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Mercer Bullard: Think DOL’s Fiduciary Rule Is Too Strict? Blame SEC

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Had Securities and Exchange Commission Chair Mary Jo White succeeded in passing a fiduciary standard rule, the Department of Labor’s fiduciary rule would likely be less stringent. So says Mercer Bullard, law professor at the University of Mississippi Law School. In a candid interview with ThinkAdvisor, the investor watchdog provided a withering assessment of Chair White’s performance.

For two decades, Bullard, a former SEC attorney, has been an influential shareholder voice on investing issues. He has testified more than 20 times before Congress and led petition drives resulting in heightened regulatory oversight. For the DOL’s rule, his input focused largely on payment grids, in addition to advocating for the inclusion of fixed indexed annuities under the rule.

He has served on the SEC’s Investment Advisory Committee and is founder of Fund Democracy, a group advocating for mutual fund reform.

A surprising item on his curriculum vitae is a seven-year stint at a financial planning firm, which ended in January of this year.

ThinkAdvisor recently spoke by phone with Bullard, who discussed the DOL rule, the Dodd-Frank Act, what Social Security is and isn’t and his idea for a standardized annuity to avert elder financial exploitation. Here are excerpts:

How do you rate Securities and Exchange Commission chair Mary Jo White’s job performance?

She’s been such a bad SEC chair for investors that there isn’t much room to go backwards. She repeatedly made promises to get fiduciary rulemaking done, though failed to get it through the Commission. But that turned out to bite the industry because the rule she would have done probably would have been a much watered-down version of the DOL’s fiduciary rule.

Do you expect President-elect Donald J. Trump to ease or repeal the DOL rule?

That’s certainly on the table. His circle of advisors seems to be consistent with wanting to repeal it. He clearly has the authority to effectively repeal it.

Many financial advisors will be happy if the DOL rule is repealed. Ultimately, though, the fiduciary rule stands to benefit clients. Shouldn’t FAs be thinking about that?

They’re thinking about their bottom line.

Are you a Democrat?

I’m an independent, and I agree with Republicans on a lot of issues. But I don’t advocate on those issues because the industry can certainly accomplish that.

In an interview with me for Research Magazine in 2003, you said that “The Securities Industry Association [now Securities Industry and Financial Markets Association (SIFMA)] is well known for attacking anything that smells of investor protection.” Still think so?

That’s certainly true and has been proven many times over in connection with the DOL rulemaking. I have never seen a lobbying campaign characterized by so many outright lies in the financial services arena as I saw in connection with the DOL rulemaking.

Mr. Trump repeatedly said, when campaigning, that he would repeal the Dodd-Frank Act. Do you expect that will happen?

It would require statutory amendments, which means the Senate would have to go along. So, depending on whether a filibuster survives, it would be hard to get major changes to it or anything else that [needs] Senate approval. What do you think will happen with the Consumer Financial Protection Bureau now that Mr. Trump will have direct oversight of it?

The virtual absence of customer protection by banking regulators was long an obscene omission in the law. It’s really unfortunate that the CFPB may be under fire.

Consumer protection doesn’t seem to be a priority for the president-elect.

It’s hard to predict what he’s going to do because there’s a populist angle that includes a bit of anti-Wall Street sentiment, which suggests that he would support investor protection. On the other hand, [his] insider appointments are generally anti-regulation, which would suggest that he would be [as well].

How will the DOL rule chiefly affect financial services firms?

The problem for firms that have brokers who are more susceptible to financial conflicts is that the rule will reduce their revenues. The firms that haven’t relied on sales motivated by differential compensation will do better in the new DOL environment.

How will the rule affect FAs’ commissions?

Within the category of mutual funds, for instance, the advisor’s commissions will be flattened, but the firm’s compensation doesn’t have to be. And that’s one of the gross misrepresentations that the industry has made about the rule. It argues that it would prevent the payment of commissions. In fact, not only does it allow payment of commissions, it allows firms to continue to get exactly the same differential compensation they’ve been getting, as long as there’s separation between the firm and its revenues and the compensation its advisors receive.

As a contributor to the book “Exploring Advice,” by PiEtech president Kevin Knull, you wrote that “only a fiduciary standard can provide an effective counter to differential compensation … and to financial incentives that encourage advice … driven by the advisor’s self-interest.” What are some of the most significant differentials?

The multiples of compensation advisors get for selling a stock fund over a short-term bond fund, for example. Typically a stock fund pays a commission that’s three or more times as much as the commission on a short-term bond fund. So advisors have an enormous financial incentive to recommend a higher allocation of stock funds because it will substantially increase their compensation.

You wrote too that “The fiduciary standard goes to an advisor’s standard of conduct, whereas financial advice goes to the quality of the advisor’s services” but that these are “closely related.” Please explain.

