to current rules under ERISA that would limit access to professional retirement planning and guidance for those who need it most would potentially reduce American workers’ overall level of retirement savings..................................................................................................................... 8

II.

The impact of ongoing asset-based fees could impede efforts by low- and moderate-income workers to save for retirement. .................................................. 9

III.

Consumer protections and education initiatives for investment advice in the retail and small plan markets adequately protect investors and plan sponsors without putting beneficial investment options out of reach................... 11

IV.

Experience in the United Kingdom and Australia does not support adoption of similar regulations in the United States............................................. 14 A. B.

United Kingdom........................................................................................ 14 Australia.................................................................................................... 15

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EXECUTIVE SUMMARY

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Any change to current rules under ERISA that would limit access to professional retirement planning and guidance for those who need it most would potentially reduce American workers’ overall level of retirement savings.

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The impact of ongoing asset-based fees could impede efforts by lowand moderate-income workers to save for retirement.

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The field of professional investment advice is already a highlyregulated industry.

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Expansive new rules under ERISA could disrupt the carefully considered regulatory regime applicable to broker-dealers and investment advisers, and also negatively impact areas of the financial services industry that the rules are not intended to target.

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Experience in the United Kingdom and Australia does not support adoption of similar regulations in the United States.

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INTRODUCTION The United States Department of Labor (“DOL”) is expected to propose amendments to the definition of “investment advice”1 in an effort to expand the class of financial professionals subject to fiduciary duties covered by the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and Section 4975 of the Internal Revenue Code of 1986, as amended (the “Code”), and thereby curb the effects of perceived conflict of interest transactions in the marketing and development of retirement investments.2 In support of this proposal, certain proponents of such expansive new rules under ERISA claim that (i) consumer protections for investment advice in the retail and small plan markets are inadequate, and (ii) the current regulatory environment creates perverse incentives that ultimately cost retirement savers billions of dollars a year.3 In reaching these conclusions, proponents of these expansive rules rely on outdated academic studies, as well as the experience of other nations that have adopted financial services legislation or regulations that seek to regulate conflicts of interest.

However, proponents of expansive new rules under ERISA fail to address two likely negative outcomes of any change to the current rules. First, a large proportion of individual investors, especially low- and moderate-income or low- and moderate-wealth individuals, seek the advice of financial professionals for the intangible benefits of professional guidance. These intangibles include encouragement to plan and save for retirement and the development of financial literacy. These individuals generally do not have the knowledge necessary to navigate the many complex investment options available, nor the time and proclivity to acquire such knowledge. These individuals are 1

29 C.F.R. § 2510.3-21(c) (2014).

2

Sarah N. Lynch, U.S. Labor Department offers glimpse into new fiduciary plan, Reuters (Mar. 12, 2014), available at http://www.reuters.com/article/2014/03/12/labor-fiduciaryidUSL2N0M911P20140312; Julian Hattem, GOP, Dems attack Obama regulation, THE HILL (June 22, 2013), available at http://thehill.com/regulation/administration/307177-obama-regulation-attractsgop-dem-critics; Aaron Lucchetti, Delay on Pension Oversight, THE WALL STREET JOURNAL (Sept.

20, 2011), available at http://www.wsj.com/articles/SB10001424053111904194604576580701406432990.

3

Kevin Cirilli, White House readies crackdown on financial advisers, THE HILL (Jan. 22, 2015), available at http://thehill.com/policy/finance/230457-white-house-readies-crackdown-on-financialadvisers [Last visited: Feb. 12, 2015]; Dave Michaels and Margaret Collins, White House Aide Calls for Stricter Broker Rules on 401(k)s, BloombergBusiness (Jan. 22, 2015), available at http://www.bloomberg.com/news/articles/2015-01-22/white-house-aide-calls-for-stricter-brokerrules-on-401-k-plans [Last visited: Feb. 12, 2015].

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also often apprehensive about making the wrong decision, which causes them to avoid saving and investing for their retirement altogether or leads to them make investments that will not provide the returns needed to provide adequate retirement income. As a result, such individuals engage financial professionals for guidance, with the understanding that financial professionals are typically compensated on a commissionbased model. In fact, studies have indicated that many low- and moderate-income investors prefer a commission-based fee structure over a fee-based advisory relationship.4 Financial professionals have been a primary reason why low- and moderate-income workers have become retirement savers. Without the encouragement provided by financial professionals, it is probable that such individuals would save less, or not at all.

