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GoodIntentionsGoneWrong:TheYetToBeRecognizedCostsoftheDepartmentOfLabors

ProposedFiduciaryRuleRobertLitanandHalSinger1July2015

1RobertLitanisanonresidentseniorfellowattheBrookingsInstitutionandseniorconsultanttoEconomistsInc.HalSinger isaseniorfellowattheProgressivePolicy InstituteandaprincipalatEconomists Inc.Fundingforthispaper was provided by the Capital Group, which provides investment management services worldwide. Theanalysisandconclusionsaresolelythoseoftheauthors.

Abstract:TheDepartmentofLabor(DOL)fiduciaryrulehasbeenjustifiedbasedoneconomicanalysesby the DOL and the Council of Economic Advisers (CEA) that are flawed and filled with internalcontradictions.These flaws comemostly from cherrypickingandmisreading the relevanteconomicliterature,andfromignoringsignificantcoststomillionsofsmallsaversthattherulewouldimpose.Thesecostscomelargelyfrom(1)smallsaverslosingaccesstohumanfinancialadvisors(becausesmallaccountswouldbecomeuneconomictoserve,andexposeadvisoryfirmstonewliabilityrisks),(2)smallsavers being forced into feebased advisory relationshipsthat cost more than current commissionbasedarrangements, and (3) small savers and firms not beingencouraged to savemore, take fulladvantageofemployermatches,orcreateretirementplansinthefirstplace.TheDOLsRegulatory ImpactAnalysis (RIA) thus concludeserroneouslythatthenetbenefitoftherulewouldberoughly$4billionperyear(theCEA,makingrelatederrors,pegsthebenefit at $17 billion).A conservative assessment of therules actual economic impacttaking into account thecategoriesofharmnotedabovethatareignoredbyDOLandCEAfindsthatthecostofdeprivingclientsofhumanadviceduringa futuremarketcorrection (justoneof thecostsnotconsideredbyDOL)couldbeasmuchas$80billion,ortwicetheclaimedtenyearbenefitsthatDOLclaimsfortherule.Infact,thedecisiontostayinvested(ornot)duringtimesofmarket stress swamps the impact of all other investmentfactors affecting longterm retirement savings, includingmodestdifferencesinadvisoryfeesorinvestmentstrategies.Roboadvice,whichtheDOLassumeswillovertimereplacehumanadvisorswhofindituneconomictoserve small savers under the new rule, cannot effectively perform this critical role.(An email or textmessage in the fallof2008, forexample,wouldnothave sufficed tokeepmillionsofpanicked saversfrom selling,with devastating consequences for their nest eggs). In effect, the DOL rulewagers thewelfareofmillionsofAmericansonthemistakennotionthatendingcommissionbasedcompensationisbetter for small savers than assuring them continued access to human financial advice through anaffordableandtimetestedmodel.Atamoretechnicallevel,theRIAclaims(basedonflawedassumptions)thattheannualbenefitfromitsrulewouldbe$4billionperyear.Aconservativereckoningofthesamecalculation,takingaccountoftheharmsoverlookedbyDOL,however, finds the rulewouldactually imposenetyearlycostsof$2 to$3billion (on theaverage ten yearbaseof retirementassets). The lossofbrokerageadvicealone couldadverselyaffectupto7millionpeople.AlesscostlyalternativethatwouldmeettheDOLsobjectiveswouldbetorequireenhancedbutsimpledisclosuresrelatingtobrokerscompensationfromcompaniessponsoringinvestmentproductstheysell.TheDepartmentsonlybasis forrejectingthis idea isaclaimmadewithoutanyempiricalsupportthatinvestorscouldnotprocessthisadditionalinformationifitweremadeavailable.Thisisanextremelyslimreeduponwhichtobaseanentirerulethatcouldradicallychangethewayinvestmentadviceisprovidedina$1trillionsegmentofthemutualfundmarket.HowcantheDepartmentknowtheefficacyofgreaterdisclosure,withoutat leastfirstgivingenhanceddisclosure intheretirementsavingscontextat leasta

AconservativeassessmentoftheruleseconomicimpacttakingintoaccountthecategoriesofharmthatareignoredbyDOLandCEAfindsthatthecostofdeprivingclientsofhumanadviceduringafuturemarketcorrectioncouldbeasmuchas$80billion.

try?Intheend,ifitisopentofactbasedadjustmentsinitsapproach,theDOLwillhavesetinmotionareform process that establishes new protections for small savers without disruptions that wouldunintentionallyharmthoseitseekstohelp.Whileregulatorylawandbestpracticegenerallyrequirelesscostlyalternativestobepursued,therearealsopracticalreasonsfortheDOLtotakethiscourse.Becauseofthedisruptiontotheindustrythattheruleaswrittenwillbringincludinga forcedoverhaulof theentire internal compensation systemsofbrokerage/advisory firms, and massive new paperwork and contracting requirements for millions ofclients, under an impractical eight month deadlinethe likely result will be an implementationnightmare.Amongotherthings,millionsofsmallsaversmaybesurprisedwhentheyarenotifiedin2016thatnewObamaAdministrationrulesmeantheyarebeingdroppedby longtimeadvisors,orforcedtopaymuchmoreviafeebasedaccountsinordertokeepthem..

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Table of Contents

Executive Summary ................................................................................................... 1

I. The DOL Proposal and Regulatory Impact Analysis: A Quick Guide ...... 5

II. Brokers and Financial Advisors Provide Valuable Retirement Savings Services to Middle Income Savers that the Proposal and its Regulatory Analysis Fail to Consider ......................................................................................... 8

A. Background on How Brokers Are Compensated for Rendering Valuable Services ....................................................................................................................... 9 B. The DOLs Proposal Fails to Consider Multiple Benefits Provided by Brokers and Advisors ............................................................................................................. 10

III. DOLs Proposed Fiduciary Rule Would Discourage Brokers and Advisors from Serving Savers with Modest Portfolios, to their Detriment 12

IV. The Multiple Costs to Middle-Income Savers from Reduced Choices in Investment Advice Resulting from DOLs Proposed Rule Not Considered in the Regulatory Impact Analysis ........................................................................... 15

A. Middle-Income Savers Who Would Not Use Investment Advisors Because of the Proposed Rule Would Incur Significant Costs ......................................................... 16

1. Costs Due to Increased Market Timing ......................................................... 16 2. Costs Due to Less Rebalancing ...................................................................... 19 3. Costs Due to Less Saving ............................................................................... 20 4. Costs Due to Less Use of Employer Matches ................................................ 21

B. The Benefits Claimed for the Proposed Rule Are Overstated ........................... 22

V. A More Cost-Effective Alternative to the DOLs Proposal Exists ........... 23 A. A Less Burdensome Alternative ......................................................................... 23 B. The RIA Lacks Any Real World Empirical Support for Rejecting Greater Disclosure .................................................................................................................. 25 C. Policy Implications ............................................................................................. 27

Conclusion ................................................................................................................. 28

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EXECUTIVESUMMARY

Toparaphraseawellknownadage,theroadtoabadplacecanbepavedwithgoodintentions.SuchisthecasewiththeDepartmentofLabors(DOL)proposedrulethatwouldimposefiduciaryobligationsonsecuritiesbrokersandfinancialadvisorsprovidingadviceforindividualretirementaccounts(IRAs).Currently, brokers and advisors providing retirement advice must comply with requirements of theSecurities and ExchangeCommission (SEC) that their recommendationsbe suitable for investors,taking account of their income, assets, and expressed risk preferences or tolerances. A fiduciarystandardwouldtreatbrokersandadvisorsasthefunctionalequivalentofattorneysandphysicians,andis being proposed specifically to reduce the costs of supposed conflicted advice from brokers andadvisorswhoarecompensatedbyprovidersofmutualfundsandotherretirementassetvehiclesinwaystheDepartmentarguesarenotfullyunderstoodbyinvestors.TheDepartmentsproposaland itsaccompanyingRegulatory ImpactAnalysis (RIA)useavarietyofassumptionstoestimatethatthiscostreductionduetoanassumedreductionoffeesonmutualfundswith frontend loads,which are purportedly linked to an underperformance in investors retirementportfolioswillbe roughly$4billionannuallyovera tenyearhorizonbeginning in2017.2Subtractingadditionalcompliancecostsofaminimumof$240millionannually,thenetbenefitsclaimedfortheDOLrule come to approximately $3.76 billion annually, or about 25 basis points (0.25 percent) on anassumedtenyearaverageinvestmentbaseof$1.478trillion.Thisstudyshows that theDOLsbenefitestimate (in realitymoreofassumption, thananestimate) isseriouslyoverstated.AsdemonstratedinPartIV,theallegedunderperformanceassociatedwithbrokersoldfundsidentifiedbytheRIAintheliteraturedisappearsthatis,isconvertedtooverperformancewhenoneshifts fromdomestic to foreignequities. Inaddition,changing the timeperiodunderstudycanleadtodifferentresults.Accordingly,theempiricalfoundationuponwhichtheDOLsproposedrulerestsisshakyatbest.LiketheRIA,acompanionstudybytheCouncilofEconomicAdvisers(CEA)selectivelycitestheacademicliteratureinsupportofitsclaimthatIRAinvestorssufferunderperformanceof100basispointsperyeardue toconflictedadvice.3TheCEAassumes that typical401(k)plan investorspay fundexpensesofonly20basispoints,butthatinvestorspay130basispointsinfundexpensesaftertheyrolltheirassetsover toan IRA.Butdata from the InvestmentCompany Instituteshow the realdifference in fees isamere 17 basis points,which casts doubt on CEAs $17 billion cost estimate (to the extent this cost

2. FiduciaryInvestmentAdvice:RegulatoryImpactAnalysis,Apr.14,2015,at116,Table3.4.21[hereafter

RegulatoryImpactAnalysis],availableathttp://www.dol.gov/ebsa/pdf/conflictsofinterestria.pdf.3. CEA,TheEffectsofConflictedInvestmentAdviceonRetirementSavings,(Feb.2015),availableat

www.whitehouse.gov/sites/default/files/docs/cea_coi_report_final.pdf.

2estimate isderived from the feedifferential). 4Moreover,CEAuses an assetbaseof$1.7 trillionbywhich to multiply an (inflated) 100 basis points, when the relevant base of assets affected by theproposedruleaccordingtotheDOLsstudyisroughly$1.5trillion(theaveragebaseofIRAinvestmentsinmutual fundswitha frontend loadbetween2017and2026). Itbearsnotingthat theRIAdoesnotrelyontheCEA$17billionestimatetoarriveatits$40billionbenefit(overtenyears)fromtheproposedrule,butinsteadreliesonanassumptionthatitsrulewouldacceleratethedeclineinloadsharespaidtobrokers,whichpurportedlyarelinkedtounderperformance.DespitethelackofcredibilityoftheCEAs$17billionestimateanditsdistantrelationshiptotheRIAsanalysis,thefigureisstillcitedbytheDOLasabasisforwhythestakescouldnotbehigherforthegovernmenttorewritetherulesgoverningtheretirementinvestmentadvicemarket.5At thesame time, theRIA (like theCEA) fails togivepropercredit toevidence indicating that its rulewould induce brokers either to back away from potentially millions of individuals with modestretirement portfolios (small savers), or instead continue to serve them only by charging on apercentageofasset(wrapfee)basis.TheDOLhastriedtocushiontheblowbycreatingexceptionstoitsproposed rulecalledBest InterestContractExemptions (BICE),which theDepartmentclaimswillcontinuetoallowbrokerstoserveclientsonacommissionbasis.6ButtherequirementstoqualifyforaBICEaresoonerousandunworkablethatitisunlikelythatmanybrokerswillseekanexemption.We showhere that ifbrokers leave the smallsaver segmentasmanywouldbecause theproposedrulesmakesituneconomicforbrokerstoservethemwithoutchargingcommissionstheirclientswouldbe deprived ofmultiple benefits that brokers now provide to them. Cumulatively, just these two ofbrokerprovided benefitscoaching to stay invested through market downturns, and assistance inportfolio rebalancingconservatively total44.5basispoints annually (seeTable1below),enough tooutweightheDOLsclaimed25basispointbenefitsforitsrule,andtoevenmoresubstantiallyoutweigha more accurate, lower accounting of the rules claimed benefits. Advocates of the proposed ruleassume naively that robo advisors will over time fill the gap so small savers will continue to beadvised;butas this report shows,emailsand tweets froma robotwillnotpreventan investor fromselling inapanic,andthevalueofthathuman interactionduringperiodsofmarketstresswillswampanythingelseasmallsaverdoeswithrespecttooutcomesandretirementsecurity.

