The Trump administration is preparing to roll back Obama administration regulations to protect consumers from unscrupulous investment advisers. And last week, Trump economic adviser Gary Cohn criticized Obama’s rules using a food analogy.
“This is like putting only healthy food on the menu, because unhealthy food tastes good but you still shouldn’t eat it because you might die younger,” Cohn told the Wall Street Journal last week.
But Jason Furman, who chaired the Council of Economic Advisers during President Obama’s second term, says that analogy makes no sense. Many people enjoy eating a plate of french fries, he argues, but no one enjoys paying more money for lower investment returns. “That's not a matter of taste; that's a matter of misleading consumers,” he told me.
Furman championed the Obama rules, which are scheduled to take effect in April, during his time in the White House. They seek to reduce conflicts of interest in investment advisers and require advisers to put clients first. But Donald Trump’s election puts that work in danger. On Friday, Trump ordered the Department of Labor to consider rescinding the regulations.
In a Monday phone interview, Furman told me that overturning the rules would leave unsophisticated investors at the mercy of unscrupulous advisers who put their own profits ahead of the interests of their clients. The transcript of our conversation has been edited for length and clarity.
Timothy B. Lee
What problem was the Obama administration trying to solve with these new rules?
The retirement system has been shifting away from defined-benefit pensions toward defined-contribution retirement plans. Defined-contribution plans have a lot of attractive features. They give individuals a lot of control and flexibility. But they also give you the opportunity to make some really bad decisions.
One of the periods of maximum vulnerability for bad decisions is when you retire. Often you leave your 401(k) plan — where you got advice based on your best interest — and you switch to an IRA. And IRA advice is like the Wild West. You have some perfectly good advice being given, but there is also a lot of really bad advice being given.
The problem is that bad advice can drive out the good advice. The bad advisers are being compensated by the products they're selling rather than by the customer, so customers appear to be getting free advice. Often they don’t even know they aren’t getting advice in their best interest.
At the Council of Economic Advisers, we estimated that this costs consumers $17 billion per year. It's a really big deal.
Timothy B. Lee
So the law already required advisers in 401(k) plans to offer advice based on the best interest of clients?
Yes. This is about IRAs.
Pretty much every study that's looked at this has come to the same conclusions. They will send people in to ask questions of 100 brokers. And the ones who are getting paid to give you bad advice give you bad advice.
For example, studies have shown that the federal government’s Thrift Savings Plan is one of the most cost-effective options people have for investment. But people were being advised to move their money out of that into much more costly options that didn't have a better return.
Timothy B. Lee
Let me ask you about the argument Trump economic adviser Gary Cohn made in favor of repealing the fiduciary rule: “This is like putting only healthy food on the menu, because unhealthy food tastes good but you still shouldn’t eat it because you might die younger.”
This isn't like food. It's not like some people like bad investments because they're enjoyable, and other people don't. Everyone wants to have the best investments. You might have different taste for risk and something like that. But the evidence says that even before taking into account the fees, you get a lower rate of return on the products that come out of conflicted advice.
People are getting higher fees and a worse product. That's not a matter of taste; that's a matter of misleading consumers.
It costs money to give someone advice; you need an office and a computer and other stuff. This regulation doesn't raise the cost of giving that advice.
So there are a few options. If advisers want to charge people for advice up front, they can still do that. If advisers want to offer people a cheaper way of giving them the advice, now they realize they're paying for it, they can do that.
The new rule even includes something called a “best interest contract exemption” (BICE) that says if you are giving advice that is in someone's best interest, you can continue to be compensated by the products you're advising to go into. A lot of brokers are going that way.
Timothy B. Lee
Can you explain how that works? What does an investment advising firm have to do to continue receiving commissions for products they recommend?
Right now, advisers just have to recommend products that are “suitable,” but not necessarily products that are in the best interest of clients.
Under the BICE, first advisers have to promise to act in the client’s best interest — that’s the fiduciary rule. There has to be a set of policies and procedures they adopt to make sure that the broker isn't recommending things just because they get paid for them. And there has to be disclosure of the compensation arrangement.
Merrill Lynch is switching over to direct user fees. Most of the other firms are going the BICE route. They've actually taken it pretty seriously; they have put all sorts of procedures in place to make sure the individual giving the advice isn't being compensated very differently even if the firm is getting commissions.
I would say, by the way, that of the Republican economists I know, there might be more sympathy for this regulation than any other regulation the Obama administration has done. Almost all of them think there's really no argument for the high-fee, actively managed products that bad advisers might steer customers into. They think the world should be moving to low-fee funds.
Companies that adopt BICE risk getting sued if they don’t provide good advice. If the result of this is that they're all too afraid to do anything other than recommend the lowest-fee funds, that wouldn't be so terrible.