Any change to current rules that would lead to higher fees for investment advice and guidance may have the perverse effect of reducing the number of—and the amounts set aside by—these low- and moderate-income retirement savers.

Second, any change to current rules that would increase the regulatory burdens on financial professionals who service small plans and low- and moderate-income retirement savers will, in turn, likely result in knowledgeable and experienced financial professionals ceasing to make their services available to such plans and retirement savers.

Moreover, any change in the current rules that would have the effect of prohibiting the receipt of compensation through “revenue sharing”5 and similar arrangements for the services that financial professionals provide will likely result in a substantial increase in the out-of-pocket costs borne by these retirement savers. It is reasonable to conclude that many low-to moderate-income retirement savers would make the decision to “fend for themselves” in an increasingly complex investing environment if the anticipated changes to current rules result in a reduction in the number of financial professionals that are available to work with these retirement savers at a higher out of pocket cost. Because retirement savers that engage a financial professional are likely to have significantly more

4

OLIVER WYMAN, ASSESSMENT OF THE IMPACT OF THE DEPARTMENT OF LABOR’S PROPOSED “FIDUCIARY” DEFINITION RULE ON IRA CONSUMERS 12 (2011), available at http://www.dol.gov/ebsa/pdf/WymanStudy041211.pdf; RAND INSTITUTE FOR CIVIL JUSTICE, “Investor and Industry Perspectives on Investment Advisers and Broker-Dealers” (2008) (hereinafter RAND INSTITUTE Study), available at http://www.rand.org/content/dam/rand/pubs/technical_reports/2008/RAND_TR556.pdf (study sponsored by the U.S. Securities and Exchange Commission). See also infra note 18 and accompanying text.

5

“Revenue sharing” refers to the practice whereby mutual funds pass some of the cost of general plan administration, marketing, and other non-investment-related fees (such as commissions paid to financial professionals) to investors. Without revenue sharing arrangements, investors would most likely be forced to pay additional out-of-pocket fees to financial professionals.

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assets at retirement than those who do not,6 the unintended consequence of expansive new rules under ERISA will likely be materially reduced retirement savings.

Perhaps more importantly, any failure to consider how changes to current rules would interface with existing securities laws and regulations would create a confusing divergence in addressing the needs of investors with smaller account balances. A simple, real world example can readily demonstrate the need for coordination between the different regulatory regimes. Posit the circumstance of a broker working with a 25-year old IRA investor. Such a broker would ordinarily recommend allocating the young investor’s savings to a stock mutual fund based on the investor’s age and goals. Under the securities laws, with appropriate disclosure to the client, the broker would be allowed to receive a commission from the mutual fund for such investment. Such commission would compensate the broker for the incremental effort required to analyze the various products available to serve the client’s needs, without charging the client an incremental fee. However, were the broker deemed to be an ERISA fiduciary, the broker generally would not be able to recommend an investment that generates a larger fee than an alternative investment, as such conduct would likely be deemed to be a self-dealing prohibited transaction–even with full disclosure. Were the broker to recommend that the young investor purchase funds, such as money market funds, that do not generate commissions for the broker, the broker may violate the suitability rules under federal securities laws. Thus, the broker would still have to recommend the appropriate category of investments, and would have to charge the client more for its efforts in evaluating such choices. If the client were seeking advice regarding assets in an IRA and in a nonretirement securities account, the broker would be subject to different standards, even if the client’s goals and objectives were the same for each account. And because, in such circumstances, the broker’s advice will often be given in a single meeting with the client, who likely will not understand how or why the law pertaining to the investment of pension plan assets mandates the different advice or different out of pocket costs for the client, the client is likely to be confused and to doubt the broker’s judgment and advice.