4. StatementofInvestmentCompanyInstitute,BrianReid,HearingonRestrictingAccesstoFinancialAdvice,

June17,2015,at7[hereafterICIStudy].5. StatementofThomasE.Perez,SecretaryU.S.DepartmentofLaborBeforetheHealth,Employment,

LaborandPensionsSubcommitteeCommitteeonEducationandTheWorkforceU.S.HouseofRepresentatives,June17,2015,availableathttp://Edworkforce.House.Gov/Uploadedfiles/Testimony_Perez.Pdf.

6. ProposedBestInterestContractExemption,Apr.20,2015,availableathttp://webapps.dol.gov/FederalRegister/HtmlDisplay.aspx?DocId=28202&AgencyId=8&DocumentType=1[hereafterBICEProposal].

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TABLE1:FORGONEBENEFITSOFBROKERADVICE(ESTIMATEDCOSTOFTHERULEINANNUALBASISPOINTS)

Benefit LowEnd HighEnd Midpoint SourceAvoidanceofTiming 0 54 27 VanguardRebalancing 0 35 17.5 VanguardTOTAL 44.5

The foregonebenefits (orcost)estimatesshown inTable1conservativelyexcludeadditionalbenefitsattributabletobrokersthatareignoredbytheRIA:documentedencouragementtoincreasesavingsortotakegreateradvantageofemployermatchingplans,andothernonpecuniarybenefits.Becausethesebenefitsarenoteasilyquantifiableintermsofbasispoints,theyarenotincludedinthetable,buttheyarenonetheless real and shouldnotbedismissed (and they serve tomake thequantified estimatesabovemoreconservative).The secondbroker reaction, turning to thewrapfeebusinessmodel,would clearly increase investorcostsrelativetothecommissionmodel(especiallyforexistingsmall longterm investors),anoutcomethattheRIAfailstoconsider.Forthoseclientswhoaredriventosignupforadvisoryservicesunderthewrapfeemodel,theaddedcostisestimatedheretobe31basispointsperyear,whichalsoexceedstheRIAspurported25basispointbenefitfromtheDOLrule.Importantly,ourcostestimatesconservativelyalsodonottakeintoaccountoftheprospectthatfewernewcompaniesparticularlyamong small firms thatcannotafford to implementa401(k)programwouldcreateSEPorSIMPLE IRAs,andthusfewer individualswouldhaveaccesstothiskindofsavingsaccount.7Togetahandleonthedollarlevelsofnetharm(asopposedtoharmexpressedinbasispoints)imposedbytherule,considerthefollowingexample.Assumeconservativelythattheonlyassetsthatareaffectedbytherulearethe$1.487trillionaveragebaseofIRAinvestmentsinmutualfundswithafrontendloadbetween2017and2026.(Inreality,thecostsoftherulewouldbefeltbyinvestorswhorelyonbrokerassistancewithout the use of a frontend load.) Assume further that half of investors (on a dollar

7. BradfordP.Campbell,U.S.ChamberofCommerce,LockedOutofRetirement:TheThreattoSmallBusinessRetirementSavings,June2015,availableathttp://www.centerforcapitalmarkets.com/wpcontent/uploads/2013/08/USChamberLockedOutofRetirementWhitePaper.pdf(UndertheDOLsnewproposal,evenprovidingasmallbusinesswithmarketingmaterialscontainingsampleinvestmentlineupsforSEPIRAsorSIMPLEIRAscouldconstituteinvestmentadvice,ascouldprovidinganindividualaccountholderwithcertaineducationalmaterialsthatreferencethespecificinvestmentfundsthatareavailabletohimorher.Consequently,smallbusinessesmayfinditevenhardertoofferretirementplansthantheydotoday.)(emphasisadded).

4weightedbasis)losetheirbrokersasaresultoftherule,whiletheremaininghalfmaintaintheirbrokersbutareforcedtoconverttoawrapfeecompensationmodel.Thenetannualharmfromtherule,takingaccountoftheRIAsclaimedbenefits,wouldbe$1.895billion(equalto$1.487trillionx{0.5x[0.445%0.25%]+0.5x[0.31%0.25%]}.Thedamagefromtherulecouldbeevenworse.Themaximumnetharmwouldarise if100percentofinvestors in thispoolofassets lose theirbrokers, inwhichcase thenet investor losswouldbe$2.899billionperyear(equal to $1.487 trillion x [0.445%0.25%]). At the otherextreme, the minimum net harm under our model wouldresult if100percentof investors inthispoolmaintaintheirbrokersunder thewrapfeemodel,whichgeneratesa lossof$0.892billionperyear(equalto$1.487trillionx[0.31%0.25%]). In short, even our lowerbound estimates showthatthenetbenefitsofDOLrulearenegativethatis,causemore harm than benefiteven if one assumes(inappropriately, we argue) that DOLs estimated benefits(without accounting for the costs we identify here) of 25basispointsisaccurate.The net benefits (or harm) from the proposed rulealternativelycanbeunderstoodastheportionofretirementsavingsinmutualfundsthatwouldhavetobe restrained frommarket timing in a future substantialmarket correction to offset the purportedbenefitsofthefiduciaryruleclaimed intheRIA.Usingan illustrativeexampleofafuturestockmarketdownwardcorrectionof25percent,weshowthatbrokersneedtopersuadeIRA investorsholdingamere15percentofIRAaccountdollars(0.15x0.25x$1.087trillion=$40.8billion)toavoidtimingthemarketinordertototallyoffsetthe$40billionintenyearinvestorsavingsclaimedbytheDepartmentforitsproposedrule.Stateddifferently,ifhumanadvisorspersuade,roughly,justoneinsevenclientstostay investedthroughamarketdownturn, ittotallyoffsetstheclaimedDOLrulestenyearbenefits. Ifinsteadadvisorspersuadetwoofeverysevenclientstostayinvestedthroughsuchdownturns,theharmtosmallsaversfromlosingthiskindofhumanadvicecouldreachasmuchas$80billion,twicethesizeoftheDOLspurportedbenefitsfromtherule.OurresultscallfortheDOLtogobacktothedrawingboard,andeitherwithdrawitsproposalordevelopanalternativethatstandsareasonablechanceofdeliveringmorebenefitsthancosts.Fortunately,onealternativeclearlywouldmorecosteffectivelyachievetheDepartmentsobjectivetoreducethecostofconflicted advice: enhanced, but simple disclosures relating to brokers compensation from thecompaniessponsoringtheinvestmentproductstheymaysell.TheDepartmentsonlybasisforrejectingthisideaisaclaimmadewithoutanyempiricalsupportthatinvestorscouldnotprocessthisadditionalinformationifitweremadeavailable.Thisisanextremelyslimreeduponwhichtobaseanentirerulethatcouldradicallychangethewayinvestmentadviceisprovidedina$1trillionsegmentofthemutualfundmarket.How can theDepartment know theefficacyof greaterdisclosure,without at least firstgivingenhanceddisclosure intheretirementsavingscontextat leastatry?Enhanceddisclosure inthe

OurresultscallfortheDOLtogobacktothedrawingboard,andeitherwithdrawitsproposalordevelopanalternativethatstandsareasonablechanceofdeliveringmorebenefitsthancosts.

5retirementcontextcouldbeaugmentedbytheproposalsfromSIFMAthatFINRA,withtheapprovalofthe SEC, impose a best interestof the client standard for allbrokers and advisors, in all contexts,includingforretirementaccounts.TheDOLandtheObamaadministrationappeartobesignalingthattheexemptionscouldbeexpandedtoaccommodate thecontinuationofcommissions.Whatapparentlymattersmost toLaborSecretaryThomasPerez isthebestinterestrequirementforfinancialadvisors.8 Ifthat isthecase,thentheDOLshouldcallforimproved,concisedisclosurewithoutalengthy,highlyprescriptiveruleaccompaniedbya240pageRIA (and, indoingso, theDepartmentwouldbeacting inmannerconsistwith the iterative,targetedapproach to information technologychallenges that theAdministration is tobecommendedfor initiatingthroughoutthefederalgovernment,aswediscussfurtherbelow).Thebenefitsfromthatapproach implemented the rightwaywould surelyoutweigh the relativelymodest compliance costs,andthenDOLcouldmonitortheresultsintheyearsaheadtogaugeprogress.

I. THEDOLPROPOSALANDREGULATORYIMPACTANALYSIS:AQUICKGUIDETheDOLoverseesandsetsstandards,undertheEmploymentRetirement IncomeSecurityAct (ERISA)andthe InternalRevenueCode(IRC),foranyonewho ispaiddirectlyor indirectlytoprovideadvice inconnectionwithindividualorcompanysponsoredretirementfunds.Financialinvestmentprofessionals,including stock brokers and financial advisors, have a responsibility to recommend investments,consistent with a clients financial status, investment objectives and experience, and risk tolerance,among other factors. The Financial Industry Regulatory Authority (FINRA) enforces this suitabilityrequirement.9Manybrokersandadvisorsactasthedistributionarmsformutualfundsandarecompensatedfordoingso in various ways, including sharing in sales commissions or load shares, which the Departmentestimatestobe150basispoints in2013,fallingovertimeevenwithouttheproposedruleto103basispoints by 2026.10 TheDepartment is apparently not satisfied that these commissions are falling fastenough.BrokersandadvisorsareallowedtobecompensatedbyprovidersofinvestmentproductsunderoneofmanyProhibitedTransactionExemptions(PTEs)establishedbytheDepartment,oriftheydonotmeetoneof the five testsestablishedby theDepartmentby rule in1975 fordefininga fiduciary.Thekeyelementsof this testare that the investmentadvicebegivenona regularbasis, iscustomized to theparticular circumstances of the client, and that the advice serves as the primary basis for a clientsinvestmentdecisions.

8. JaretSeiberg,GuggenheimSecurities,QuickHit:PerezLeavesDoorOpenforChangestoFiduciaryPlan,

June17,2015(WebelieveLaborSecretaryPerezopenedthedoorforimportantchangestohisfiduciarydutyproposalaslongasitpreservesthebestinterestrequirementforfinancialadvisorstoretirementaccounts.).

9. Forasummaryseehttp://www.finra.org/investors/suitabilitywhatinvestorsneedknow.10. RegulatoryImpactAnalysis,at113,Table3.4.11.

6TheDepartmentnotesthatmuchhaschangedintheretirementmarketsince1975,includingthehugeincrease in assets invested in IRAs and companysponsored defined contribution (DC) retirementplans. Financial products have grown increasingly varied and complex.Many individuals investing inretirementaccountsdonothaveinvestmentexpertiseandareunabletojudgewhodoes,theDOLfears,andarenotawareofhowadvisorsarecompensated.In2010,theDepartmentrespondedtothesedevelopmentsbyproposingamoreexpansiveapplicationoffiduciarystandardstoallretirementinvestmentadvisors,butwithdrewthemafterstrongopposition.InApril2015, theDepartment issuedamodifiedversionof its2010proposal,whichexcludedcertaintypesofconductandtransactionsfromfiduciaryobligations,butwhichnonethelessdidlittletochangethe core featuresof the2010proposal,which subject toonequalification tobediscussed shortly, isdesignedtoprohibitbrokersandadvisorsfromreceivinganyformofcompensationfromthesponsorofany investment product they might recommendwhat the Department calls conflicted adviceregardlessoftheproductspastperformance.TheDepartmenthasconcludedthatthischangeinthelegalstandardiswarrantedforseveralreasons:

IRA (andpresumablyDC)plan investorsdeserve specialprotectionbecause there arenodooverswhenitcomestoretirementinvestinganddrawdowns.

There isanalleged failure in themarket for investmentadvice,arising from the fact thatmutual funds compensate brokers and some investment advisors via load shares whenindividuals purchase their funds from the brokers or advisors. The Departments RIAcalculatesthatthisconflictedadvicecostsinvestorsinloadfunds$8billionayear.

