Michael, last time we spoke you said the U.S. was 20 years behind Australia in terms of regulation, but 20 years ahead in terms of independence [non-institutional ownership of advice practices]. Where are things at now regarding regulation in the US?
We’re still making very little progress on fiduciary rule-making. Our department of labour (DOL) fiduciary rule would have applied across the advice channels, the brokerage and product channels, and the insurance and annuity channels, but only in the retirement account realm. So if I had an IRA (individual retirement account) and a regular brokerage investment account with you, I would actually have two different standards depending on which account we were discussing. We would have the much lower suitability “know-your-client” standards for the brokerage account, but a full fiduciary standard for the brokerage account.
Trump put the kybosh on the DOL fiduciary rule, right?
Yes, but Trump didn’t ultimately kill it, he just slowed it down. The industry lobbying groups actually got it vacated in the courts and the essential basis of the rule – which is somewhat ironic – is that our vertically integrated product distribution firms said ‘oh no, if we introduce this fiduciary rule it will increase the cost of regulation which will increase the cost of advice and reduce consumer access’. They made this entire case that we can’t put this fiduciary rule in place because it will reduce access to advice for the middle class. The irony is that the actual case they made in court which prevailed in front of a judge is that the rule is a dramatic overreach on behalf of the DOL because they’re applying fiduciary advice regulations and they are salespeople. There’s a difference between an advice fiduciary that exists in a position of confidence and trust with their clients – that’s the legal definition in the US – and what they do, which is purely selling products. That was literally the exact opposite of what they said to the public in the media.
So they separated themselves to the courts, but not to the public. Is it a matter of disclosure, then?
They prevailed on that argument, that it was an overreach to apply the fiduciary rule to the product channels because they’re not in the advice business, they’re just salespeople, and it would unduly burdensome to apply fiduciary rules to salespeople, which arguable is sort of true, except all they’ve been doing is marketing to the public that they’re in the advice business. And they literally fought the rule in the court of public opinion by saying this is a bad rule that will reduce consumer access to advice; not consumer access to products, but consumer access to advice. Then they made the opposite argument in the courts and won on it!
Remarkable. You have to give them credit for being agile, if anything.
Um, yes! It’s still kind of a challenge in the US. I don’t mean this as a knock against ASIC, but our regulators do take a lot more input and consideration when they make their rules because there is some pressure in the US about not being too arbitrary and capricious that they disrupt private industry.
Is that an extension of the Trump regime and the freedom of capitalist venture mandate?
There were some Republican conservative overtones to not having the fiduciary rule because people should be making their own decisions and not having others decide which type of person it is that they want to work with. The more recent version of our regulatory uptake is our SEC (the securities and exchange commission) which is the most directly analogous to ASIC here, which oversees the regulation of investment advice as well as investment markets. The SEC has now taken up a new rule that would be their version of applying a broader best interest standard. When you read the details, it is literally a copy of the suitability standard, which we already have. They literally just rewrote it with the same words and put ‘best interest’ at the top.
So it’ll get ratified, but it’ll mean nothing?
Correct. They put forth a draft statement and there will effectively be two sets of disclosures. If you’re a broker or an investment adviser you’ll have a fiduciary interest to act in the best interests of your clients, and consumers are like… “what’s the difference?” It is, to be fair, slightly more stringent than what is there now, so they can legitimately make the case that they are trying to lift the standard towards best interests, but it’s not actually a fiduciary best interest standard and just creates more confusion and perpetuates the problem.
It seems like there are a lot of issues in the US with distinctions between regulation on the provision of products and services that are slight and probably beyond the comprehension of most consumers.
That is the product industries known and deliberate tactic. Like, ‘we’ll allow terms and labels to be confusing, and we’ll explain it in 67 pages of disclosure, because we all know no one will read it, and then we’ll get to do our thing.’
You may have heard that vertical integration was left untouched by Australia’s Hayne royal commission, the feeling being that not only is it too tough to unwind, but clients often benefit from in-house deals. Where is the US on this?