Any change to current rules under ERISA that would have the effect of regulating the conduct of broker-dealers, which is the responsibility of the U.S. Securities and Exchange Commission (“SEC”) and the Financial Industry Regulatory Authority (“FINRA”), should take into consideration the existing comprehensive regulatory framework applicable to securities broker-dealers. The SEC is the agency that Congress designated to oversee and regulate the conduct of persons providing investment advice and effecting securities transactions in the United States.7 Congress also mandated that 6

See JON COCKERLINE, THE INVESTMENT FUNDS INSTITUTE OF CANADA, NEW EVIDENCE ON THE VALUE OF FINANCIAL ADVICE 13 (2012).

7

State securities authorities also exercise jurisdiction over broker-dealers and their registered representatives that operate in their respective jurisdictions.

6

any registered broker or dealer must be a member of a registered securities association unless an exemption applies.8 Since the enactment of the Securities Exchange Act of 1934 (the “Exchange Act”), FINRA (or its predecessor) has been the sole registered securities association.

FINRA is an independent, not-for-profit organization whose purpose is “to protect America’s investors by making sure the securities industry operates fairly and honestly.”9 FINRA views its mandate as playing “a critical role in America’s financial system—by enforcing high ethical standards, bringing the necessary resources and expertise to regulation and enhancing investor safeguards and market integrity—all at no cost to taxpayers.”10 The SEC and FINRA have intimate familiarity with the regulatory regime already in place to oversee broker-dealers and their registered representatives.11 These capital markets regulatory authorities should undertake any remedial action necessary to address the perceived inadequacies of the system in protecting the needs of investors with smaller account balances, including workers saving for retirement.

In its 2015 “Regulatory Examination and Priorities Letter,” FINRA continues its regulatory focus on the need to address the effect of conflicts of interest in providing advice to clients, and the continuing need for broker-dealers to focus on “Putting Customer Interests First.”12 FINRA’s focus on business conduct and sales practice initiatives already addresses, within the regulatory framework currently in place for regulating the conduct of broker-dealers, the very concerns driving the DOL’s foray into securities regulation.

8

Securities Exchange Act of 1934 § 15(b)(8), 15 U.S.C. § 78o(b)(8) (2013).

9

About FINRA, FINANCIAL INDUSTRY REGULATORY AUTHORITY (Feb. 5, 2015, 11:55 AM), http://www.finra.org/AboutFINRA/.

10

Id.

11

FINRA is not a government agency, but is an independent, not-for-profit organization authorized by Congress to protect investors by making sure the securities industry operates fairly and honestly.

Brokers and dealers would be subject to FINRA’s disciplinary regime upon violation of FINRA’s rules or federal securities laws. For example, with respect to the suitability obligations of brokerdealers, a 2008 study noted that the “SEC takes the position that violation of suitability requirements is tantamount to committing securities fraud.” See RAND INSTITUTE Study, supra note 4 at 14 and accompanying text.

12

See, e.g., FINANCIAL INDUSTRY REGULATORY AUTHORITY, REGULATORY EXAMINATION AND PRIORITIES LETTER (2008-15), available at http://www.finra.org/Industry/Regulation/Guidance/P122861.

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Under current rules, retirement investors have access to substantial resources when making decisions about what type of investment advice they would like to receive and the fees associated with the different types of advice. Moreover, the securities regulators have extensive examination and enforcement programs designed to deter and punish egregious behavior. As a result, U.S. capital markets regulators effectively address—in a direct and surgical manner—improper conduct by securities broker-dealers and registered investment advisers. Therefore, any change to current rules under ERISA that fails to take into account the comprehensive oversight and enforcement programs administered by securities regulators could have the effect of limiting retirement savers’ access to beneficial investment guidance and products.

Finally, as this memo demonstrates, many of the sources relied upon in support of expansive new rules under ERISA are inconclusive, and in several instances refute the conclusions reached by proponents of such rules. Moreover, there is no evidence to support the view that previous rules adopted by the United Kingdom and Australia have not been harmful to lower- and moderate-income investors.

I.

ANY CHANGE TO CURRENT RULES UNDER ERISA THAT WOULD LIMIT ACCESS TO PROFESSIONAL RETIREMENT PLANNING AND GUIDANCE FOR THOSE WHO NEED IT MOST WOULD POTENTIALLY REDUCE AMERICAN WORKERS’ OVERALL LEVEL OF RETIREMENT SAVINGS.