Disclosure of the sources of advisors compensation is insufficient to offset the marketfailure, based on purported evidence (drawn from a single experimental study) thatinvestorshave littleunderstandingof thenatureof theiradvisorsconflictof interest,andeveniftheyunderstoodthis,manyinvestorscannotdistinguishgoodadvicefrombad.

Accordingly, theDepartmenthasproposed to effectively replacemandateddisclosureswith abroadfiduciaryobligationonallbrokersandadvisorsprovidinginvestmentadviceregardingretirementplans.Theproposalcontainsanumberofexemptions,includingaBestInterestContractExemption(BICE)that would allow brokers and advisors to receive commissions and 12(b)1 fees from mutual fundcompanies,butatthesametimeagreetosubmittoaseriesofotherrequirements,includingtheclearrecognition that they are acting as fiduciaries and agree to charge reasonable fees, a vagueopenendedobligationwithseeminglynobounds.11

11. TheBICEwouldcreateacontractbasedclaimagainstbrokerdealers,whichcouldgiverisetoaprivate

rightofaction.TheDOLhasnoenforcementjurisdictioninthisspace,soitsproposaleffectivelyseeksenforcementthroughprivate(mostlikelyclassaction)litigation.Asdiscussedabove,FINRAcurrentlyenforcesthesuitabilityrule.AsdiscussedfurtherinPartVbelow,FINRA(orsomecombinationofFINRAandtheSEC)couldenforcesomethingsimilartoabestintereststandard.

7TheRIAassumesthattheapplicationof itsnew,revisedfiduciarystandardwouldeliminatehalfoftheannual $8 billion in claimed underperformance of brokersold mutual funds with an upfront loadrelativeto loadfundssolddirectly.TheRIAcomesto itsannual$4billionbenefit(halfofthepotentialbenefit)by firstestimatingabaselinebroker load share,beginningat134basispoints in2017andfallingduetoincreasedcompetitionto101basispointsin2027.Inotherwords,theRIAestimates,evenwithout theDepartmentsproposed rule, that the load shareearnedbybrokerson themutual fundstheysellisprojectedtodeclineby33basispointsoverthenextdecade,beginningin2017.Sowhere do the benefits from the proposed rule come from? Based on its reading of the relevantacademicliterature,whichwecriticizeinPartIVbelow,aswellasoriginaleconometricanalysis,theRIAconcludes that a 100 basis point increase in broker load shares leads to 50 basis points of underperformance.12The reasoning for theapparent relationshipbetween load sharespaid tobrokersandunderperformanceofbrokersoldfundsisthattheloadinducesbrokerstorecommendonlythefundsforwhichtheyarecompensated(thepresenceandamountofthiscompensationisalsounknowntotheinvestors),andthesefundsturnouttosystematicallyunderperform.Byeliminatingthisallegedbiasinrecommendationsthroughtheproposedfiduciarystandardsrule,overadecade,theRIAarguesthatallcurrent IRA and defined contribution investorswill eventuallymove to fundswith the performancecharacteristicsoffundsdirectlysoldbythemutualfunds.TheRIAalsoimplicitlyassumesthatwhilethisishappening,brokerswillcontinuetoserveallsegmentsoftheretirement investmentadvicemarket,includingsmallsavers.Table3.4.11oftheRIAsuggeststhatitscalculatedimprovedperformancedifferential,whichstartsoutat 10 basis points, eventuallywill grow to 51 points in ten years, as currently held IRA and definedcontributionfundsmovetothebetterperformingfunds.Inotherwords,theRIAbelievesthatitwilltakeadecadebefore theallegedly contaminated fundswork theirwayoutof the investmentpipeline. Indollars,theimprovedperformanceaverages$4billionannuallyoverthetenyearperiod,whichonatenyear average investment base of 1.487 trillion,minus the aminimum of $240million in compliancecosts,turnsouttorepresentanannualizedbenefitofroughly25basispointsor0.25percent(equalto$3.76billiondividedby$1.487trillion).ThisstudywillshowthattheRIAsbenefitestimate isconsiderablyoverstated,andmoreoverdoesnottakeaccountof theevengreater costs to investors fromeither losingaccess to their currentbrokerbecauseof therule,ormoving toan investmentadvisorcompensatedonamoreexpensivewrap feebasis.Moreover,aswediscussfurtherbelow,theDepartmentseemstowanttohave itbothwayswiththeBICE.On theonehand, itseeminglywants topermitbrokers tocontinue theircurrentcompensation

12. ItbearsnotingthatoneofthestudiesrelieduponbytheDOLtodocumentthisallegedunderperformancefindsthatbrokersoldmutualfundsoverperformedthebenchmarkforcertainclassesoffundssuchasvalueweightedforeignequityfunds.Evenmoresignificant,theInvestmentCompanyInstitutefindsthattheunderperformanceassumptionisreversedwhenamorerecentstudywindow,20072013,isused.SeeTestimonyofBrianReidbeforetheSubcommitteeonHealth,Employment,Labor,andPensionsoftheHouseCommitteeonEducationandtheWorkforce,June17,2015,at3.WeofferamoredetailedrebuttaloftheacademicpapersuponwhichDOLreliesinPartIV,infra.

8arrangements so that theywillnotabandon the smallsaver segmentof the retirementmarket,asa2011OliverWymanstudyarguedinresponsetotheDepartmentsearlier2010proposal.Ontheotherhand, it argues throughout the RIA that the only source of quantifiable benefits of the proposal isimprovedinvestmentperformancebyclientswhograduallymovetheiraccountsawayfrombrokersoldload funds, which presumably comes about because the proposed rule eliminates such forms ofcompensation. The Department cannot have it both ways: either the rule will lead to substantialdiminutionofbrokerservicestothesmallsaversegment,ortheDepartmentwillnotdeliverthebenefitstheRIAclaimsfortherule.Therestofthisreportisorganizedasfollows:InPartII,weprovideabriefbackgroundonhowbrokersare compensated for rendering valuable services. In Part III,we explain howmany brokerage firmswould likely react to the DOLs proposed rule, either by exiting the segment of the IRA marketrepresentedbyindividualswithmodestlysizedportfolios,orbyswitchingtoafeebasedadvisorymodelfor these investors. InPart IV,weestimate themultiplecosts tomiddleincome savers from reducedchoices in investmentadviceresultingfromtheDOLsproposedrulenotconsidered intheRIA.PartVoutlinesa lessburdensomeapproach thatwouldmuchmorecosteffectivelyachieve theDOLspolicyobjective.

II.BROKERSANDFINANCIALADVISORSPROVIDEVALUABLERETIREMENTSAVINGSSERVICESTOMIDDLEINCOMESAVERSTHATTHEPROPOSALANDITSREGULATORYANALYSISFAILTOCONSIDEROverthepastfourdecadesorso,middleincomeAmericanshaveturnedpredominantlytotaxdeferredinvestmentaccounts,eitheron theirown (IRAs),or throughcompanysponsoreddefinedcontribution(DC)planstosaveforretirement.Whenindividualsleavetheirfirmsorretirefromthem,theyoftenrollovertheirbalancesintotheIRAaccounts.AbouthalfofallIRAaccountbalancesincludesomerolloverfunds.13According toa2011OliverWyman study,89percentof IRAassetswereheld in traditionalIRAs,whichincludesbothcontributoryandrolloverIRAs.14TheRIAandaccompanyingdocumentsontheDOLswebsitemakeclearthatsaversforretirementrelyonmultiplesourcesofadviceforhowtoinvesttheirfunds.15AbouthalfrelyonfamilyandfriendsortheInternet,butaboutthesamenumberrelyonpaidinvestmentadvicefrombrokerdealersorregisteredinvestmentadvisors, the twogroupsofprofessionalswhom theRIAacknowledgeswouldbemostbeaffectedbyitsproposedfiduciarystandardsrules.16Despitenoddingtothepotentialimpactoftherulesonthesupplyofbrokerrelatedservices,theRIAlargelydiscountstheseeffects,andessentiallyassumes

13. RegulatoryImpactAnalysisat54(RolloversfromemploymentbasedplansaccountformostIRAfunding.AlmosthalfofallIRAsincludeatleastsomerolloverfunds.).

14. OliverWyman,AssessmentoftheimpactoftheDepartmentofLaborsproposedfiduciarydefinitionruleonIRAconsumers,Apr.12,2011,at9(Figure5).

15. RegulatoryImpactAnalysis,at53.16. Id.at55(DependingonaRIAsparticularcustomerbaseandbusinessandcompensationmodel,itmay

bemateriallyaffectedbythisrule.).WediscussthisadverseimpactonbothbrokersandRIAs,andtheircustomers,morefullyinthetextbelow.

9thatbrokerscontinueprovidingadvice to thesameclienteleasbefore,butwithout theconflicts thatallegedly lead to their clients to invest in underperforming mutual funds. Before documenting thisoversightand critiquing the conclusionaboutunderperformance,webriefly reviewhowbrokersarecompensatedandthenatureoftheirservices.A. Background on How Brokers Are Compensated for Rendering ValuableServicesTherearetwoprimaryIRAbusinessmodelsthatserveindividualswithIRAsavingsaccounts:(1)advisoryIRAs, which offer continuous advice such as investmentspecific advice, portfolio monitoring, andaccount surveillance; and (2) brokerage IRAs, which involves noncontinuous help and investmentserviceswithregularaccesstoabroker(forfullservicebrokerageIRAs)orlimitedpersonalcontact(fordiscountbrokerageIRAs).17Importantly,feesonadvisoryIRAaccountsarealmostalwaysstructuredasawrapfeethatis,theclientischargedannuallyapercentageofhisorheraccountassets.Incontrast,brokeragefirmsarecompensatedthroughtransactionspecificdirectcommissions,annualaccountfees,andvariousindirectsourcesofcompensation(suchasmarketinganddistributionfees,socalled12(b)1fees,paidbymutualfunds).Discountbrokeragefirmsgetpaidthesamewayasfullservicebrokers,albeitwithreducedfees.AccordingtotheRIA,41percentofIRAaccountholdersholdtheirfundswithbrokerdealers;forthosewithportfoliosof$10,000orless,32percenthavetheiraccountswithbrokers.18ADeloitte2014study,which is posted on theDOLswebsite announcing the proposed rule and the RIA, indicates that 43percentofsurveyrespondentsIRAswereheldinabrokerage;thestudydoesnotprovidedetailonthetypeofcompensationused.19Brokersprovidemyriadbenefitstoinvestors,includingadvicerelatingtobroaderdiversificationandriskreduction. The economics literature recognizes that investors voluntarily and knowingly pay fees inexchange for these benefits.20Most importantly, brokers prevent investors from engaging inmarkettiming; theyassist investors in rebalancing theirportfolios;and theyencourageclients to fullyexploit

17. OliverWyman,AssessmentoftheimpactoftheDepartmentofLaborsproposedfiduciarydefinitionruleonIRAconsumers,Apr.12,2011,at6.

18. RegulatoryImpactAnalysis,at53(Figure3.1.13).19. AdvancedAnalytical&Deloitte,FinancialAssetHoldingsofHouseholdsintheUnitedStates,2014Update,

Table7,Oct.13,2014,availableathttp://www.dol.gov/ebsa/pdf/conflictsofinterestreport3.pdf.TheothertypesofinstitutionswhererespondentsIRAswereheldincludecommercialbanks(45.7percent),savingsloan/bank(2.1percent),CreditUnion(1.4percent),InsuranceCompany(1.5percent),andInvestment/ManagementCompany(0.8percent).

20. See,e.g.,Kihn(1996)(demonstratingthatmutualfundsfeesareatleastpartlyexplainedbyadesireonthepartofinvestorsforcustomerservice);Chalmers&Reuter(2014)(showingthatsaversaremorelikelytoseekbrokerrecommendationswhentheyhavelowerlevelsoffinancialliteracy);DelGuercio&Reuter(2014)(nearlyallmutualfundshareholdersindicatethattheyhavehadcontactwiththeirfinancialadvisorintheprior12months,andthattheyhavebeenreceivinginvestmentadvicefromthisadvisorforamedianof10years);Gennaioli,Shleifer&Vishny(2014)(brokerclientsmayrationallyacceptlowerexpectedreturnsinexchangeforthebrokerservicestheyperceiveashigherquality,suchasthepersonaltrustthatcomesfromrepeatedfacetofacecontact).

