Stunning Academic Study May Cause DOL to Retain Original Proposal for Fiduciary Definition

April 10
00:04 2012

Just as supposed advocates of the fiduciary standard offered to compromise by accepting SIFMA’s new definition of fiduciary to include normally prohibited self-dealing transactions, new research was released rocking the retirement world. The Impact of the Broker-Dealer Fiduciary Standard on Financial Advice,” a working paper by Michael Finke, Associate Professor at Texas Tech University in Lubbock, Texas and Thomas Langdon of Roger Williams University, has revealed a stunning conclusion: IRA investors and the brokerage industry are both statistically unlikely to suffer – and some may actually benefit – should the DOL adopt its new Fiduciary Rule as originally proposed.

The paper, originally published on March 9, 2012, received national exposure with an article written by Blaine F. Aikin (“Fiduciary Standard Doesn’t Raise Costs: Study,” InvestmentNews, April 1, 2012). Aiken leads the piece with the blunt assessment the Texas Tech study “casts significant doubt on brokerage industry claims that the fiduciary standard leads to higher costs and fewer product choices for investors.” Aikin is Chief Executive of fi360 Inc. and a member of the steering committee for the Committee for the Fiduciary Standard. The study was, in part, funded by both groups, Aikin disclosed.

By coincidence, three days after Aikin’s article was published, Oliver Wyman released the long-sought-for underlying data behind their controversial 2011 IRA Study. Many cite this study, funded by 12 financial firms, as the reason the Department of Labor (DOL) abruptly withdrew their proposed Fiduciary Rule in September 2011 under the shadow of bipartisan political pressure. Congress had asked the DOL to conduct a thorough analysis as to business impact of the new definition. The DOL agreed but the industry twice failed to provide the data behind the claim. According to published reports (“Oliver Wyman Releases Data to DOL on IRA Fiduciary Costs,” AdvisorOne, April 5, 2012), an attorney representing Oliver Wyman stated the release was held up due to “a confidentiality agreement kept Oliver Wyman from releasing the data sooner.”

No published reports have to date linked the timing of the release with the Texas Tech study. reviewed both data sets and the differences are game changing. Although there has been no official word, it now appears, unlike statements attributed to anonymous sources within the Labor Department, the DOL may have a hard time finding a good reason to backtrack from its original new definition of fiduciary proposed more than a year ago. The empirical strength of the methodology, sample size and analysis of the Texas Tech study is matched only by the ostensible weakness of those same traits in the Oliver Wyman study.

From what was released, it doesn’t appear the Oliver Wyman study represents a rigorous academic analysis. For example, the sample size is at most 12 firms (suggesting only the sponsoring firms may have participated in this study, further suggesting any results may be biased) and as few as 4 firms depending on the particular data set, and the most relevant data set has the smallest sample size (suggesting the sample size might have been too small to yield any statistically significant conclusions). Compare this to the sampling approach used by the Texas Tech researchers, which randomly selected 207 registered representatives in the four strict fiduciary states and the 14 non-fiduciary states. Even when the Texas Tech report incorporates the entire universe of data for a state-by-state analysis, it uses sophisticated mathematics to overcome any potential statistical weakness. Specifically, on page 19 of the paper, the authors state “Due to the small sample size (50 states and the District of Columbia), we include one control variable to account for the log of mean household income within the state.”

We were unable to get a comment from the DOL by the deadline., however, was fortunate enough to interview one of the authors of the Texas Tech study.

Michael Finke, Ph.D., CFP® is Ph.D. Coordinator and Associate Professor of Personal Financial Planning at Texas Tech University. He is a 2011 recipient of the Academic Though Leadership Award by the Retirement Income Industry Association, the 2008 and 2009 recipient of Best Paper Awards from the Academy of Financial Services, and former recipient of the AFCPE Outstanding Journal Article and CFP Board Financial Planning Research Awards. Dr. Finke served as President of the American Council on Consumer Interests, and is the editor of the Journal of Personal Finance. He received a doctorate in consumer economics from the Ohio State University in 1998 and in Finance from the University of Missouri in 2011. He was kind enough to share a few words concerning his paper and the topic of the universal fiduciary standard in general.

FN: Dr. Finke, thanks for taking the time to give our readers a chance to explore your thinking on this issue. We’ve read “The Impact of the Broker-Dealer Fiduciary Standard on Financial Advice” and you are to be complimented on its thoroughness and timeliness.
Dr. Finke: Thanks for contacting me. It is an issue I’ve written a few papers on including the one you cite.

FN: What are your thoughts, if any, on the Oliver Wyman Report?
Dr. Finke: Some of the results from the Wyman report are consistent with my own research (see “Compensation and Client Wealth Among U.S. Investment Advisors,” working paper, April 4, 2011).  It does appear that commission advisors cater to a lower-wealth clientele than fee advisors.  This is to be expected, since commissions provide greater compensation (percentage) for low- to moderate-wealth customers, and many fee advisors require relatively high minimum asset thresholds.