Any change to the current rules under ERISA that would expand the class of individuals and firms considered fiduciaries would reduce the availability of essential advisory services for low- and moderate-income workers saving to meet their needs in retirement. Proponents of expansive new rules under ERISA focus on the cost to retirement savers of arrangements that they view as inappropriately conflicted while ignoring the benefits that the currently available arrangements create, including readily accessible and affordable investment advisory services, and a full range of investment and financial products and services that address the needs and risk-constraints of individual clients. Academic studies explain that securities brokers help investors save more, better customize their portfolios to individual risk tolerance, increase overall investor comfort with investment decisions, and improve financial literacy.13 Any regulatory approach that would have the effect of pricing low- and moderateincome savers out of the investment advisory market would potentially leave these individuals without access to financial professionals who could have encouraged them to 13

See Daniel Bergstresser et al., Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry (October 2009), 22 REV. FIN. STUD. (ISSUE 10) 4129 (2009), available at http://ssrn.com/abstract=1479110; Nicola Gennaioli et al., Money Doctors (Nat’l Bureau of Econ.

Research, Working Paper No. w18174, 2012), available at http://ssrn.com/abstract=2089246.

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develop sound saving habits through their active and full participation in qualified savings accounts (e.g., 401(k) plans, IRAs, etc.). Consequently, too many low- and moderate-income savers would be left with insufficient assets to carry them through retirement; or worse, these savers would invest poorly on an individual basis and risk losing the little savings they do have.14 Proponents of expansive new rules under ERISA have failed to consider the negative effects of rule changes that would expand the definition of investment-advice fiduciary under ERISA, which would jeopardize the average American’s access to professional retirement planning and guidance. Certain potential changes to rules under ERISA would result in a reduction in the number of workers who save to meet their needs in retirement, thereby leaving many future retirees scrambling to save in the late stages of their lives when it might be too late.

II.

THE IMPACT OF ONGOING ASSET-BASED FEES COULD IMPEDE EFFORTS BY LOW- AND MODERATE-INCOME WORKERS TO SAVE FOR RETIREMENT.

Ongoing asset-based fees could ultimately reduce Americans’ overall level of savings, which could exacerbate an already troubling savings gap among low- and moderate-income retirement savers.15 While many studies compare investment returns on funds with high loads and revenue sharing to returns on funds without these costs, such studies often fail to provide a complete picture. Specifically, these studies seem to ignore the fact that curtailing these cost-sharing arrangements16 will likely cause an increase in the upfront cost of investment advice, potentially putting such advice out of 14

Any regulation that would broadly expand the ERISA fiduciary definition would likely reduce the number of financial services providers due to increased compliance costs, regulatory burdens, and uncertainty, and also would have a negative impact on low- and moderate-income savers’ access to financial professionals. A similar reaction was observed in the United Kingdom following the passage of the Retail Distribution Review. See Part IV.A, infra.

15

See OXFORD ECONOMICS, ANOTHER PENNY SAVED: THE ECONOMIC BENEFITS OF HIGHER US HOUSEHOLD SAVING (2014), available at http://www.oxfordeconomics.com/penny-saved/download.

16

Some of the most common cost-sharing arrangements include 12b-1 fees, trailing fees, and revenue sharing arrangements. 12b-1 fees, named for the SEC regulation that permits them, are fees paid by a mutual fund out of fund assets to cover distribution expenses and sometimes shareholder service fees, which are fees paid to persons to respond to investor inquiries and provide investors with information about their investments. Trailing fees, or trailing commissions, are yearly commissions paid by many mutual funds to financial professionals for bringing long-term investors to the fund. Trailing fees provide an incentive for financial professionals to provide advisory services to potential investors without requiring those investors to pay for the services out of pocket. For an explanation of revenuesharing arrangements see footnote 5, above.

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reach for certain low- and moderate-income American workers.

Nevertheless, proponents of expansive new rules under ERISA seize upon these incomplete studies as evidence that the system is broken, and that it can only be fixed by an even more restrictive “one-size-fits-all” regulation.