10their employersmatchingprograms. Thebenefit relating to avoidingmarket timing isparamount intermsoftheimpactoninvestmentoutcomes;whetheraninvestorstaysinornotoverlongtimeframesswampstheeffectsofeverythingelse.In Part IV,we document and attempt to quantify these benefits that brokers and advisors provide,includingencouragingtheirclientstosavemorethantheyotherwisewould(thatis,thepotentialcostoftherule).21Manyofthesebenefitsarepecuniaryinthattheymanifestinhigherreturnsfortheinvestororhighersavings.Others,suchaspieceofmind,arenonpecuniary,butcouldstilljustifyafeeorevenalowerreturn.B. TheDOLsProposalFails toConsiderMultipleBenefitsProvidedbyBrokersandAdvisorsBy narrowly focusing on their compensation arrangements from mutual fund providers, the DOLsproposed rule and the RIA ignore multiple benefits that brokerdealers and registered investmentadvisors bring to clients. The RIA casually dismisses these benefits: Although we acknowledge thepossibility that factors other than conflicts of interest could be at play, we do not find enoughcompelling evidence or justification to challenge our conclusion.22 The Department needs to lookharder.TheRIAacknowledgesthatthebrokersdeservefaircompensationfortheirservices.23Thereportalsoacknowledgessomesupportintheacademicliteraturefortheideathatatleastofsomeofbrokersfeescan be interpreted as fair payment for financial services that yield consumer benefits other thanimprovedinvestmentperformance.24Butwithoutanyempiricaljustification,theRIAgoesontoassertthatnoneofthischallengestherobustevidencethat investorsdonotunderstandthecostoftheiradvisorsservicesandcannotdeterminewhetherthevalueofthoseservicesoutweighedtheircost.25Moreover, theRIA is completely silenton thewelldocumented finding thatbrokersencourage theirclients tosaveand theyaresuccessfulatdoingso.26Thereportalso ignores the findings thatbrokers

21. See,e.g.,DanielBergstresser,JohnChalmers&PeterTufano,AssessingtheCostsandBenefitsofBrokers

intheMutualFundIndustry,22(10)REVIEWOFFINANCIALSTUDIES41294156,4131(Brokersmayhelptheirclientssavemorethantheywouldotherwisesave,theymayhelpclientsmoreefficientlyusetheirscarcetime,theymayhelpcustomizeportfoliostoinvestorsrisktolerances,andtheymayincreaseoverallinvestorcomfortwiththeirinvestmentdecisions.).SeealsoLIMRA,AdvisorsPositivelyInfluenceConsumersBehaviorandSentimentTowardPreparingforRetirement,July11,2012,availableathttp://www.limra.com/Posts/PR/News_Releases/LIMRA__Advisors_Positively_Influence_Consumers__Behavior_and_Sentiment_Toward_Preparing_for_Retirement.aspx?LangType=1033(showingthatconsumerswhorelyonfinancialadvisorsaremorelikelytobesavinginaretirementplanandtobesavingatahigherratethanthosewithoutanadvisor).

22. RegulatoryImpactAnalysis,at22.23. Id.at97(Alsoasdiscussedearlier,however,availableevidencesuggeststhatonlyafractionofthe

performancegapcanbeattributedtofaircompensationforservices.).24 Id.at94(citingFoersteretal(2014)).25 Id.at94.26. SeePartIV,infra.

11helpreduceinvestorstendencytounderdiversifyinlocalstocksbyovercomingthehomebiaseffect.27The RIA instead infers that because broker fees involve opaque and complex structures, brokercompensationmustbeunfair.While sucha factpattern (if true)gives rise to thepossibilityofunfairpricing, it ismerely anecessary condition,not a sufficientone, for adopting a rule that, inpractice,would make the brokerage commissionbased business model uneconomic when serving manyinvestors,especiallythosewithmodestretirementportfolios.Inanyevent,anyallegedunfairnessofthebrokeragerelationship isunrelatedtothe issueofwhetherbrokersoffervaluableservicestotheirclients,whichtheRIAdoesnotevenattempttoitemize,letalonequantify.TheDepartmentsRIAfailstoprovideanyanalysisorestimatesofthebenefitsofthehumanadvicethatbrokersandfinancialadvisorscompensatedonacommissionbasisprovide.AndthebasesonwhichtheRIAdismissesthesebenefitsareflimsyatbest:

OvercomingBehavioralQuirks:TheRIAcitesasinglestudybyMullainathanetal(2012)forthepropositionthatbrokersfailtopreventinvestorsfrombehavioralquirks,andifanythingmake them worse.28 The authors of this unpublished working paper concede that theirresultsareintriguing,buttheyarealsoonlyafirststepinwhatisaveryimportantresearcharea.29Wecitecontraryevidencebelow.

Rebalancing:TheRIA citesa single studybyBergstresseretal (2009) for thepropositionthatbrokersprovide investorswithnohelp inallocatingtheir investmentsacrossdifferentassetclassesatagivenpointintime.30Whetherornotthisistrue,itisindependentofthepointthatgoodadvisorshelpinvestorsrebalanceovertime.TheRIAconcedesthatadvisorsofferrebalancingadvice,butsuggeststhatsuchadvicecouldalternativelycomefromroboadvisors31 or could be achieved at lower cost through a timedenominated fund.32 TheDepartmentsspeculationmaywellbe true,but itdoesnotdispute the fact thatadvisors(includingbrokers)providerebalancingadvice(whichwelaterquantify).

AvoidanceofMarketTiming:TheRIA citesa single studybyBullardetal (2008) for the

propositionthat load investorsdisplaysignificantlypoorertimingthannoload investors.33

27. Bergstresser, supra,at4149 (finding that brokersold fundsaremore likely to invest in foreign funds,suggesting that the broker channel may somehow combat the homebias effect, where investors appear tooverinvestinlocalsecurities.).

28. RegulatoryImpactAnalysis,at94.29. SendhilMullainathan,MarkusNoeth,&AntoinetteSchoar.TheMarketforFinancialAdvice:AnAudit

Study,NBERWorkingPaper17929(2012)at18.30. RegulatoryImpactAnalysisat92.Bergstresseretal(2009)defineassetallocationbyaskingwhether

brokers,inaggregate,channelmoneytowardassetclassesinawaythatreflectsanabilitytotimemovementsinbroadmarketperformance.Bergstresseretal(2009)at4142.Bythisdefinition,assetallocationinvolvessuperiormarkettimingrecommendations,shiftingbetweenstocks,bonds,andcashinadvanceofmarketmoves.Id.

31. RegulatoryImpactAnalysis,at231.32. Id.at102n.196(Forexample,anadvisormightrecommendthatanIRAinvestorconstructadiversified

portfoliobybuyingseveralmutualfunds(andperiodicallytradingtorebalancetheportfolio)incircumstanceswherethesamediversificationandexpectedreturncouldbeachievedwithlesstransactioncostbybuyingasingle,internallydiversifiedfundthatoffersongoing,internalrebalancing.).

33. Id.at92.

12

But this finding does not indict brokersold funds, in particular, nor does it rebut theproposition thatbrokersdohelp investorsavoid thedangersofmarket timing,andaswepointlater,haveincentivestodothis.

InPartIV,weestimatethevalue(inbasispointswherepossible)associatedwitheachofthesebenefitsthatare so casuallydismissedby theRIA.Beforedoing so,weexplainhow theproposed rulewouldundermineabrokersincentiveandabilitytoprovidethesebenefits.

III. DOLSPROPOSEDFIDUCIARYRULEWOULDDISCOURAGEBROKERSANDADVISORSFROMSERVINGSAVERSWITHMODESTPORTFOLIOS,TOTHEIRDETRIMENT

TheDOLsproposedrulewouldgreatlyexpandtherangeofconditionsunderwhichan individualwhomerelyprovides investmentservices inabrokeragecontextwouldbesubjecttoERISA fiduciaryrules.Facedwith thisnewduty forbrokerageaccounts,manybrokerage firmswould likely reacteitherbyexiting the segmentof the IRAmarket representedby individualswithmodestly sizedportfolios (thesmallsaver segment), or by switching to a feebased advisorymodel for these investors. The RIAdismissesthefirstpossibility,relegating ittoatransitionproblem,and ignoresthesecondpossibilityentirely.Wewant to visit each likely response in greater detail, because clientswould be adverselyaffectedbybothreactionseffectsthattheRIAessentiallyignores.InresponsetotheDepartments2010proposal,OliverWymanreleasedathoroughstudydocumentingthe likely exit of brokers from the smallsaver segment of the retirement investmentmarket.OliverWymanestimated thatbecauseof accountminimums imposedby thebrokerage firms for access toadvisoryaccounts,over7.2millionIRAswouldnotqualifyforanadvisoryaccount,andthat3.8millionofthoseaccountswouldnotbeservicedonacommissionbasisundertheproposedrule.34TheRIArebutstheseconclusionsbypointingtotwochangesfromthe2010rulethatareembodied inthe2015proposal.35OneclaimisthatunderPTE86128,brokerswouldbeabletochargecommissions,contrarytoanassumptionintheOliverWymanstudy.36ItiscuriouswhytheRIAwouldgotosuchgreatlengths in its efforts to quantify the supposed benefits of its rule, which stem from the induced

34. OliverWyman,at2,1617.Advisorfocusgroupsindicatedthatbroker/dealershavetalkedaboutaddingaccountminimumforfirsttime,whichwoulddisenfranchisesmall investors.See Investment InsightsOnline, IBDForumDOLFocus,June10,2015

35 RegulatoryImpactAnalysis,at223,19n.37.36.Toqualifyforthisparticularexemption,however,brokerswouldneedtosupplytheDepartmentwith

substantialinformation,whichcouldbeverycostly,althoughtheRIAcontainsafootnotesayingtheseinformationconditionsdonotapplytoIRAs.Morefundamentally,indescribingPTE86128,theRIAstatesthatitsreliefonlyappliestoafeetosuchfiduciaryoritsaffiliateforeffectingorexecutingsecuritiestransactions.Id.at18(emphasisadded).Itisnotatallclearthatthisexemptionwouldcovertheexistingloadpaidtobrokerstocompensatethemforthetimetheyspendinforminganddiscussinginvestmentoptionswiththeirclients,timewhichgoesbeyondmeresecuritiesexecution.Morebroadly,accordingtoonecommenter,theDOLhashistoricallybeenverynarrow,slowandrigidintheirPTEapproach.SeeU.S.ChamberofCommerceVowstoUseEveryToolAgainstDOLFiduciaryPlan,THINKADVISOR,Mar.3,2015(quotingDavidHirschmann,presidentandCEOoftheChambersCenterforCapitalMarkets).

