Conflict of interest and inversions: two very big deals that must…MUST…not go unnoticed.

April 6th, 2016 at 9:55 am

OK, it’s official: my mind is blown by two new, smart, common sense, progressive initiatives that the Obama administration–with great input from Treasury and the Labor Dept.–has managed to implement this week. Each deserves, and will get, individual attention and explanation from me. But for now, let us marvel at what’s happened here, especially as you may be distracted by the political horse race.

The new conflict of interest rule

This new rule, as I’ve written before, requires financial advisors providing advice on retirement accounts (and 401(k)’s that will ultimately get rolled over into such accounts) to put their clients’ interests ahead of their own.

Boom. That’s it.

Now, you may have thought that’s what happens already, and with many ethical advisors, it surely is. But before these new regs, brokers could and did nudge retirement savers to investments with higher fees or a broker’s commission that did more for the advisor than the advisee. Now, these financial advisors must meet a “fiduciary” standard, meaning they “cannot accept compensation or payments that would create a conflict unless they qualify for an exemption that ensures the customer is protected.”

How big a deal is this? From one of my earlier pieces:

All of which turns out to be extremely costly to retirees at a time when too many older persons are financially underprepared for retirement. In what looked to me like a pretty unbiased review of the literature by White House economists, they find that conflicted advice reduces returns by about 1 percent per year, such that a poorly advised saver might end up with a 5 percent vs. a 6 percent return. They multiply that 1 percent by the $1.7 trillion of IRA assets “invested in products that generally provide payments that generate conflicts of interest” and conclude that the “the aggregate annual cost of conflicted advice is about $17 billion each year.”

The financial industry, as you’d expect, lobbied hard against the rule, but team Obama seriously stiffened their spines–Labor Sec’y Tom Perez was relentless in keeping the rule moving forward–while, at the same time, hearing out the opposition and accommodating many of their ideas to reduce the burden of the new reg.

This is one of the administration’s biggest wins for middle-class people trying to do the right thing and save for their retirement.

The new anti-inversion rules

Meanwhile, the Treasury Dept. surprised the heck out of me by making another run at blocking inversions, taking by far their most serious steps to date. So serious, in fact, that a few short days after Treasury’s announcement, Pfizer decided not to go forward with their long-planned inversion with now Irish (formerly New Jersey) company, Allergan.

I’ve written a lot about this too and won’t review details, other than to remind you that inversions are a tactic by which a domestic firm relocates its tax mailbox much more so than its operations. So these firms still fully avail themselves  of  US infrastructure, markets, an educated workforce and so on, but they avoid paying most of what they should for it.

One main tactic, the one Pfizer was clearly pursuing, is “earnings stripping,” which sounds bad and is bad. It’s where the former US firm–now a subsidiary of the foreign parent–loads up on debt issued by the foreign parent, which in US corporate tax law, gets deducted from tax liability.

Apparently, once Treasury blocked this form of tax avoidance, Pfizer decided it wasn’t worth it to move their mailbox.

To be very clear, these tax inversions are about one thing and one thing only: avoiding the US corporate tax. They are not about tapping some new efficiencies that will make firms more productive. To the contrary, they lead firms that make drugs, or hamburgers, or medical devices, to focus on tax law, not whatever it is they actually produce.

I’m sure the affected firms wouldn’t quite agree, but in that regard, you ask me, Treasury’s done them a favor. They can now spend less time trying to lower their tax bill and more time focusing on production.

One other point, and here I’ll get back to the horse race. Because Congressional conservatives would never have let either of these new rules become law, they’ve been run through executive action. That means the next president could reverse them.

In others words, as if the stakes in the next election weren’t already high enough, they just got a lot higher.

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5 comments in reply to "Conflict of interest and inversions: two very big deals that must…MUST…not go unnoticed."

  1. Amateur says:

    Very good news. Smart move, O.

  2. Chmeee says:

    Yeah, great news.

    I’m thinking about getting out of the business. This all sounds good on the surface, putting the best interest of my clients first, disclosing any potential conflicts of interest etc. We already have those things in place, and it’s put in writing, given at the first meeting.

    You would think that the ruling wouldn’t effect me then. But the company has already told us what to expect; no more payments for assets under management (12-b1 fees, because they’re considered promotional fees under the rules) except for management advisory fees, no more upfront commissions on annuity sales (I’ll still sell them where appropriate though). If a client rolls over their 401(k) I’m not allowed to get paid for it.

    This will cause my income to drop significantly unless I raise my advisory fees, which, as accurately argued by the industry, will put my services out of reach for the smaller investors since I have a $50k minimum to open that kind of account. Small investors starting out who can only save a few dollars each month won’t be worth my while anymore since I won’t be getting paid.

    In effect, the rules will actually cause me to look out for my best interests by dropping those smaller clients and focusing only on the ones who have the money to afford to pay me. You can bet it’s going to be the same across the industry.

    Good luck middle class…

    • Anonne says:

      If you’ve fairly consistently outperformed the S&P 500, then I’m sorry for your customers and the middle class. If your customers, in 20 years, would have done better investing in an S&P ETF, then it’s not much of a loss to the middle class.

  3. Eli Rabett says:

    Chmee, scam and leap is an old tactic but one guaranteed to cost you. For one thing young clients are going to primarily be the ones with small accounts, and due to the majic of compound interest, time and earnings growth are going to be the clients you want in the future. If you turn them away they will not come back.


  4. John C. says:

    It’s about time Obama started paying attention to this. I’d also add that it’s part of a much larger issue: economic concentration. Since the early 80’s, the anti-trust division of the Justice Department has been asleep. We’ve seen wave after wave of mergers and aquisitions, accompanied by wave after wave of layoffs. We now have major industries dominated by a few payers: telecommunications, airlines, banking, etc. The oligarchs are free to gouge their customers and move jobs overseas. I think it’s a major part of the inequality issue. Sadly, I’ve heard very few economists discuss the issue. One exception is Robert Reich in his new book Saving Capitalism.