As 2020 opens a new year and decade, the broad financial advice industry is working to make it easier for brokers and financial advisers to sell high-priced, high-commission, complex products to clients, with the focus on tapping retirement accounts that hold trillions of dollars in investor savings.
Sadly, this is the opposite direction in which the financial advice industry needs to move. It’s as if the industry wants to abolish the memory of the pain and destruction clients suffered in the wake of the 2008 financial crisis and the role played in that disaster by advisers who sold esoteric products that blew up, from hedge funds to real estate investment trusts.
As a result, the public’s esteem and respect for financial advisers sank to new lows.
Such alternative investment or complex products usually pay salespeople the steepest commissions. And it is apparent the financial advice industry, under a Republican regime that preaches deregulation, wants to jump-start the chase for commissions, even as many of the largest players in the industry are focusing on a business model of charging clients fees or cutting commissions to the bone.
The new SECURE Act is seen as a “big win for annuity providers,” as Jamie Hopkins noted in a recent InvestmentNews blog. My colleague Greg Iacurci reported last August that “variable and indexed annuities are lambasted in some circles as being high-cost insurance products, with all-in annual expenses often exceeding 3% or 4%,” or roughly double the cost of paying for an adviser and the investments in a financial plan.
Meanwhile, the chairman of the Securities and Exchange Commission, Jay Clayton, recently has made clear that he wants retail investors to have more access to private funds, including high-risk, high-commission private placements. The basic, and flawed, argument is that if big public pension funds can buy private equity and real estate, shouldn’t retail investors be able to as well?
Pricing is a problem for retail investors who buy alternative investments. Broker-dealers typically charge an all-in, 10% commission for such products, the maximum under industry rules overseen by the Financial Industry Regulatory Authority Inc.
The annuity industries and Mr. Clayton no doubt have decent intentions for consumers and retail financial advisers. The Insured Retirement Institute, a trade group that promotes annuities, said the SECURE Act “expands opportunities for workers to obtain guaranteed lifetime income products” in a statement last month.
The problem is some brokers and advisers can’t help themselves when it comes to selling products with eye-popping commissions. And the higher the commission, the less likely investors will be able to have enough cash to put to work in any given investment to generate the targeted returns.
“Humans are like roaches — they are very innovative and take advantage of any situation the best or worst way possible,” said Carolyn McClanahan, founder of Life Planning Partners. “The problem with the various current regulators is that they don’t quite understand how ill-equipped the public is when understanding the product they are getting, and disclosures do no good.”
“Brokerage firms overwhelm clients with disclosure and persuade them with half- baked facts,” she said.
There is room in 401(k)s for low-cost annuities that provide investors income for life, Ms. McClanahan said. “But complex variable annuities with high fees have no place in retirement plans.”
In a phone interview Tuesday, I asked IRI executives whether they had any concerns, now that the SECURE Act is in place, that the industry would see sale practice abuses with annuities.
The officials stressed that while the SECURE Act made it easier for retirement plan sponsors to include various types of annuities in company retirement plans, it did not erode investor protections.
“We think plan participants [investors] will continue to have significant levels of protection they currently have because the fiduciary level of the plan provider remains the same,” said Paul Richman, chief government and political affairs officer at IRI.
That type of response fails to take into consideration Ms. McClanahan’s point: Plenty of brokers will chase commissions and sell products that charge clients the steepest amount, regardless of whether the products are appropriate or suitable for clients.
When big commissions are dangled before their eyes, some brokers can’t help themselves. For example, just last month, Next Financial Group was fined $475,000 by two states for a variety of shortcomings in supervision and compliance stemming from sales of nontraded REITs. Brokers typically garner a 7% commission for the sales of such REITs.
At the end of 2018, Finra reported it had uncovered deficiencies around variable annuities, including unsuitable and largely unsupervised recommendations related to annuity exchanges. Finra’s report also detailed lax due diligence on private placements.
Brokers generate steep commissions in such annuities transactions. Needless or abusive variable annuity exchanges have been a persistent problem for advisers and clients for decades.
Laws and regulation that prime the pump to increase the sale of high-commission products to retail investors are misguided, particularly as industry giants like the Charles Schwab Corp. are cutting commissions, for some trades, to zero. Clients should have the option to pay an adviser a commission for a transaction, but the charge should make sense and be fairly priced, not an incentive to sell the product.