Given the complexity of investment products and services available in the capital markets, many Americans need—or prefer to use—professional guidance to achieve their financial goals.17 Unfortunately, most Americans lack the time and resources necessary to navigate the sea of complex investment options, and therefore rely on professionals to help them set and achieve attainable retirement goals, understand risk, and select appropriate investments. Instead of requiring a separate fee from Americans who cannot afford or are unwilling18 to pay separately for advice, financial professionals offer the option of commission-based arrangements as compensation for their services. If commissions and other sell-side compensation arrangements were prohibited, financial professionals would be forced to require an asset-based or hourly fee, thereby discouraging low- and moderate-income Americans from seeking out what would have otherwise been affordable investment advice. Without such advice, including the inherent education about the need for retirement savings, these individuals may not take the actions necessary to establish adequate retirement savings. Indeed, studies have shown that, all things being equal, a statistically significant positive correlation exists between active advisory relationships and both aggregate household wealth and IRA ownership.19

17

Many Americans make similar choices when deciding whether or not to use professional tax preparers. While they could do their federal, state, and local tax returns without the assistance of a professional tax preparer, the vast majority of Americans want help with this complex area of the law.

18

A 2011 study conducted by the consulting firm Oliver Wyman found that an overwhelming majority of retirement savers prefer commission-based brokerage accounts over asset-based fee advisory models for IRAs. This preference was especially pronounced among low- and moderate-income investors. OLIVER WYMAN, ASSESSMENT OF THE IMPACT OF THE DEPARTMENT OF LABOR’S PROPOSED “FIDUCIARY” DEFINITION RULE ON IRA CONSUMERS 12 (2011), available at http://www.dol.gov/ebsa/pdf/WymanStudy041211.pdf.

19

DANIEL SCHRASS, OWNERSHIP OF MUTUAL FUNDS THROUGH INVESTMENT PROFESSIONALS, 2012 8-10 (2013), available at www.ici.org/pdf/per19-02.pdf. This study finds that households with a median income of $80,000 and no ongoing advisory relationship have a median of $150,000 of financial assets. In contrast, households with a median income of $87,500 and an ongoing advisory relationship have a median of $275,000 of financial assets. The data show that despite earning only 8.57% less than households with a financial adviser, households without a financial adviser save 45.45% less. This suggests that the existence of an ongoing advisory relationship encourages Americans to set and accomplish savings goals. Id.

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III.

CONSUMER PROTECTIONS AND EDUCATION INITIATIVES FOR INVESTMENT ADVICE IN THE RETAIL AND SMALL PLAN MARKETS ADEQUATELY PROTECT INVESTORS AND PLAN SPONSORS WITHOUT PUTTING BENEFICIAL INVESTMENT OPTIONS OUT OF REACH.

Proponents of expansive new rules under ERISA point to the weight of commissions and other cost-sharing arrangements on long-term returns as evidence of inadequate protection, but fail to address the fact that, without such commissions, many of the investment products currently sought by retirement savers would otherwise be unavailable.

For instance, the sale of an annuity requires substantial upfront work by a financial professional to determine the type of annuity most suitable for a particular retirement saver, which riders are appropriate,20 and the portion of the retirement saver’s portfolio that should be invested in the annuity. Given many retirement savers’ inability to pay out of pocket for the cost of such research, eliminating commissions would put annuities out of reach for many retirement savers. Annuities offer features and benefits that are generally not available in other retirement planning products, including principal protection and guaranteed lifetime income. In addition, variable annuities21 can provide guaranteed returns and withdrawal benefits tailored specifically to each policy owner.

From product development to advertising to sale, issuers and distributors of annuities must comply with state and federal laws that protect consumers’ interests. Both the SEC and FINRA have significant authority to supervise the sale of variable annuities, which are required to be sold by a registered representative of a registered broker-dealer that is a member of FINRA. The representative also must be licensed by the state to sell variable insurance products. The SEC and FINRA have rules that strictly govern the activity of variable annuity salespersons, and impose detailed standards concerning advertising, supervision, and suitability of individual sales.

20

A rider is a supplementary document appended to a form contract that modifies the terms of the agreement. A financial professional will use a rider, or series of riders, to customize an annuity to the specific needs of a particular investor.

