In his effort to paint himself as the victim of a witch hunt, former Brookings Institution economist Robert Litan has published a column in Fortune this week in which he seeks to rebut recent criticisms of his study on the Department of Labor conflict of interest rule, including my Huffington Post blog from last week. In my blog, “In Litan Scandal, It Isn’t the Money, It’s the Economics,” I make the point that what is most shocking about the Litan-Singer report is not the bias but the poor quality of the analysis. Litan’s latest column demonstrates that same failing.
In criticizing my analysis, Mr. Litan states that I ignore the multiple restrictions brokers must adhere to in order to rely on the best interest contract exemption. But the Litan-Singer study doesn’t stop at suggesting that these requirements will inhibit the rule’s use. That is a point about which one could have a reasoned discussion that might include, for example, the previous occasions on which industry has made the same threat and failed to follow through. Instead, the study states, more than once, that individual brokers would be prohibited from earning commissions under the rule. That is factually incorrect, and it is an error of monumental proportions in a study that claims to analyze the rule’s impact.
Mr. Litan’s column conveniently omits any mention of a second fundamental error in the study that I point out in my blog. The Litan-Singer study states that the cost savings in the Department of Labor’s regulatory impact analysis come from moving brokers away from commissions. This is not correct. The estimated cost savings are based on the assumption that brokers who operate under a best interest standard and where conflicts are reduced will recommend lower-cost, higher quality investments and that the documented under-performance of broker-sold funds will be reduced as a result. Again, this misunderstanding of the regulatory impact assessment’s central premise is an error of such a fundamental nature that it decimates the report’s credibility.
Mr. Litan states, again incorrectly, that I claim brokers provide no value. Perhaps he missed this sentence of my blog: “The point is not to suggest that broker-dealers offer no benefits, rather that there is simply no basis for Litan and Singer’s estimates of any such benefits.” As I noted in my previous blog, Litan and Singer’s argument hinges on showing that investors will be harmed if they lose access to advice from brokers, but they provide no evidence in their study that brokers provide the benefits that they ascribe to them in seeking to quantify that harm.
Their evidence that brokers can benefit customers by urging them not to “time the market” is based on target date funds, not brokerage accounts. They dismiss the independent research, which though limited is at least directly relevant, that suggests brokers may actually worsen customers’ timing decisions. And they fail to consider how brokers’ conflicts – the fact that they only get paid when the customer trades – may contribute to poor timing decisions. Their claim that brokers provide benefits of portfolio rebalancing depends on brokers’ providing ongoing account management, something brokers disclaim any obligation to do. Indeed, one of the broker-dealer community’s key objections to a fiduciary rule is that it could impose an ongoing duty of care after their one-time, transactional recommendations have been made.
Mr. Litan also mischaracterizes the Vanguard Study on which he relies to reach these conclusions about broker-dealer benefits. It does not, as he suggests, highlight the value of broker assistance. As the Vanguard Study clearly states, it seeks to quantify the benefits that advisors can add “through relationship-oriented services such as providing cogent wealth management via financial planning, discipline, and guidance, rather than by trying to outperform the market” and to do so “relative to others who are not using such strategies.” It says nothing specific about the value provided by brokers. Indeed, it could more plausibly to read as specifically refuting a favorite brokerage industry talking point, repeated as “unquestionably true” by Litan and Singer, suggesting that brokers’ one-off transactional recommendations are more affordable than fee-based accounts offering on-going advice.
There is one factually accurate statement in Litan’s critique of my blog. I did not choose to include a rebuttal of the study’s suggestion that disclosure offers an acceptable solution to this problem of conflicted advice. I have done so elsewhere, however. In fact, my colleague and I devoted several pages of our original comment letter on the rule to a discussion of the limitations of disclosure in addressing conflicts. There is ample evidence, some of which is cited in our letter, that disclosures are ineffective for this purpose and no contrary evidence that we are aware of, or that the authors present, that they are effective. While we support improved disclosures, they are not a credible alternative to a best interest standard combined with real restrictions on harmful conflicts.
Mr. Litan seeks to paint himself as the victim, but the real victim here is objective scholarship. Not to mention the millions of working families and retirees who would be left, under the Litan-Singer plan, without meaningful protections when they turn to financial professionals for retirement investment advice.
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