13disappearanceoftheallegedbrokerdistortioninmutualfundchoices,iftheruleinfactdidnotprohibitcommissionsonthesaleofloadmutualfunds.Putanotherway,theentireevidentiaryrationalefortherulethusdependsonindividualbrokersnolongerreceivingcommissions.TheDepartmentmight respond to this lineofargumentbypointing to itsBICE,which itdesigned topermitsecuritiesandinsurancebrokeragefirmstocontinuereceivingcommissions,butwhichdoesnotdosoforindividualbrokers.37Inanyevent,eveniftheBICEweremorebroadlyconstrued(orchanged)tocoverindividualbrokers,thentheabilityofbrokerstocontinuereceivingcommissionsclearlywouldundercutRIAsempiricalanalysisofthebenefitsoftherule,whicharepredicatedonthose loadsharecommissions(andtheallegedassociatedunderperformance)goingaway.In fact, the BICE carveout can only be claimed if brokers agree to a series of obligations, whichcumulativelymeanthatrelativelyfewcanreasonablybeexpectedtodoso.Asoneseasonedfinancialprofessional,DeanHarman,recentlytestifiedbeforeaCongressionalcommittee,toqualifyfortheBICEabrokerandhisfirmwouldhaveto:38

Enter intoacontractpriortohavingameaningfulconversationwithapotentialclient,evenatanearlystageintheprocesswhenthebrokeroradvisoristryingtoestablishpersonaltrustwiththeclient;

Recommendonlyassetsonanapprovedlist(which,likeanyotherexemptionstoLaborsrules,

wouldbedifficulttochange); Provide very detailed disclosures which, among other things, require the broker to make

performanceprojectionsfortheclientsinvestmentsinordertocalculateprojectedcostratios,a requirement that could put theDOL rules in conflictwith SEC and FINRA rules prohibitingperformance objections (we do not reject the idea of strengthened simplified disclosures,however,asdiscussedinPartV,infra);

Provideverydetailedandupdated,brokerspecific,disclosuresoffeesontheInternet; Maintainforsixyearsverydetailed,prescriptiverecordson,amongotherthings,thequarterly

returnsforeachadvisorsclientportfolios; Charge reasonable compensation for their efforts, without any guidance as to what

reasonablemightbe;

37. ProposedBestInterestContractExemption,FederalRegister,Vol,80,No.75,April20,2015,at21971.38. TestimonyofDeanHarman(founderandmanagingdirectorofHarmanWealthManagement),beforethe

SubcommitteeonHealth,Employment,LaborandPensionsoftheHouseCommitteeonEducationandtheWorkforce,June16,2015,at1521.

14

Liveunderthreatoflitigationforfailuretoenforcecontractsforadvice,whichnotonlyfailstorecognizethatbrokerandfinancialadvisorsarealreadyregulatedbyFINRA,butataminimumwillincreasethecostofliabilityinsuranceforthesefinancialprofessionals.

Incombination,theserequirementsaresorestrictiveandpotentiallycostlythatfew,ifanybrokers,arelikelytoadheretothem,especiallyintheirdealingswithsmallersaverswithmodestportfolios,inordertoreceiveabenefittheabilitytocontinuechargingcommissionsthatalsoishighlyrestrictive,inthatonlyfirms,butnotindividualbrokers,wouldbeabletoreceivecommissions.Thus,theRIAsdismissaloftheOliverWymanestimatesonthegroundsthatbrokerscancontinuecollectingcommissions ismuchtoofacile.Morebroadly,theRIAassumesnaivelythatbrokersintheabsenceofaloadcommissionwouldcontinueservingindividualsinthissegmentundertheproposedrule.AccordingtotheRIAsprediction,investorswouldmove over time to funds that performmore like activelymanaged funds sold directly. Basiceconomicsimpliesthatmanybrokerswouldabandonasubstantialnumberofthesesmallsaverclientswhenconfrontedwithenhancedlegalrisksandcostsofdoingso.Thus,manyoftheseinvestorswouldbe leftwithout investmentadvicewhenrollingover theiremployerplan funds into IRAsupon leavingtheirfirmsorretiring,or inmakingnewcontributions.And if investorsare leftontheirown,howcantheDepartmentconfidentlyclaimtheywillmove,onaverage,tobetterperformingfunds?Maybethatiswhy the RIA notes that even if the purported benefits of the rule are cut in half, they still exceedcompliancecosts(ignoring,asweshowinPartIVbelow,thecoststoinvestorsfromlosingotherbenefitsprovidedbybrokers).Alternatively,smallsaversandother IRAanddefinedcontribution investorswhoarenowservedonacommissionbasecouldbesteered(bythenondefectingadvisors)intoacompensationarrangementonawrapfeebasis,chargedasapercentageof theiraccountbalances. It iswithoutquestion that theseinvestorswouldfaceincreasedcostsfromdoingso,costswhichtheRIAtotallyignores.According toOliverWyman, an investors costs associatedwith a forced transition to thewrapfeemodelwould increase by approximately 75 to 195 percent, depending on the size of the investorsassets.39Forexample, foran IRAwithbetween$50,000and$100,000 inassets, theaveragecost forbrokerage accounts is $230; by comparison, the average cost for feebased accounts is $555, a 142percent increase.40Thesehigher feeswouldeatawayan investorsretirementsavings:Ahypothetical40yearold individualwith$25,000 inanIRAand25yearsofsavingwouldhaveanadditional$24,000(8%)ofretirementsavingsavailableatage65underthebrokeragemodel,incomparisontotheadvisormodel.41Eightpercentagepointsover25years is theequivalentofacumulativeaveragegrowth rate(CAGR)of31basispoints(or0.31percent),anamountthatexceedsthe25basispointsofbenefitstheRIAclaimsfortheproposal.

39. OliverWyman,at2123.40. Id.at22.41. Id.at23.

15Another illustration shows the added costs of forcing small longterm savers to switch from acommissionfundedmodelofadvicetoafeebasedmodel.Considerahypotheticalfamilythat invests$100,000 for the long termbasedon itsadvisors initial recommendationsandhasagreed topayanupfrontcommissionforadvice.Thefamilymembersarenotinterestedinahigherlevelofservicewithannualwrap fees; they justwant tobuyandhold.According toananalysisby theCapitalGroup, thecumulativetenyearcostofadviceunderthefeemodel(a1.1percentannualplatformfee)is$18,432,whereas the comparable costof the commissionmodel (amaximum3.5percent commission feeonClassAshareswithanannual0.25percent12(b)1 fee) is$11,265.42 Ineffect, forcingsuch families toconverttothewrapfeemodelwouldcausethemtopaytwiceforthesameinvestments.Itfliesinthefaceof reason topunishsmall longterm investors in thisway,when theyarecurrentlydoingexactlywhattheDOL(andallsensibleadvisors)wouldwantthemtodothatis,saveviaqualityfundsforthelongtermat lowcostbecauseany loadhasbeenamortizedandtherecurringannualcostofadvice isjust25basispoints.Itwouldmeanthatmillionsofsaverswouldbeharmedbytheproposedrule.ThecoststosaversfromDOLsproposedrule identified inthissectionareonlythebeginning.BrokersprovideothersortsofvaluableadvicethataretotallyignoredintheRIA.Losingthatadvicewouldleadtotheadditionalcostsasdescribedandquantifiedbelow.

IV. THEMULTIPLECOSTSTOMIDDLEINCOMESAVERSFROMREDUCEDCHOICESININVESTMENTADVICERESULTINGFROMDOLSPROPOSEDRULENOTCONSIDEREDINTHEREGULATORYIMPACTANALYSIS

TheRIAignoresimportantbenefitsofbrokersthatgobeyondthechoiceofaparticularfundthatwillbelostbythose investors, includingcorrectionsforbehavioralquirkssuchasmisplacedattemptstotimethemarket or the failure to rebalance. In addition,without a broker, some investorswill save lessbecause they will be less disciplined or fail to match their employers contributions to definedcontributionplans.Noneofthesecostswastaken intoaccount intheDepartmentsRIA,whicharrivedatamodest$240to$570million inannualcostsoftherulebyfocusingonlyonadvisorscompliancecost(suchasdevelopingandkeepingdisclosureformsandcustomerguides).43Thissectionconcludesbycritiquing the Departments interpretation of the academic studies on which it relies to derive itsclaimedinvestorsavingsof$4billionperyearoverthenextdecade.

42. SeeCapitalGroup,NewFiduciaryRegulationsMayHurtMiddleClassInvestors(assumesa6percent

annualreturnanda0.40percentmanagementfee).43. RegulatoryImpactAnalysis,at8(TheDepartmentnonethelessbelievesthatthesegainsalonewouldfar

exceedtheproposalscompliancecosts,whichareestimatedtobebetween$2.4billionand$5.7billionover10years,mostlyreflectingthecostincurredbynewfiduciaryadvisorstosatisfyrelevantPTEconditions.).

16A. MiddleIncome SaversWhoWouldNotUse InvestmentAdvisorsBecause oftheProposedRuleWouldIncurSignificantCostsItshouldnotbelostonthereaderthatsomeofthebestdocumentationofthebenefitsofprofessionalinvestmentadvicecomesfromVanguard,44whichhasbeena leader inproviding lowcost investmentssuchas stock index funds,whichDOLs rule seeminglywants toencourage.Vanguardestimates thatadvisorsarecapableofprovidingaddedvalueaddedfortheircustomersrelativetotheaverageclientexperienceof54additionalbasispointsforbehavioralcoaching(whenweightedacrossselfdirectedinvestorswhodoanddonotengageinbehaviorconsistentwithmarkettiming)and35additionalbasispointsforrebalancing. Evenifthetypicalbrokerorfinancialadvisorwhonolongerwould serve the smallportfolio segmentof the retirementmarketbecauseoftheruleprovidedbenefitsonlyonethirdofthoseprovidedbythecapableVanguardadvisor,orabout30 basis points (equal to 0.33 x [54 + 35]), these forgonebenefits alone would exceed the purported annualizedbenefitsof25basispointsclaimedintheRIA.

1. Costs Due to Increased MarketTimingIndividual investorsareknowntodisplaycertainbehavioralquirks, which have been well documented, mostprominently in the bestselling bookNudge.45Humans arenaturally emotional, are influenced tremendously by thewaya choice is framed,and they try tomake complicateddecisions with heuristics or rules of thumb. Investmentadvisors are critical in serving as dispassionate observers, counterbalancing the behavioral quirks ofindividual investors,which canbedangerous to their financialhealth. Forexample,actual investorreturnsintogivenfundstendtotrailtheassociatedtimeweightedfundreturnsofthosebyonetotwopercent, indicatingthat investorsengage inperformancechasing(that is,buyingafundrightafter ithasperformedwell).46Some of the best research on the benefits of investment advice comes, perhaps surprisingly, fromVanguard, the advisory firm that introduced theworld to index investing. The largest benefits fromadvisorsderivefromacategoryVanguardcallsbehavioralcoaching.47Thereportprovidesexamplesofwhat itmeansbythisterm:Persuading investorsnottoabandonthemarketswhenperformancehas

44. Vanguard,Puttingavalueonyourvalue:QuantifyingVanguardsAdvisorsAlpha,March2014[hereafterVanguardAdvisorAlpha].Availableat:http://www.vanguard.com/pdf/ISGQVAA.pdf.

45. RICHARDH.THALER&CASSR.SUNSTEIN,NUDGE:IMPROVINGDECISIONSABOUTHEALTH,WEALTH,ANDHAPPINESS(YaleUniversityPress208).

46. VanguardAdvisorAlpha,at17.47. Id.at16.

Vanguardestimatesthatadvisorsarecapableofprovidingaddedvaluefortheircustomersrelativetotheaverageclientexperienceof54additionalbasispointsforbehavioralcoachingand35additionalbasispointsforrebalancing.

17beenpoorordissuadingthemfromchasingthenexthotinvestmentthisiswhereyouneedtoremindyourclientsoftheplanyoucreatedbeforeemotionswereinvolved.48Toestimatethisbenefit(theavoidanceofmarkettiming),Vanguardanalyzedtheperformanceofover50,000 selfdirected Vanguard IRA investors over the five years ended December 31, 2012, whichincludesthedownturnof200809 (thecontrolgroup).Selfdirected investorsbydefinitiondonotusebrokerassistance.VanguardcomparedthesereturnstothereturnsoftheapplicableVanguardTargetRetirementFundsforthesamefiveyearperiodthesefundsserveasaproxyforadvisorassistedfunds(thetreatmentgroup).Theyfoundthatinvestorsinthecontrolgroupwhoexchangedmoneybetweenfundsorintootherfundsfaredconsiderablyworsethanthetreatmentgroup.Inshort,thetreatmentofusinganadvisorseemstoaddconsiderablevalue.Inparticular,theVanguardstudyfoundthattheaverageinvestorwhomadeevenoneexchangeovertheentirefiveyearperiodthrough2012(accountingfor27percentofthesample)trailedtheapplicableVanguardtargetdatefundbenchmarkby150basispoints.49Evenselfdirectedinvestorswhorefrainedfromsuchactivity(accountingfor73percentofthesample)laggedtheTargetRetirementbenchmarkby19basispoints.50Totheextentthatanadvisorcanpreventmarkettiming,advisorscanbecreditedwithincreasing their clients returnsby roughly54basispoints inexpectations (equal to0.27 x150basispoints+0.73x19basispoints).This54basispointsservesasthehighendofourestimatedbenefitsofbrokeradvice,with0beingthelowerbound.Themidpointbetweenthesetwoextremes,or27basispoints,isourworkingestimateofthevalueofbrokeradviceagainstmarkettiming.Itbearsnotingthatbecausebrokerscontinuetoearn12(b)1commissionsso longastheirclientsremain inthemarket,andthose12(b)1feesare linkedtoaccountvalueswhichover timeare likely tobegreater ifclientsdonotattempt to time themarket,brokers have a clear incentive to discourage clients from abandoning themarket at rocky times, anincentivethatisalsoalignedwiththeirclientsbestlongtermfinancialinterest.Thatincentivewouldbeextinguishedunder theproposed rule (whosebenefits arederived frommaking certain assumptionsaboutotherkindsofincentivesbuiltintobrokercommissions).Analysis by Capital Groups research department supports the Vanguard findings, and if anything,demonstrates even more dramatically the potentially huge opportunity costs of trying to time themarket. For example, the hypothetical value of $1 invested in the S&P 500 Index in 1926 andcontinuously kept in themarket through its oftentumultuous ups and downswould have grown to$4,666bytheendof2013.Ifthesame investorhadbeenoutthemarketduring its45bestmonthsofperformanceduringthatlongstretch,theinvestorsnesteggbytheendof2013wouldhavebeenjust$18,even less than the$21heorshewouldhavehadbykeeping thatdollar in30dayU.S.Treasurybills.