FN: That might be the only item the two papers agree on. What we’re really talking about, though, is the issue of allowing fiduciaries to enter into prohibited (self-dealing) transactions. This has been a rising trend in America for two decades, yet it’s a principal that dates back to England and the Magna Carta. Indeed, both Great Britain and Australia are today considering an outright ban on transaction-oriented fees (i.e., commissions) where a fiduciary relationship exists. So, while both your study and the Oliver Wyman Report agree a greater percentage of lower-wealth clients use commission fee models, your study certainly suggests a different outcome should the DOL retain the wording it originally proposed for the new definition of fiduciary. Why do you believe this is so?
Dr. Finke: The question is ultimately whether consumers benefit from more visible or more opaque pricing. It is true that surveys of investors indicate a preference for commission compensation, however this is likely because most investors: a) don’t understand that they directly pay the commission; and, b) are not aware of how much they are paying for the advice. The better question is whether they would make better choices if all advisor compensation was clear and easier to compare. Most markets seem to operate more efficiently when the consumer is aware of the price they are paying for different alternatives. Great Britain and Australia may serve as laboratories for future studies on how well clients are served in the absence of commission compensation. Other similar professions such as accounting seem to have survived with fee pricing.

FN: I see, so it’s like the difference between static scoring and dynamic scoring by the Congressional Budgetary Office. Changes in government policies and regulations often change behavior. Static methods don’t account for this while dynamic methods do. In much the same way, the transparent pricing that results from the traditional fiduciary standard may actually help, not hurt, investors. How else does your study differ from the Oliver Wyman Report?
Dr. Finke: Our study investigated directly whether registered representatives in states that apply a stricter common law fiduciary standard (e.g., California) behave differently in terms of their clientele, their ability to recommend commission products, and their ability to make a broad range of product recommendations. We found that a relatively stricter standard did not have a measurable impact on how representatives were able to conduct business. The percentage of brokers to total households within states was not related to fiduciary standards.  Our study differs by studying directly how differences in standards affect the ability to provide advising services.

FN: Your study concludes this way: “Imposition of a universal fiduciary standard among financial advisers may result in a net welfare gain to society, and in particular to consumers who are ill equipped to reduce agency costs on their own…” Based on your study, what advice would you give regulators?
Dr. Finke: In any advice profession there is an imbalance of information between the customer and the professional. You pay for advice because the expert knows more than you do. This places experts in a position where they are able to take advantage of the customer, particularly if they are able to shroud important product attributes such as the pricing of services. We have ample evidence consumers need more expert financial advice, but a buyer beware standard leads to suboptimal recommendations and a lack of trust between consumers and advisors. We have the healthiest equity and insurance market in the world primarily because of our regulatory environment. My sense is that the market for financial advice, and particularly for advice within retirement accounts among consumers who may be less sophisticated than the average client of an investment advisor, will benefit from an improved standard of care.

FN: Your paper also concludes that, while benefits may accrue to the investor, “this will likely occur at the expense of the broker-dealer industry.” At the same time, it also concludes the “results provide evidence that the industry is likely to operate after the imposition of fiduciary regulation in much the same way it did prior to the proposed change in market conduct standards that currently exist for brokers.” Do you have a sense the universal fiduciary standard, though offering consumers better choice, might help some advisors (i.e., those able to adapt to transparency) and might hurt other advisors (i.e., those who cannot adapt to the new transparency)?
Dr. Finke: I agree that the key benefit from the legislation is improved choice.  To the extent that regulation improves efficiencies, there will always be winners and losers.  It is to be expected that those who don’t benefit from legislation will oppose the change.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

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1 Comment

  1. Stephen Winks
    Stephen Winks April 12, 12:14


    As you know I have long maintained that fiduciary counsel is faster, better and cheaper than commission sales but not for the reasons cited in the Texas Tech/Harvard study that is based on a fundamentally flawed thesis.

    The disagreement is the presumption that brokers fulfill their fiduciary duties in states that require fiduciary duty while they don’t in states where fiduciary duty is not required. The reason why there is no difference in client service/cost in fiduciary/non-fiduciary states is that no brokerage firm in the US assumes fiduciary liability for all the recommendations of all their brokers as required for fiduciary standing. The conclusion that fiduciary standing cost no more based on the Texas Tech/Harvard methodology is irrelevent as in neither instance is fiduciary duty being fulfilled.

    It is a violation of the internal compliance protocol of every US brokerage firm for brokers to acknowledge they render advice or have an ongoing fiduciary duty to act in their client’s best interest in fulfilling their fiduciary duties. While that would be most desirable public policy, denying brokers render advice is the brokerage industry’s principle defense against assuming fiduciary responsibility for every recommendation every broker makes.

    The reason why fiduciary counsel is less expensive and far superior than commission sales becomes self evident in a detailed analysis of both, as previously discussed. Let’s not perpetuate the thought that brokers act in a fiduciary capacity. They do so only by rare exception. Arbitration proceedings to manage client disputes are based on the thesis that brokers are neither accountable for their recommendations nor are responsible for ongoing fiduties.


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