21

A “variable annuity” is a financial product that provides guaranteed annuity payments during the annuitization phase, but allows investors to select equity securities in which to invest their principal during the accumulation phase. If the principal grows beyond the value of the guaranteed payments during the variable annuity’s accumulation phase, the retirement saver receives the increased value once the annuity starts to pay out. Conversely, if the principal drops below the value of the guaranteed payments, the retirement saver can rest assured that his or her principal will be returned during the annuitization phase. Variable annuities are therefore extremely valuable to low- and moderate-income retirement savers because they offer the potential for high upside returns without the risk of losing principal.

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Proponents of expansive new rules under ERISA are also critical of active portfolio management and suggest that research supports a view that investors would be better off investing in a passively-managed investment product. However, this theory ignores the benefit of active management across the range of asset classes. For example, indexes used in the fixed income market are not a good substitute for active management of a bond fund—an asset class that is important to investors who are in retirement or who have less appetite for risk. Finally, equity managers have outperformed domestic indexes, particularly in higher interest rate environments.22 United States securities regulators are well aware of the concerns underlying the DOL’s efforts, and have already taken significant action to address these matters, as is demonstrated by their rulemaking, education initiatives, ongoing examinations of industry participants and enforcement actions (such as the imposition of penalties and sanctions). Moreover, the SEC and FINRA both conduct regular examinations of registered broker-dealers. At the beginning of every year, each regulator publishes its examination priorities for the coming twelve months.23 Both regulators’ 2015 examination priorities included themes centered on “Protecting Retail Investors and Investors Saving for Retirement” (SEC)24 and “Individual Retirement Account (IRA) Rollovers (and Other ‘Wealth Events’),” “Senior Investors,” and “Putting Customer Interests First” (FINRA).25 In fact, FINRA is a strong supporter of putting customers’ 22

See Return of the Stockpickers, BARRON’S (Jan. 23, 2015), http://online.barrons.com/articles/returnof-the-mutual-fund-stockpickers-1420870199. Even some studies that make the case for passive investing have admitted that “good active managers can and have delivered better returns” than indexes. STEVEN BARRY, GOLDMAN SACHS, RE-THINKING THE ACTIVE VS. PASSIVE DEBATE 3 (2010).

23

SEC examination priorities for 2015 are available at http://www.sec.gov/news/pressrelease/20153.html#.VM-0glJ0yCo; FINRA examination priorities for 2015 are available at http://www.finra.org/web/idcplg?IdcService=SS_GET_PAGE&ssDocName=P602239.

24

U.S. SEC. AND EXCH. COMM’N, OFFICE OF COMPLIANCE INSPECTIONS AND EXAMINATIONS, NATIONAL EXAM PROGRAM: EXAMINATION PRIORITIES FOR 2015 (2015), available at http://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2015.pdf. “Retail investors of all ages face a complex and evolving set of options when determining how to invest their money, including retirement funds.” “Financial professionals serving retail investors are increasingly choosing to operate as an investment adviser or as a dually registered investment adviser/brokerdealer, rather than solely as a broker-dealer. Unlike broker-dealers, which typically charge investors a commission or mark-up on purchases and sales of securities, investment advisers employ a variety of fee structures for the services offered to clients, including fees based on assets under management, hourly fees, performance-based fees, wrap fees, and unified fees. Where an adviser offers a variety of fee arrangements, we will focus on recommendations of account types and whether they are in the best interest of the client at the inception of the arrangement and thereafter, including fees charged, services provided, and disclosures made about such relationships.” Id.

25

FINANCIAL INDUSTRY REGULATORY AUTHORITY, REGULATORY EXAMINATION AND PRIORITIES LETTER (2015), available at http://www.finra.org/Industry/Regulation/Guidance/P122861. “A central

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interests first, irrespective of whether the registered broker-dealer must meet a legally mandated suitability or fiduciary standard. Thus, FINRA encourages firms to align their interests with those of their customers.26 Both regulators also publish annual statistics about their enforcement activities.