48. Id.49. Id.at17.50. Id.

18OrconsideranothersetofcalculationsaBuyandHold investment intheS&P500 IndexbyfinancialanalystBarryRitholtzfortheyears19932010:51

Thetenbestdaysaccountfor50percentofthebuyandholdperformance(roughly0.2%ofthedaysfrom1993toAugust2010).

TheClassicBuy&Holdnets$324,330.15,butmissingthetenbestdaysgivesupmorethan50percentoftheBuy&Holdperformance:$156,354.12

And if you are not convinced by all this, consider the recent study by another investment advisor,Dalbar,whichfoundthatoverthepasttwodecadesthrough lastDecember,theaveragestockmutualfund investorearnedonly5.19percent,4.66percentagepoints lowerthanthe9.85percentreturnfortheStandard&Poors500stockindex.Theaverageinvestorinbondfundsdidevenworse,laggingtheBarclaysAggregate Bond index by 4.71 percentage points.52 This gap between available returns andthoseactuallyrealizedbyreallife investorscomes fromenteringandexitingthemarketatthewrongtimeratherthanstayinginvestedforthelongterm.Allthisistosaythatdrivinginvestorstofundstoavoidclaimedunderperformance(aresultwequalifyelsewhereinthisstudy)doesnotcomparetotheforegoneearningsofaninvestorwhotriestotimethemarketandmisses,whichthebestofprofessional investorsoftendo.Havingabrokeroradvisorwhocalls, not just sends an email or an investment letter in the mail, to remind investors saving forretirement to stay in themarket is extremely valuable,particularlyduringbadmarketperiods. Suchhuman advicewhichwould disappear formany investors under the rule and to the extent roboadvicereplaceshumancontact,whichtheruleappearstoencouragecanprovidehugebenefitsthatswampthebenefitestimatesoftheproposedrule.Onefinalwaytoillustrateconcretelythevalueofinvestmentadvicethatdetersmarkettimingistoask:WhatportionofretirementsavingsinmutualfundswouldhavetoberestrainedfrommarkettiminginafuturesubstantialmarketcorrectiontooffsetthepurportedbenefitsofthefiduciaryruleclaimedintheRIA?Considerafuturestockmarketdownwardcorrectionof25percent,oronealittlemorethanhalfassevereastheonethatoccurredin200809,aneventthathasoccurredtwiceinthepasttwodecades(the bursting of the Internet bubble in 2000 and the financial crash of 2008).53 Taking the RIAsestimate of IRA assets held in mutual funds with a frontend load in 2017 of $1.087 trillion, andassumingthatjustonequarterofthisamountweresoldatornearthemarketbottomandwouldnotbereinvesteduntilstockpriceshadrecoveredtheirloss,suchacorrectionwouldwipeoutover$250billionof investorwealth. Compare this to the cumulative $40 billion in purported costs over ten years ofinvesting in mutual funds characterized by conflicted advice. This exercise shows that brokers or

51. BarryRitholtz,MissingBest&WorstDaysofS&P500,RitholzBlog,Sept.14,2010,availableathttp://www.ritholtz.com/blog/2010/09/missingbestworstdaysofsp500/.

52. AsreportedinJeffSommer,TheHighCostofInvestingLikeaDaredevil,NEWYORKTIMES,June7,2015,availableathttp://www.nytimes.com/2015/06/07/yourmoney/thehighcostofinvestinglikeadaredevil.html?ref=business.

53. See,e.g.,YardeniResearch,MarketBriefing:S&P500Bull&BearMarkets&Corrections,June1,2015,Figure2,availableathttp://www.yardeni.com/pub/sp500corrbear.pdf.

19advisorsneedtopersuadeIRAinvestorsholdingamere15percentofIRAaccountdollars(0.15x0.25x$1.087trillion=$40.8billion)toavoidtimingthemarketinordertototallyoffsetthe$40billionintenyearinvestorsavingsclaimedbytheDepartmentforitsproposedrule.Andthiscalculationassumesnoother investmentbenefitsaregeneratedbybrokersandadvisors; an assumption shown tobehighlyconservativebelow.Putdifferently, ifhumanadvisorspersuade justone insevenclientstostay investedthroughamarketdownturn,54ittotallyoffsetstheclaimedDOLrulestenyearbenefits,whichaswehavealreadyshown,are spurious. If instead advisors persuade two of every seven clients to stay invested through suchdownturns,theharmtosmallsaversfromlosingthiskindofhumanadvicewouldreachasmuchas$80billion.FortheDOLtoriskthewithdrawalofsuchadvicewithoutanempiricalbasisfordoingso,whensuchalossofadvicecouldimposesuchoutsizedcostsonsmallsavers,seemsinconsistentwithitsdesiretoprotecttheinterestsofinvestors.NolessanauthorityonthestockmarketthanBurtonMalkiel,authoroftheclassicRandomWalkDownWallStreetanda leadingadvocateof investing in index funds,has recentlywarnedeven theFederalReserveChairJanetYellenfromencouraging investorstomarkettime.Ashestates:thesuggestionthatonecantellifstocksaretoohighorlowcouldinducepeopletothinkthatitispossibletotimethemarket.Weknowthatinvestorsgenerallymovemoneytoandoutofthestockmarketattheexactlythewrongtimes.55Itisonethingforinvestorswithportfoliosofanysizetoreadthesewordsinblackandwhiteinaperiodofmarketcalmorrisingtrendandnodinagreement,andquiteanothertoholdtruetothemandfightback ones emotions to sellwhen themarket is seemingly crashing and your retirement nest egg ismelting.ItispreciselyatsuchtimesthatinvestorscanbenefitfromhearinganinvestmentprofessionallikeabrokerdealerorregisteredinvestmentadvisorwhoistrainedtoputMalkielswordsintopracticeeveryday.ThepossibilityofreceivingthatbenefitclearlywillbereducedunderDOLsproposedrule,asmanybrokersandadvisorswouldfindituneconomictoservealargeclassofinvestors,especiallythosewithmodestlysizedportfolios.Thesepotentiallyhugely importantbenefitsofhumanadvicethatmanyinvestors,especiallythosewithmodestretirementnesteggs,willlosearenowhereaccountedforintheRIA.

2. CostsDuetoLessRebalancingVanguard also credits advisors forprovidingup to35 additionalbasispoints to their investor clientsfromrebalancingofthemixofequities,bondsandpossiblyotherassetclasses.56Becauseaportfoliosinvestmentsproducedifferentreturnsovertime,theportfoliodriftsfromitstargetallocation.Failingtorebalance(andinsteaddriftingwiththemarkets)implieshighervolatility,puttinganinvestorsportfolioatriskoflargerlossesrelativetoabalancedallocation.

54. Thisassumesforsimplicitythatclientsholdequalsizedaccounts.55. BurtonG.Malkiel,JanetYellenIsNoStockMarketSage,WALLSTREETJOURNAL,June2,2015,atA13

(emphasisadded),availableathttp://www.wsj.com/articles/janetyellenisnostockmarketsage1433199503.56. VanguardAdvisorAlpha,at13.

20Toquantify thebenefits from rebalancing,Vanguard identified a rebalancedportfoliowith a greaterequityallocation thatexhibited similar riskasanonrebalancedportfolio. Forexample,a rebalanced80/20stockbondportfolioexhibitsroughlythesamestandarddeviation(astandardstatisticalmeasureofvariability)asanonrebalanced60/40portfolio (around14percent).57 Ifan investor iscomfortablewith the higher risk of the nonrebalanced portfolio, she should simply select the higher equityallocation from inception and rebalance to that allocation through time, yielding a higher return.Vanguard found that thedifference in returnsbetween the rebalanced80/20portfolioand thenonrebalanced60/40portfoliowas35basispoints.58Vanguardexplainshowanadvisorcanovercomethisadditionalbehavioralfailureofinvestorstochangetheassetmixesoftheirportfolioswhenmarketconditionschange:Whether inbullorbearmarkets,reallocating assets from the betterperforming asset classes to the worseperforming ones feelscounterintuitive to the average investor. An advisor can provide the discipline to rebalancewhenrebalancing isneededmost,which isoftenwhen the thoughtof rebalancing isaveryuncomfortableleapoffaith.59TheVanguardstudyconcludesthatadvisorswhocandirectinvestorcashflowsintothemost underweighted asset class are likely to reduce their clients rebalancing costs and therebyincreasethereturnsclientskeep.60Evenifthreequartersofallbrokersprovidedthiskindofadviceandnolongerservedinvestorsbecauseoftherule,itwouldrepresentanadditional25basispoints(0.75x0.35basispoints)offoregonebrokerbenefits,oralternatively,additionalinvestorcoststhatwouldnullifyallofthegainsclaimedbyDOLforitsrule.Weuse35basispointsasthehighendofourbenefitestimate,with0beingthe lowend,and17.5basispointsbeingthemidpoint.

3. CostsDuetoLessSavingYetanotherbenefitofferedbyadvisors thatwasneglectedby theRIA is thehigher savings ratesbysaversthatadvisorscanhelpinduce.Theabsenceofabrokeroradvisorofferingtheirservicesmayleadtoreducedsavingdirectlybecauseofthelossofcounseling,andindirectlybecauseoffewercompanysponsored 401(k) plans. Research from LIMRA, a leading life insurance and financial services tradeassociation, shows that consumers who rely on financial advisors are more likely to be saving in aretirementplanandtobesavingatahigherratethanthosewithoutanadvisor.61Thesurveyfoundthat78percentofnonretiredconsumerswhoworkedwithanadvisorcontributedtoaretirementplanoranIRA,whileonly43percentofconsumerswhowerenotworkingwithanadvisorwerecontributing totheirretirementsavings.Evencontrollingforincome,whichislikelypositivelyassociatedwiththeuseofanadvisor,LIMRA found thatconsumerswhoworkwitha financialprofessionalaremore likely tobe

57. Id.at14.58. Id.at14,FigureIII2(equaltothedifferencebetween9.71percentless9.36percent).59. Id.at15.60. Id.at15.61. LIMRA,AdvisorsPositivelyInfluenceConsumersBehaviorandSentimentTowardPreparingfor

Retirement,July11,2012,availableathttp://www.limra.com/Posts/PR/News_Releases/LIMRA__Advisors_Positively_Influence_Consumers__Behavior_and_Sentiment_Toward_Preparing_for_Retirement.aspx?LangType=1033.