One element of giving good advice is ensuring that it’s not conflicted. Some of the compensation conflicts are so extreme that it’s hard to believe advice given in certain circumstances is not painted by the advisors’ financial incentives. For example, it’s hard to argue that it’s suitable advice when the advice to invest in a stock fund is given in the shadow of a multiplier with respect to the compensation received.

What else do you think Chair White failed at but which needed to be done?

It’s a no-brainer that there are fundamental structural flaws in ETFs that are a threat to the industry. But she has simply not addressed them. You wrote that an effective financial plan matches the liquidity of a client’s assets with the client’s potential liquidity needs. Don’t most plans do that?

Financial plans that include variable annuities frequently do not, and that’s been the way in which variable annuities have been most abused. That is, selling annuities to those who have liquidity needs that are inconsistent with what, essentially, should be treated as illiquid investments.

Is there a place for fixed annuities in a retirement portfolio?

Fixed annuities are what defined benefit plans are based on, and there are still many employees who have a fixed-annuity retirement plan without knowing it. A fixed annuity should be thought of as a component of your retirement plan that provides for a very high level of certainty that you’ll have some minimum level of income in retirement.

Indeed, you wrote that a fixed income stream provided by an annuity can minimize underperformance risk with both active and passive management.

Yes. And in some ways, fixed annuities are the opposite of variable annuities in the way they’re sold, not just in the way their returns vary.

Social Security is a fixed annuity, correct? Many people depend on it for guaranteed income in retirement.

Social Security should not even be discussed in the same breath with “annuity” or “retirement plan.” Social Security payments represent only the continuing decision by a current Congress to transfer wealth to retirees. The idea that it represents some kind of claim on a trust in any sense other than politically is simply incorrect. However, political promises are very hard to break.

But what about the fact that the Social Security trust fund is running dry and is projected to last only till 2034? Mr. Trump, thus far, has no plan for Social Security reform. The trust fund isn’t the issue. When it runs out isn’t going to have much bearing on whether people get [benefits] because Social Security is a current redistribution of wealth, not a promise by the government that when you start Social Security, you’ll get it for the rest of your life.

So, then, the trust fund isn’t that important?

The other reason the trust fund doesn’t matter is that you can simply shift other revenues to Social Security, and that’s potentially what we’re doing now. The trust fund doesn’t represent a pool of money like a 401(k), to which I or a group of Social Security recipients have a contractual right. The trust fund represents a U.S. obligation. But Social Security is always going to be strictly and solely a function of Congress’s decision in any given year to say that this is the Social Security benefit you will receive.

Do you expect Social Security payments to be reduced now that we’ll have a Republican Congress?

The way they would cut it would be to increase the cost of Medicare [premiums recipients pay]. All you do is take [out of Social Security benefits] a much bigger piece to pay for Medicare. That will be a much easier way to cut Social Security than to reduce the calculations of benefits. So how should FAs advise clients regarding Social Security?

Determine what the potential room is for breaking the implied promise about Social Security and how [clients] can factor that into their retirement spending based on their age.

You point to substantial empirical evidence showing that the “greatest threat of elder exploitation” is from people the elderly know, including close relatives. What can be done?

We need to take the model for reporting child abuse and overlay it on elder abuse. We need to take steps to turn what are permissive rules about protecting the elderly from abuses by relatives into obligations on the part of financial professionals, medical professionals and others who are fiduciaries acting in the best interest of their clients [and patients].

Any other approach that you suggest?

We could adopt standardized models for structural low-risk investment mechanisms so that investors could at least know that if they buy a certain version of a product, it’s the one that the SEC has identified to have a very low abuse risk.

Such as?

A fixed annuity, very transparent and without bells and whistles. You’d call it “the Simple Annuity,” which kicks in, maybe, after age 80. This would be easy for people to identify and buy, and would be the best protection against abuse.

What are the chances of that being introduced?

The SEC’s philosophy has to change. The DOL could have taken this approach but decided not to.

While conducting your advocacy work, you joined Plancorp, a St. Louis-based financial planning firm, onboard from 2009-2016. What prompted that?

It was a good experience for me to be part of an organization that’s the subject of regulation and to get a better sense of how advisors work. It was a tiny piece of compensation. I helped them out with regulatory issues and strategic planning and was the point of contact [in Mississippi] for a handful of clients.  But it was never as good a fit as I would have liked.

Are you satisfied with what you’ve accomplished as a pro-investor advocate?

I’ve been able to make a lot more law than I ever imagined I could. But my advocacy career has been increasingly constrained by partisanship in Washington. There’s been a pretty steady decline in the civility and rational nature of the debate.

You’re not giving up advocating, are you?

I’m thinking about where to have an effect, not so much by making persuasive arguments but perhaps by gathering and analyzing data that speaks more directly to investor issues. So I’m working toward a doctorate in finance to be able do more of the kind of sophisticated quantitative analysis that was particularly influential in the DOL debate. It may be a more effective way to advocate in the future.

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