The SEC’s statistics show a clear trend towards increased enforcement actions against broker-dealers starting in 2005.27 FINRA’s statistics exhibit a similar upward trend starting in 2010, especially with respect to the number of individuals barred and suspended.28 As demonstrated by the SEC’s and FINRA’s actions and initiatives, the securities regulators are aware of the potential for retirement savers and other low- to moderateincome investors to receive advice that might not be geared primarily for their benefit, and have already taken significant steps, through an array of initiatives, to address these concerns. Their actions have been targeted at deterring and punishing abuses, and improving access to the information necessary for investors with smaller account balances (including retirement savers) to better understand the choices they have available so that they use investment advisory services more effectively.

The regulators charged directly with the protection of these investors have not opted to adopt a far-reaching prohibition that could have the adverse effects that have been noted above; rather, they have worked (and continue to work) to make improvements in the industry that protect such investors without potentially curtailing the ability of such investors to access much-needed and wanted professional expertise.

failing FINRA has observed is firms not putting customers’ interests first. The harm caused by this may be compounded when it involves vulnerable investors (e.g., senior investors) or a major liquidity or wealth event in an investor’s life (e.g., an inheritance or Individual Retirement Account rollover).

Poor advice and investments in these situations can have especially devastating and lasting consequences for the investor.” Id. 26

Id. “Irrespective of whether a firm must meet a suitability or fiduciary standard, FINRA believes that firms best serve their customers—and reduce their regulatory risk—by putting customers’ interests first. This requires the firm to align its interests with those of its customers.” Id.

27

https://www.sec.gov/news/newsroom/images/enfstats.pdf.

28

http://www.finra.org/Newsroom/Statistics/.

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IV.

EXPERIENCE IN THE UNITED KINGDOM AND AUSTRALIA DOES NOT SUPPORT ADOPTION OF SIMILAR REGULATIONS IN THE UNITED STATES. A.

United Kingdom

Proponents of expansive new rules under ERISA cite the 2013 passage of the United Kingdom’s Retail Distribution Review (“RDR”) as evidence that additional regulation would not limit access to financial advisory services for low- and moderateincome individuals. However, the experience in the United Kingdom, even if accurately portrayed, cannot be easily extrapolated to the U.S. regulatory environment.

The RDR was first introduced by the Financial Services Authority (the Financial Conduct Authority’s (“FCA”) predecessor) in 2006, giving the UK financial services industry at least seven years to adjust in preparation for its eventual passage. A study commissioned by the FCA helpfully explains that, during this adjustment period, “there was some exit from the advisory market, particularly in the period leading up to the RDR, by banks and by some financial advisers.”29 Thus, while it may be accurate that 97 percent of the remaining advisers achieved accreditation shortly after the RDR was passed, many others may have exited in the years leading up to the RDR’s passage.

Furthermore, the FCA study does not find that advisers faced with tighter regulation continue to serve low-balance accounts, but merely that “there remains a large number of advisory firms and advisers to serve consumers,”30 without specifying the socioeconomic characteristics of these consumers.

Indeed, the FCA notes that “[s]ome measures of the RDR may have had an effect on the levels of engagement in the industry.” The report notes that there is evidence suggesting a slight decline in the number of existing investors who opened investments post-RDR, with this most notable for investors in the £50,000-£100,000 segment.31 Whilst not definitive proof, it is consistent with the contention that–for example–bank29

EUROPE ECONOMICS, RETAIL DISTRIBUTION REVIEW POST IMPLEMENTATION REVIEW 84 (2014), available at http://www.fca.org.uk/static/documents/research/rdr-post-implementation-revieweurope-economics.pdf. (Note that proponents of the DOL amendment cite this same study in support of its passage). The FCA report attempts to diminish any correlation between the RDR and the exit of advisers from the industry, claiming that the decision of advisers to exit the marketplace was “strategic,” due to “declining profitability and regulatory failings” and that the effect of the RDR initiative on such decisions was likely “partial and indirect at most.”

30

Id. at 54.

31

£50,000-£100,000 is equivalent to roughly US$76,500-US$153,000.

