By John Berlau, CrowdfundBeat Sr. Guest Editor director of the Center for Investors and Entrepreneurs, Competitive Enterprise Institute.
Three years ago, President Barack Obama signed into law the Jumpstart Our Business Startups (JOBS) Act, modestly but significantly liberalizing securities markets for investors and entrepreneurs. In signing that bill into law on April 5, 2012, Obama paid heed to the wisdom of ordinary American investors and made the case for easing barriers to their investing in startups.
“Because of this bill, start-ups and small business will now have access to a big, new pool of potential investors — namely, the American people,” Obama proclaimed. “For the first time, ordinary Americans will be able to go online and invest in entrepreneurs that they believe in.”
But the authors of the Department of Labor’s new proposed “fiduciary rule” don’t seem to share the view Obama professed on investor choice in signing the JOBS Act. Rather, those who wrote the DOL’s sweeping new seven-part group of regulations that would sharply curtail choices of assets and investment strategies in 401(k)s, IRAs, and other savings plans, appear to share the mindset of Obamacare architect and MIT economist Jonathan Gruber. Gruber has been shunned by former allies since he was caught on camera boasting about how the health care overhaul passed due to the “stupidity of the American voter.”
By curtailing investment in IRAs, the rule could eviscerate the gains entrepreneurs and savers have made from the JOBS Act in the freedom to raise capital and invest. And the authors of the rule seem to want it that way, for paternalistic Gruberesque reasons. Again and again in the rule, DOL expresses the view that American investors must be protected from their own stupidity. According to page 4 of the rule:
“[I]ndividual retirement investors have much greater responsibility for directing their own investments, but they seldom have the training or specialized expertise necessary to prudently manage retirement assets on their own.”
Therefore, they “need guidance on how to manage their savings to achieve a secure retirement.”
Can’t savers who feel they need this guidance seek it out from a variety of investment professionals under a system with strong disclosure and anti-fraud rules? Absolutely not, says the Obama administration.
“Disclosure alone has proven ineffective,” states the rule. “Most consumers generally cannot distinguish good advice, or even good investment results, from bad” (page 36). In fact, proclaims the DOL, “recent research suggests that even if disclosure about conflicts could be made simple and clear, it would be ineffective — or even harmful.”
So, in the DOL’s view, the only solution is to tax these dim-witted investors — for their own good, of course — and expose financial professionals to a flurry of lawsuits and penalties if administration officials deem their advice not to be in savers’ “best interests.”
Besides being unnecessary and intrusive, the rule is legally dubious and a major case of executive-branch overreach. The DOL is massively stretching its limited authority over pensions under the Employee Retirement Income Security Act (ERISA) of 1974 to bypass the Securities and Exchange Commission, which has primary jurisdiction over investments, and reshape the retirement-savings industry.
The DOL claims authority by reclassifying a broad swath of investment professionals as “fiduciaries” with a government-imposed “best interest” standard, which subjects them to heavy penalties and lawsuits if the DOL or a court determines that they deviated from this standard. This is true even for financial professionals whose clients manage their own 401(k) portfolios or hold self-directed IRAs.
In the 40 years since ERISA was first enacted, DOL regulations have for the most part strictly applied the term “fiduciary” to managers of defined-benefit plans and those who provided individualized investment advice on a regular basis, such as registered investment advisers. Under the new rule, financial professionals who provide even one-time guidance or appraisal of investments could find themselves classified as “fiduciaries.” Because most of the exemptions in the new rule are vaguely written, the rule could enable cronyism for certain types of financial-service providers and companies offering investments.
This means investment professionals dealing with 401(k)s, IRAs, HSAs, and Coverdell accounts (the DOL rule claims jurisdiction over the last two under the rationale that they are subsets of IRAs and pensions) will have to either look to the government for permission to offer certain types of investments or get out of the business altogether. A study by the consulting firm Oliver Wyman and the Securities Industry and Financial Markets Association concluded that 12 million to 17 million investors could lose access to their current service providers under a similar “fiduciary” mandate.
And potential restrictions on IRA service providers could sharply curtail crowdfunding and other alternative investment assets and strategies by IRA holders. Self-directed IRAs can invest in a wide range of assets. As worries about monetary policy have been on the rise, gold and silver have found popularity as IRA holdings. Real estate has long been a staple as well. The growth of peer-to-peer lending has stemmed in part from the ability to put the loans created by Prosper and Lending Club into IRAs.
And as CrowdFund Beat and others have reported, self-directed IRAs serving accredited investors now have access to crowdfunded startups available through SEC Rule 506(c), which legalized general advertising of investment of non-public companies in 2013 pursuant to the JOBS Act. When Title III of the JOBS Act or new congressional legislation legalizing equity crowdfunding for ordinary investors is finally implemented—and hopefully that will be soon—there should be no barriers to self-directed IRAs serving the masses providing access to these exciting new investments. Ditto with the SEC’s recent final rule on Regulation A+, which will allow non-accredited investors to hold shares in simplified filings of less than $50 million
Yet, much of this progress in lifting barriers to crowdfunding could be short-circuited if this restrictive “fiduciary” rule comes to fruition. Last time, the proposal specifically included “appraisers” in its definition of fiduciaries, a category that included directed custodians of IRAs. Appraisers are still covered in the new rule.
Although there are some slightly expanded exemptions, the current rule still labels as “fiduciaries” those who provided an “appraisal, fairness opinion, or similar statement whether verbal or written concerning the value of securities or other property if provided in connection with a specific transaction or transactions involving the acquisition, disposition, or exchange, of such securities or other property by the plan or IRA.”
Tom Anderson, board manager of Pensco Trust, a San Francisco-based IRA custodian that is now one of the leaders in offering crowdfunding options, wrote in comments to the DOL in 2011 that imposing a fiduciary standard “would result in higher costs and potentially fewer service providers to self-directed IRAs,” which “in turn, could result in fewer investment choices.” Anderson’s comments were written on behalf the Retirement Industry Trust Association, a trade group for custodians of self-directed IRAs, who helped successfully shelve the first DOL rule.
Anderson’s warnings still largely apply to the new rule, especially since it is full of phrases such as “generally accepted investment strategies” that could cause heightened liability for those who assist investors in buying nontraditional assets for their IRAs.
Those investors who believe, contra DOL, that they can “prudently manage” their own investments and are indeed capable of “distinguish[ing] good advice” from bad should make their voices heard now. The deadline for comments to DOL is July 6, and they can be sent to. e-ORI@dol.gov (Include RIN 1210-AB32 in the subject line of the message). Investors can also let lawmakers who voted for the bipartisan JOBS Act know that if the current DOL rule goes through, much of the gains from that law will be undone.
John Berlau, senior fellow for finance and access to capital at the Competitive Enterprise Institute, will be discussing the DOL Fiduciary Rule and other policies affecting crowdfunded investing at the 2nd Annual Crowfunding USA Forum at the National Press Club in Washington, DC on May 7 and 8.