The classical model notwithstanding, people are not rational economic actors. We know this because the motorcycle market exists. Rational actors are skeptical about advice offered by people who have an economic interest in that advice’s being taken: “Ridiculous? Oh, no, Mr. Smith, in six months all the grandfathers in Cleveland will be wearing those skinny jeans!” Or, “It may seem counterintuitive, but a Porsche 911 is the ideal first car for your teen-ager!” Etc.
The new “fiduciary rule” put forth by the Obama administration is an attempt to rationalize the irrational.
Do not be intimidated by the terminology. A “fiduciary” is simply someone with a legal duty to act in the best interest of someone else. For example, a corporate manager is legally required to seek to act in the best interest of his shareholders, even when — especially when — doing otherwise might benefit him personally. A trustee has a fiduciary responsibility to the intended beneficiaries of the trust. And now, under a new rule put forward by the Obama administration with zero authorization from Congress, certain brokers offering financial advice to investors in 401(k) plans and IRAs will be governed by the fiduciary standard.
Despite the administration’s insistence to the contrary, the fiduciary standard is not just a Hippocratic oath for financial advisers. Because acting in the client’s best financial interest requires that the compensation of advisers not be excessive, the fiduciary rule imposes a universal standard — a very murky one — on commissions and fees: They must be “reasonable.”
Who gets to decide what is “reasonable”?
There already are laws against misleading investors about the nature of investment vehicles.
The murkiness is not, from the Obama administration’s point of view, a defect in the “reasonableness” standard. The murkiness is the point. The rule does not prohibit brokers from being compensated through commissions, nor does it, on the other hand, spell out in any meaningful or quantifiable way (such as a percentage) what constitutes “reasonable” compensation. As former deputy assistant secretary of labor Michael Davis puts it in an interview with Investment News: “There’s no hard-and-fast rule. What’s reasonable for one engagement might be completely unreasonable for another.”
There are three kinds of people who love such murky standards: cheats and lawyers, to begin with; and combine the first two to produce the third: politicians.
There already are laws against misleading investors about the nature of investment vehicles. If you promise that junk bonds issued by the Trump Organization will pay 11 percent per annum for ten years with no risk of default, you are guilty of fraud, plain and simple, commission or no commission. (Happily for Mr. Trump, who currently is being tried on fraud complaints related to Trump University, other instances of fraud are more difficult to prove.) But this isn’t about that. This is about establishing, under the guise of consumer protection, a new tool for twisting the corporate arms of financial institutions that displease Democratic politicians.
#share#Because the fiduciary standard here is so murky, and so wonderfully plastic in the hands of a weaponized bureaucracy, the government will have the power to exert enormous influence on financial firms simply by going after the advisers who sell their products on the grounds that doing so may violate the fiduciary standard. Of course that sounds paranoid. A few years ago, though, it would have sounded equally paranoid to suggest that the IRS was targeting nonprofit groups based on their political affiliations and would demand disclosure of the contents of their prayers, or that the mayor of a major U.S city would attempt to subpoena local pastors’ Sunday sermons as part of a crusade to allow men in dresses access to women’s public toilets. But these things came to pass.
There is no plague of wanton financial advice upon the land. Private wealth in the form of retirement savings is an enormous center of real power, and the Left seeks to have as much control over it as possible, for the same reason it seeks a monopoly on education and insists that 88-year-old nuns have health-care plans with birth-control benefits: Power is power is power.
It is difficult not to smile at the idea of fiduciary probity being enforced by the great minds that brought you Obamacare.
Commissioned sales create economic incentives, and those incentives can create conflicts of interest. That cannot be regulated away, and it will affect IRA advisers in exactly the same way it affects the gentlemen in the shoe department at Bloomingdale’s. Americans somehow manage to make important financial decisions, such as buying houses and automobiles, despite the influence of commissioned salespeople who are not subject to intensive federal oversight. And it is difficult not to smile at the idea of fiduciary probity being enforced by the great minds that brought you Obamacare. But this is not really about investment advice. It is about who controls wealth.
It would take a remarkably liberal reading of the 1974 Employee Retirement Income Security Act, under the authority of which the administration claims to be acting, to find justification for this new rule. Congress has already twice attempted and failed to stop the rule through specific legislation; the fight from here probably will proceed largely in court. An expected prohibition on the use of options in retirement accounts did not materialize, partly as a sop to Wall Street, partly as a way to make it more difficult to challenge the new rule in court. But Wall Street, which donated so generously to Senator Obama’s 2008 presidential campaign, should not delude itself into thinking that it will, in the long run, end up with a place at the table rather than a place on it. When it comes to investors, the Democrats have fully embraced the mock-motto of the IRS: “We have what it takes to take what you have.”
No, your financial adviser may not always be acting in your best interest, and he may have interests of his own. The same is true of Barack Obama, a fact worth keeping in mind.