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based advisers were effective in prompting a decision to invest and that, with their exit, this has resulted in a slight drag on investment levels. This is supported by research by the FCA Practitioner Panel which finds that the reduction in mid-market advisers has reduced mass market access to advice with many less capable consumers not seeking advice or investing.32

The FCA report asks whether this “advice gap” will be addressed by the market. In answering this question, it posits that online platforms and other advances in technology will help a lot of people. For everyone else, it speculates that “firms may be able to develop ‘simplified advice’ which could be both cost-reflective and affordable to the mass market” but offers no real-world suggestions as to how such a result will be achieved.33 Finally, the FCA study acknowledges that the cost of advice has increased as a result of the RDR’s passage.34 After over two years since the RDR’s passage there is still insufficient data to determine with accuracy the true effect of the RDR on overall return to retail investors. The FCA report states that, despite the measures of the RDR, “[t]here are no signs of yet of increases in trust or engagement from consumers generally in the advised investment market.”35

B.

Australia

Proponents of expansive new rules under ERISA also cite the Australian Future of Financial Advice (“FOFA”) reforms as an experience from which American policymakers can learn.36 However, the Australian retirement system differs dramatically 32

Id. at 60. The FCA Report attempts to negate this effect by stating that evidence existed that banks were “mis-selling” investors prior to the RDR, and speculates that the “unengaged consumers” who were brought into the system by the advisers who may have left the marketplace “may not have benefited from the advice they received.” Id. at 61.

33

Id. at 62 (emphasis added).

34

Id at 64-65. The report does indicate that the reforms may have resulted in lower costs to “higher wealth clients.”

35

Id. at 60.

36

FOFA introduced the following reforms: (1) a prospective ban on conflicted remuneration structures, including commissions and volume based payments, in relation to the distribution of and advice about a range of retail investment products; (2) a duty for financial advisers to act in the best interests of their clients, and place the best interests of their clients ahead of their own when providing personal advice to retail clients (there is a safe harbor which advice providers can rely on to show they have met the best interests duty); (3) an opt-in obligation that requires advice providers to renew their clients’ agreement to ongoing fees every two years; (4) an annual fee disclosure statement requirement; (5) enhanced powers for the Australian Securities & Investments Commission (“ASIC”).

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from the United States retirement system and thus Australia’s financial advice regulation is not a rational model for the United States.

Australian employers are required by law to make periodic contributions of 9.5 percent of employee salaries into tax-advantaged retirement plans. While certain employees may be eligible to direct these contributions toward defined benefit plans, the contributions are typically invested in an individual savings account in what is called a “Superannuation Fund.” Employees have the right to select the type of Superannuation Fund to which contributions will be made, which can be organized in one of several ways. Individuals who fail to designate a type of Superannuation Fund have their mandatory employer contributions directed to a fund that offers a “MySuper product,” which must hold diversified assets and comply with government-mandated reporting standards.

Because the Australian workforce has a mandatory retirement savings program in place, the FOFA initiative advanced by the Australian government was aimed, in part, at improving financial literacy in an effort to help Australians make educated choices about the Superannuation Fund most suitable for them. To the extent the introduction of FOFA reduced the size and accessibility of the Australian investment adviser industry, its impact did not have the same effect that expansive new rules under ERISA would have on the U.S. system. Specifically, Australians who no longer sought advice from a financial adviser as a result of the reforms still had meaningful retirement savings by virtue of mandatory contributions to Superannuation Funds. In contrast, lack of access to financial professionals in the American system could discourage low- and moderateincome workers from opening and contributing to their retirement accounts. As a result of the differences between the Australian and U.S. retirement systems, using FOFA as a basis for comparison in evaluating any potential changes to current rules under ERISA is inappropriate.

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This memorandum is not a legal opinion. The discussion contained herein is based on the law as in effect, and the facts as presented, as of the date of this memorandum. We undertake no duty or obligation to revise or otherwise supplement this memorandum based on changes in the law that may occur, or different facts that may come to our attention, after the date hereof. This memorandum is provided to Richard Foster, Senior Vice President and Senior Counsel for Regulatory and Legal Affairs at the Financial Services Roundtable, and to Felicia Smith, Vice President and Senior Counsel for Regulatory Affairs at the Financial Services Roundtable, and no other person or entity is entitled to rely on it without the express written consent of Debevoise & Plimpton LLP.

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