What we’ve learnt over the last 20 or 30 years is financial advice is very effective for distributing product, because you give the advice and the product is the solution. It kind of seems natural because the advice led up to it. And so product companies around the world have been shifting to become ‘advisers’. But now we’re seeing regulators say: ‘Ya’ll want to call yourself advisers? Fine, we’re going to regulate you that way!’ And while ultimately that’s a positive for consumers, and frankly is prudent in that regard, the problem is they literally regulate the product sales business out of business, cause there’s nothing left at that point. To me that door could should remain open to allow a realm for vertically integrated companies to call their employees product sales people. They just have to clearly convey that they’re sales people.
Disclosure as a cure all?
Allow sales to exist with a separate regulatory structure to advice. And when you do that, you don’t need such a high standard. Y’know, there’s nothing wrong with salespeople. The problem is that they went from salespeople to advisers, and they’re still regulated as salespeople. We need a salesperson standard and an advice standard, and clear title regulation so consumers understand which is which. In the US we’re all financial advisers. Some fall under a fiduciary standard and some don’t, which no one understands. We need to help people understand the difference between an adviser and a salesperson.
OK, so keeping the product distribution channel clear and separate from the advice channel. Seems pretty fundamental.
It really is. I mean, not everybody wants a full advice relationship. If I go into a clothing store to buy a shirt I understand the salesperson works on commission and their advice is a little tainted, but I just want a shirt. know it’s a sales relationship but I can still have a productive engagement with the salesperson.
So, it is just a disclosure issue?
To me, it’s not just a disclosure issue alone because the adviser position acts from such a position of trust. If you’re my adviser I’m not reading any disclosure you ever give me, because I already trust you. The point of trusting you is that I don’t need to read your crappy disclosures! You have to eliminate conflicts and create title reform to make clear what the nature of the relationship is in the first place.
SMSFs have had a huge growth in the last 10 years, what’s the closest thing to an SMSF in the US?
The closest analogue is an IRA or individual investment account, which are tax preference accounts for retirement and are self-directed by investors, which means lots of advisers get involved in the management process. And we have our 401K plans, which are roughly similar but exist in the employer market place.
Those 401Ks, they’re generally not defined benefit plans anymore are they?
Correct, they’re defined contribution plans. IRAs have lots of flexibility while 401Ks only a little bit of flexibility. But it’s virtually all individual voluntary savings contributions, which is different to your SMSF space, which is government-mandated dollars going in that you get to manage. Our parallel to your super system is our social security system. When you get to full retirement age at 66 you get a certain benefit based on your working years, and you get some flexibility about starting early or late, but you have no way to convert that to a lump sum and roll it out. It was discussed as a policy debate back in the early to mid-2000s under president Bush and went nowhere.
Is one more common than the other?
IRAs are a staple for savers in the US but 401K plans are common as well. Contributions are actually a bit steeper in 401K plans. The caveat is there are no government contributions; it’s purely voluntary, so we end up with an extremely wide range. Higher income folks who are reasonable savers can end up with extremely large account balances. The mass of average workers barely ever have any discretionary dollars to save over and above their living expenses and so they tend to have virtually no account balance and rely on social security.
Has there ever been a push for mandated contributions?
It crops up from time to time, but no. There is a free spirit, independence mentality that is part of America, like ‘It is my God-given right in this country to be an idiot and not save a dollar for my retirement if that’s what I want, and I’ll be damned if the government will tell me otherwise!”
I’m sure it’s in the constitution somewhere.
Oh yeah. That free-will spirit has really made mandatory contributions a no-go. The closest we’ve gotten is really creating automatic enrolment processes that default people in, stemming from research into choice architecture and nudging behaviours. Automatic enrolment in 401K plans has become very common and demonstrably successful in improving people’s retirement savings income rates. There’s a bunch of discussion now around whether we would do that with IRAs for people who don’t have access to a 401K plan, which is nice in theory but logistically much more difficult because of overlapping regulations.
Michael Kitces is a core faculty member of the Portfolio Construction Forum Finology program, and visited Australia again recently, to present at the Forum’s Finology Summit