21contributingtoadefinedcontributionplanorIRA.Moreover,LIMRAfoundthat61percentofinvestorswhoworkwithanadvisorsavedatahighrate(definedasdeferringmorethansevenpercentofsalaryintoaretirementplan)comparedwith38percentofinvestorswhodidnotworkwithanadvisor.LIMRAattributed thesedifferences to the role thatadvisorsplay inproviding information, recommendation,andguidance.A more recent LIMRA study from 2015 shows that investors who work with an advisor and havebetween $50,000 and $500,000 saved in their employer plan contribute more to their definedcontributionplans,62andtheyalsosavemoreoutsideoftheirretirementplans.63Thelatterresultsmaybe attributable to the fact that investors with more assets tend to use advisors more frequently.Nonetheless, the studyalso finds that [c]ontrolling forhouseholdwealth, individualswhoworkwithpaidfinancialprofessionalsaremorelikelytohaveformal,writtenretirementplansandtobeconfidentthattheyareontrackwiththeirretirementsavings.64TheupshotfromtheLIMRAstudies isthattotheextentretirementsaverswithmodestportfolios losethehumantouchofabrokerorfinancialadvisorbecauseoftherule,someofthemwilllosethebenefitsin retirement of enhanced saving over their lifetimes. TheDepartmentmade no effort in its RIA toestimatethemagnitudeofthisbenefitortotakeitintoitsbenefitcostcalculus.

4. CostsDuetoLessUseofEmployerMatchesThediscouragementofadvisoryservicesprovidedbybrokersandfinancialadvisorsduetotheproposedrulecouldprevent investors from fully takingadvantageofemployermatches incompanysponsored401(k) plans. There is already $24billion inunusedmatches lefton the table according to FinancialEngines.65 Examining 4.4 million retirement plan participants at 553 companies, the financialconsultancyfoundthatoneinfouremployeesismissingoutonreceivingthefullcompanymatchbynotsavingenough, leavinganaverage lossof$1,336 incompanyprovidedmatcheseachyear,withsomeemployeesgivingupasmuchas$20,000inemployermatchesperyear.Failingtofullytakeadvantageofanemployermatchisanotherbehaviorquirkthatcanberemediedbygoodadvice.Theproblemseemstobethatthedefaultsavingsratesthatarehardcodedbyemployersaretoolow.AccordingtoAonHewitt,thedefaultcontributionrateformostplansremainsat3percent(orless),66wellbelowthe10to15percentofannualincomethatadvisorsoftenrecommendsaverssetasideforretirement.Mostemployermatchingprogramsoffera50to100percentmatchofasmuchas6percentofanemployeessalary.Accordingly,amodestincreaseinsavings(from3to6percent)would

62. LIMRA,MattersofFact:Consumers,Advisors,andRetirementDecisions(andResults),May2015,at4,availableathttp://limraloma.dmplocal.com/dsc/collateral/Facts_about_retirement_decisions.pdf

63. Id.at6.64. Id.at16(emphasisadded).65. FinancialEngines,MissingOut:HowMuchEmployer401(k)MatchingContributionsDoEmployeesLeave

ontheTable,May2015,availableathttp://corp.financialengines.com/docs/FinancialEngines401kMatchReport050615.pdf.

66. AonHewitt,2014UniverseBenchmarks:MeasuringEmployeeSavingsandInvestingBehaviorinDefinedContributionPlans,at3,availableathttp://www.aon.com/attachments/humancapitalconsulting/2014UniverseBenchmarksHighlights_Final.pdf.

22triggerthefullemployermatch inmostcases.Removingbrokersoradvisorsfromtheequationmeansthatanyefforts toencourageemployees to savemore througheducationandpersonalizedoutreachwouldfallentirelyonemployers.B. TheBenefitsClaimedfortheProposedRuleAreOverstatedTheRIAsestimateof$4billion inannualbenefitsoftherule isbasedonaseriesofacademicstudiescitedthroughouttheanalysispurportingtoshowthatinvestorsinbrokersoldloadmutualfundsunderperform mutual funds sold directly. The RIA misuses these studies, however, and in the process,substantiallyoverstatesanybenefitsclaimedfromthem.ConsiderfirsttheChristoffersenetal.(2013)paper,whichclaimstoshowunderperformancebyover100basispoints.67Infact,thisestimatepertainsonlytotheyearinwhichthefundispurchased,buttheauthorsprovidenoestimateofunderperformanceduringallyearsforwhichthefund isheld.68This isnotaminordetailwhichtheauthorsclaimbutafundamentaloversightthatdoesnotpermitreliableconclusionstobedrawnfromthispaperaboutanyannualizedunderperformanceoffundsassociatedwithconflictedadviceoverthelongrun.In addition, Christoffersen et al. combines data from 1993 through 2009, which may not berepresentative of the current relative returns from conflicted payments. To test the robustness oftheseresults,the InvestmentCompany Instituteexaminedfundperformanceusingdatafrom2007to2013,oryearscoveringboththefinancialcrisisandthesubsequentrecovery(inGDPandstockprices)and found that funds soldwith frontend loadsoutperformedMorningstarbenchmarks. Inparticular,theICIfoundthatthesalesweightedaveragereturnsforsharessoldwithfrontendloadsoutperformedtheMorningstaraveragereturn forall fundswithsimilar investmentobjectivesby27basispointsperyear.69TheICIsanalysiscallsintoquestiontherobustnessofanyclaimofunderperformancebybrokersold funds inparticular,andataminimumhighlights the sensitivityof the results to the timeperiodexamined.Moreover, the very lowRsquaresof the regressions (thedegree towhich their statistical estimatesexplain thevariation in returns) in theChristoffersen studyof just fourpercent strongly suggest thatsomeimportantvariablesareomitted,whichifcorrelatedwithbrokersfees,wouldbiastheirresults.AnotherpapertheRIAheavilyreliesupon,authoredbyBergstesseretal.(2009),findsthatfundssoldbybrokersunderperformthosesolddirectly forcertaintypesof funds (e.g.,domesticequity funds),but

67. SusanChristoffersen,RichardEvans&DavidMusto,WhatDoConsumers'FundFlowsMaximize?EvidencefromTheirBroker'sIncentives,68JOURNALOFFINANCE20135(2013)(theaverage2.3[percentagepoints]paymenttotheunaffiliatedbrokeranIRAinvestororothercustomercanexpecta1.13[percentagepoint]reductioninannualperformanceofthemutualfund).

68. ForfurthercritiquesofthisandotherstudiesrelieduponbytheRIA,seeNERA,ReviewoftheWhiteHouseReportTitledTheEffectsofConflictedInvestmentAdviceonRetirementSavings,Mar.15,2015,at6,availableathttp://www.nera.com/content/dam/nera/publications/2015/PUB_WH_Report_Conflicted_Advice_Retirement_Savings_0315.pdf.

69.ReidTestimony,at3.

23overperform forother types (e.g.,valueweighted foreignequity funds).This ishardlyconsistentwiththeRIAs claim thatbrokerage services costs consumers50 to100basispoints for theentiremutualfund market. Moreover, brokersold funds are defined by Bergstesser et al. as those sold by anyintermediary, which can include a bank, a brokerage firm, or a noncaptive thirdparty broker; bycombining a varietyofdistribution channels, the studydoesnotpermitone to isolate theeffectsofbrokerinvolvementalone.TheRIAalsoerrsbyfocusingontheaverageperformanceoffundsratherthanofinvestorsinfunds.Yetthereturnsofanyparticularfundmayormaynotreflectthereturnsearnedby investors inthatfund,whocantradeinandoutoffunds,nordoanypercentageoffundstatisticsreflectthefactthatinvestorscanbedisproportionatelyinvestedinbetterperformingfunds.Forallthesereasons,thepurported25basispointgainfromtheruleclaimedbyDOLisoverstated,mostlikely toa significantdegree.Because theestimatedcostsof the ruleare significantly larger than thepurportedbenefits,there isnoneedforustodiscounttheDOLsbenefits,although ifthatweredone,ourestimateofthenetcostsofDOLsrulewouldbeevengreaterthanstatedhere(andforthisreason,ourestimateisconservative).

V. AMORECOSTEFFECTIVEALTERNATIVETOTHEDOLSPROPOSALEXISTSSince1980,Presidentshave requiredExecutivebranchagenciesnotonly toanalyze thebenefitsandcostsoftherulestheypropose,butalsotoconsiderwhether lessrestrictivealternativesareavailablethatcouldachievethesameorsimilarobjective.Section1ofPresidentObamasExecutiveOrder13563requiresExecutiveBranchagenciestoidentifyandusethebest,mostinnovative,andleastburdensometools forachieving regulatoryends.70Weexplainwhata lessburdensomeapproachwould look likehere.71Ouranalysissupportsatruebestintereststandard,withoutalloftheunnecessaryrequirementsthattheDOLhas includedwith it.Ouralternativewouldbe lessexpensivetoenforcethroughFINRA72and/orSEC,whicharetheproperbodiestooverseebrokers.And iftheDOL isconcernedthatcurrentdisclosuresareinsufficient,thenwesuggestasimpleroutetogreatertransparency.A. ALessBurdensomeAlternativeThe Department is charged under ERISA with protecting the interests of individuals saving forretirement.TheDepartmenthascarriedout thismandate in itsproposalby focusingprimarilyon thedisparityinfeesandperformancebetweenactivelymanagedmutualfundswithfrontendloadssoldbybrokers versus activelymanaged load funds sold directly by fund complexes. The RIA attributes the

70. ExecutiveOrder13563,Section1.71. Inofferinganalternative,wearesensitivetothefactthatbrokersalreadyhavesubstantialdutiestotheir

clients,includingloyalty,disclosureandsuitability.See,e.g.,DutiesofStockbrokerstotheirCustomers,availableathttp://www.securitieslaw.com/information/dutiesofstockbrokers.asp.

72. FINRAalreadyregulatesbrokersunderthesuitabilitystandard,sothereisnoreasonwhyitcouldnotoverseethebestintereststandardaswell.

24disparityininvestorperformancetoconflictedadvicebybrokers,andthefailurebybrokerstodisclosehowtheircompensationfrommutualfundscandistortinvestordecisions.Butfeesandrelativeperformanceofparticularinvestments,suchasmutualfunds,arenottheonly,oreven the primary, factor in the size of individual or household retirement nest eggs. How much isregularlysaved,theabilitytoavoidtemptationstotimethemarket,theregularrebalancingofdifferentasset classes to adapt to changing risk tolerances of individuals as they age, and the investmentperformance of portfolios net of fees, all determine the size of investment portfolios individuals orhouseholdshaveavailable to themwhen theyretire. In focusing largely,oronly,onmutual fund feesandperformance, theDepartmentsproposalneglects thebenefitsof investmentadvice thatbrokersand advisors can and do have on the other factors that determine the size of an individuals orhouseholdsretirementportfolioatanytime,includingthedateonwhichwithdrawalsbegin.Whetherornot it is intended, thedeprivationof thatadvicedue to theproposed rulewill thushurtmanyinvestors,especiallythosewithmodestlysizedportfoliosthattherulewillrenderuneconomicforbrokersandadvisors tocontinue toservice.Moreover,even if theruledidnotcausemanybrokers toleave thesmallsaversegmentof themarket,amoredirect,and far lesscostlyalternative to theruleexists,whichtheDepartmentdidnotadequatelyconsider.ThatalternativewoulddirectlyaddressDOLsmaincomplaintabouttheexistingbrokeragearrangementin the retirement advice industrynamely, that customers do not know of the compensationarrangementsbetweenbrokersand theprovidersof the investmentproducts they recommend.Thatmarketimperfection,however,iseasilycured.TheDOLcaneasilyandatverylittlecostremedytheawarenessproblembyimposingstrongerandmoreexplicit requirements in thecaseof retirementaccounts thatbrokersandadvisorsbothorallyand inclear bold writing on a page in front of any written products they provide state such commissionrelationships. If need be, the Department could provide specific plainEnglish language that thesedisclosuresshouldcontain,alongthelinesofsomethinglike:

Yourbroker[financialadvisor]willbecompensatedbythe[nameofthecompany]ifyoupurchasethisinvestmentproduct,throughaninitialchargeequalto___percentofyourinvestmentandofany subsequentpurchasesof this investmentproduct,and throughannual 12(b)1distribution chargesequal to__percentof the totalamountof yourpurchasesofthisinvestmentproduct.

Byexplicitlyquantifyingtheamountofcompensationatstake,thisproposalwoulddirectlyaddressoneofthecritiquesofthecurrentdisclosureregimeleveledbytheDepartmentinitsRIA.73

73. RegulatoryImpactAnalysis,at68(thedisclosuresgenerallydonotquantifytheconflictthatpertainstoaparticularrecommendation[byabrokerorfinancialadvisor).Id.at77(Most[IRA]investorsdonotunderstandwhattheypayforadviceandforinvestments,howtheiradvisorsarecompensatedandregulated,theconflictstheiradvisorsmightface,nowhowthoseconflictsmightaffecttheiradvice.)Id.at80(Inaddition,investorsoftendonotknowwhattheypayforadvice).

25TheDepartmentalsohasoutlinedadditionalmodeldisclosuresinAppendixIandIItoitsBICEproposal.ThetableinAppendixIissimilartothesuggestionhere,thoughintabularform.AppendixII,however,callsforbrokerstodiscloseinreality,estimatethecostsofholding individualassetsovera1,3and10 year time horizon, an exercise that necessarily would require the broker to estimate futureperformance.Wehavealreadynotedhow this is likely toconflictwithexistingFINRAprohibitionsonmakingsuchprojections,andinanyevent,couldbesubjecttomanipulation.Accordingly,somethinglikethe table inAppendix Iwouldbeappropriate, the table inAppendixIIwouldnotbe.TheDepartmentnonethelesselsewhereclaims thateven ifmore explicit disclosures were required, apparentlyincluding the ones it recommends as part of theBICE, thesmallsaver investors it is most concerned about cannotunderstandthesedisclosures.Thisassertionisanexpressionin supportof governmentpaternalismwithout recognizingthat inother contexts in life, just as important as theoneregarding retirementadvice, society reliesondisclosure toaddress an information failure. In particular, ourgovernment permits citizens to make their own medicaldecisions that can have much more immediate and lifechangingconsequencesthandecisionsaboutwheretoputtheirretirementsavings.B. TheRIALacksAnyRealWorldEmpiricalSupportforRejectingGreaterDisclosureInanyevent, theonlysupport in the research literature theDepartmentcanmuster insupportof itsassertionthatdisclosuredoesnotisworka2011studybyLoewenstein,CainandSah,whichaccordingto the Regulatory Analysis (at 7), suggests that even if disclosure about conflicts could bemadesimpleandclear,itwouldbeineffectiveorevenharmful.Butthisstudyinfactisnostudyatall,buta theoretical paper advancing one hypothesis, without any real world empirical support. This is anextremelyslimreeduponwhichtobaseanentirerulethatcouldradicallychangetheway investmentadviceisprovidedina$1trillionmutualfundmarket.Asforthestudyitself,itisfarlesssupportiveoftheDepartmentspositionthantheRIAwouldsuggest.Even the title of the article highlights both the pitfalls and potential74 of disclosure, while theconclusionstatesthatpeopledeserveaccurateinformationwithwhichtomakeinformeddecisions,sodisclosure is inherently desirable, 75 and that while disclosure hasmanifest pitfalls, there are alsoenormous opportunities for designing policies thatwill enhance its benefits. 76 Finally, as explained

74. GeorgeLoewenstein,DaylianM.Cain,&SunitaSah,TheLimitsofTransparency:PitfallsandPotentialofDisclosingConflictsofInterest,101(3)AMERICANECONOMICREVIEW:PAPERSANDPROCEEDINGS(2011)423428.

75. Id.at427.76. Id.

Thisisanextremelyslimreeduponwhichtobaseanentirerulethatcouldradicallychangethewayinvestmentadviceisprovidedina$1trillionmutualfundmarket.

26below,according toa subsequentpublicationby thevery sameauthors, thedisclosure requirementssuggestedaboveareconsistentwithrecommendationsforincreasingtheeffectivenessofdisclosures.Thestudypresentstheories,supportedonlybylimitedexperimentalevidencefromafewstylizedroleplayingexperiments.Participants in theexperimentswere recruited throughwebsites,email lists,orfrompublicareaswithincentivessuchasa1in3chanceofwinninga$10Amazongiftcard.Noneofthisexperimentalevidence isderivedfrommarketbasedeconomicactivity inanyrealworld industry,norisanyofthetheoryorevidencespecifictoretirementaccounts,oreventothefinancialindustry.77The authors theorize that disclosure requirements might negatively influence consumer behavior,hypothesizingaburdenofdisclosure,78accordingtowhichadvicerecipientswholearnofanadvisorsconflictdobecomelesstrustfulofadvice,yetfeelmorepressuredtofollowthatadvice.79The studys empirical support for the burden of disclosure, however, is limited to a similar set ofexperiments,thistimeinvolving(1)dicegamesofferingthechancetoearn$5Starbucksgiftcardsandsimilarrewards;and (2) interactionamonghypotheticalpatientsanddoctors.80Onceadisclosurehadbeenmade public, participants reported discomfort associatedwith turning down advisors (biased)recommendations, leading the participants to make suboptimal choices. For example, hypotheticalpatients,afterhavingahypotheticaldoctordiscloseahypotheticalfinancialconflictofinterest,reportedfeelingpressure toaccept thehypotheticaldoctors recommendationfor fearof insinuating that the[hypothetical]doctorwascorrupt.81Yet in subsequent research, the very same authors identify conditions under which the burden ofdisclosureisameliorated:

[T]his increased pressure to comply with advice is reduced if (a) the disclosure isprovidedbyanexternal source rather than from theadvisor, (b) thedisclosure isnotcommon knowledge between the advisor and advisee, (c) the advisee has an

77. Theauthorsdoillustratethepotentialforconflictsofinterestusingexamplesfromthefinancialsector,

althoughretirementsavingsarenotmentioned.Theauthorsreferencestothefinancialsectorarelimitedtothefirstpage,andinclude(1)accountingfirmsauditingthosecorporations[suchasEnronandWorldCom,which]werealsoprovidinglucrativeconsultingservicesthatcouldhavebeenjeopardizedbyanunfavorableaudit;(2)creditratingagenciesthatevaluatedmortgagebackedsecurities[and]werehiredandfiredbyfirmswhosebondstheywererating;and(3)thedotcombubble,[inwhich]firmsthatwereunderwritingIPOswerealsogivinginvestmentadvicetotheirretailclients.Id.at426.

78. Id.79. Id.Theauthorspositthreeadditionaltheoreticalmechanismsthroughwhichdisclosurerequirements

mightnegativelyinfluenceconsumerbehavior.Id.at424.However,theydonotprovidesupportforanyofthesethreemechanismsintheirstylizedexperiments.

80. Id.at425426;seealsoSah(2013),supra.81. Id.at425.

27

opportunitytochangehis/hermindlater,or(d)theadviseeisabletomakethedecisioninprivate.82

Threeoutof fouroftheseconditionswouldseemtoapplytothedisclosureremedyproposedabove:Thedisclosurewouldcome fromanexternalsource (theDepartment); theadviseewouldpresumablyhave theopportunity to changehermind (reinvestherassets)atanypoint in time;and, theadviseewould presumably be able to make the decision in private. Therefore, the disclosure requirementssuggested above are consistent with recommendations of the very researchers on which theDepartmentrelies.C. PolicyImplicationsForonething,thekindofsimpleandcleardisclosurerecommendedherehasneverbeentriedintheretirementsavingscontext,sohowcananyacademicscholar,ortheDepartmentforthatmatter,besoconfident that it would be ineffective? At a minimum, before undertaking a major overhaul of theretirementsavingsmarket,wouldntprudencecallforat leasttryingabetterdisclosurestandardfirst,beforeabandoningenhanceddisclosureentirely?Ataminimum,onwhatbasisshouldtheDepartmentbeabletoputtheentireweightofaproposalthatwouldabandonenhanceddisclosureonthebasisofasingletheoreticalstudy,whenonthenextpage,theRIAcitesdatalimitationsoftheacademicliteratureandavailableevidenceasareasonforrelyingon the fact thatonlysomeof thegains [from theproposed rule]canbequantifiedand thenusestheseestimatedgains(whichaswehavedocumentedareoverstated)to justifyawholesalechangetothe entire retirement investment advice market?83 This is not the kind of balanced judgment anExecutivebranchagencyshouldmakeunder longstandingPresidentialExecutiveOrders, including themost recentoneadoptedby thisAdministration, to imposeonly those regulations thatare the leastburdensomeinmeetinganygivenregulatoryobjective.Enhanceddisclosure in the retirementadvice context inparticular couldbeaugmentedbyabroaderalternative recommendedby the tradeassociation representing the securities industry:askingFINRA,which regulates all brokerage activities subject to approval by the SEC, not just those relating toretirementadvice, toadhere toa requirement thatbrokersact in thebest interestof theirclients,whichisessentiallyafiduciarystandard,butwithoutallofthelegalambiguities,costsandrisksposedbytheDOLproposedstandard.84In particular, the Securities Industry and Financial Markets Associations (SIFMA) proposal defines aclientsbest interestas recommendations that reflect the care, skill,prudenceanddiligence thataprudentpersonwouldexercisebasedonthecustomers investmentprofile.Theproposalwouldnot

82. SunitaSah,GeorgeLoewenstein,andDaylianCain,TheBurdenofDisclosure:IncreasedComplianceWithDistrustedAdvice,104(2)JOURNALOFPERSONALITYANDSOCIALPSYCHOLOGY(2013,)289304,at289.

83. RegulatoryImpactAnalysis,at8.84. Guggenheim,SIFMAOffersSimplerAlternativeforFiduciaryDuty,June3,2015,availableat

https://guggenheimsecurities.bluematrix.com/docs/pdf/fedfdaa9a34f443bbeb55cba52d169dc.pdf.

28requiretheadvisortorecommendthe lowestcostproduct,buttheadvisormustdiscloseandmanagethe fees as well as avoid andmanage any conflicts of interest posed by commissions from variousinvestmentproducts.This proposal would not disrupt the economics of the commissionbased brokerage and financialadvisorybusiness, and thuswouldnotdeprive investorsof thebenefitsof these relationships,whiledirectly addressing the conflicts of concern to the DOL. Itwould also standardize the rules for brokers and financialadvisors inall investmentcontexts,and thusnotentail thecosts of maintaining and enforcing different rules fordifferentkindsofaccounts.ThissimplersolutionwouldbeconsistentwiththewaytheAdministration, commendably, is going about improvingmany of the federal governments information technologyinitiatives: by deploying small teams of technologists andsoftware programmers,working in an iterative fashion, tocomeupwiththerightanswers,withoutimposingtopdownbureaucraticsolutionsfromtheoutset.85IfDOLtakesapagefrom this initiative inwriting itsrules, itwouldclearlystartby improvingdisclosureandcoupling itwithabest intereststandard enforced by an expert body like FINRA, withoutmandating changes in compensation arrangements thatwould either deprive small savers of valuable investmentadviceorinducethemtoswitchtomoreexpensivemeansofobtainingit.

CONCLUSIONPerhaps sensing that theDOLproposalwas in trouble, theObama administrationwenton record insupport of allowing commissions to survive. One analyst predicted that a final compromise thatpreserves the commissionsystem is awin forboth sides.86But if the sourceof the alleged conflictproblem per the RIA is the load share paid to brokers, and if the benefits from the rule flow fromremovalofthesepayments(or,putmoreprecisely,fromthefasterdemiseofthesepayments),howcantheadministrationnonethelessclaimtobecarvingoutanexception forcommissions?Theanswer,aswe shown above, is that this BICE exception ismore theoretical than real, and thus the claim thatcommissionscansurviveringshollow.Fortunately,thereisnoneedforanyofthishappen.TheDOLshouldmodifyitsruleandputinitsplacea

85. ThisinitiativeisdescribedinJonGertner,ObamaandHisGeeks,FASTCOMPANY,July/August2015,pp.6066,9091.

86. JaretSeiberg,GuggenheimPartners,FiduciaryDutyFightforAdvisorsReturnstoCapitolHill,June15,2015.

Intheend,ifitisopentofactbasedadjustmentsinitsapproach,theDOLwillhavesetinmotionareformprocessthatestablishesnewprotectionsforsmallsaverswithoutdisruptionsthatwouldunintentionallyharmthoseitseekstohelp.

29simpler solution that asks FINRAor the SEC topropose abroaderbestinterest