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Sponsored By
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Craig Lemoine, PhD, CFP® | Director – Granum Center for Financial Security at The American College
Understanding the new Department of Labor Conflict of Interest Rule requires context. Without context, we may be quick to dismiss this rule as overreaching or reactionary. This rule is not a product of 2016. It is not an isolated attempt to finish what the SEC began in 2010. Its origins reach back to the Dodd-Frank Act, through the 1970s and into the years of the Great Depression. This new rule erodes the regulatory divisions created almost a century ago and brings the regulation of financial advice under one umbrella.
Origins of Financial Regulatory Policy
In 1911 (1), Kanas was the first of many states to adopt the so-called “blue sky” laws in order to offer some protections in a world of options as limitless as the deep blue sky itself. These laws regulated the sale of a handful of financial products and attempted to protect against unlawful sales practices. As more states adopted blue sky laws, products were becoming more sophisticated and the Roaring Twenties were flapping along. Markets heightened, bridges sold, bank deposits and loans grew in number and magnitude (2). But as urban institution growth slowed, banks in rural communities began to fail. As the dominos fell, the markets followed.
In October of 1929, Black Thursday was followed by Black Tuesday and 28 million shares were liquidated. Margin accounts were erased over a weekend. Banks began to fail in droves and unprecedented unemployment took hold. The U.S. economy had started to collapse and fall into a depression that would last for years.
The Great Depression set the stage for today’s financial regulatory policy. By 1930, unemployment levels exceeded 10 percent; three years later unemployment had climbed to 25 percent. Hundreds of banks became insolvent every week (3). Runs on banks would lead to illiquidity, which would lead to suspension then failure. Bank lending seized, the economy stalled and began to fail. Half of all banks had failed by 1933. The subprime mortgage crisis of recent years pales in comparison, considering that just 0.6 percent of banks failed and unemployment peaked at 8.5 percent (4).
Rise of Financial Regulation
Franklin D. Roosevelt’s presidency in 1933 saw the adoption of a series of regulatory acts intended to right a sinking ship. These federal acts included the Banking Act of 1933, Securities Act of 1933, Securities Exchange Act of 1934, Trust Indenture Act of 1939, Investment Company Act of 1940, and Investment Advisers Act of 1940. These acts were followed by the McCarran Ferguson Act of 1945.
The 12 years between 1933 and 1945 permanently structured our regulatory framework. This framework was shaped to stop unprecedented economic bleeding. These acts essentially covered banking, securities, created the Securities and Exchange Commission (SEC), regulated underwriting, mutual funds, investment advisers and the insurance industry. Brokers and dealers were primarily regulated under securities acts, insurance through states and the McCarran Ferguson act. Banks had the banking act. Investment advisors registered with the SEC under the Investment Advisors Act. States continued to regulate all of these in some capacity as well.
Evolution of the Regulatory Framework
As the economy recovered, retirement became less of an exception and more of an institution. As the regulatory framework evolved, American wealth and longevity marched alongside. In 1933 Americans lived into their early or mid 60s. Today life expectancy extends to the 80s and beyond (5). The potential for living 20 years after exiting the workplace facilitated a need for retirement security. The need was emphasized at the failure of automobile and steel manufacturers in the 1960s and 1970s wiping out unvested pension promises. These failures, coupled with a handful of large companies offering rank and file employees almost impossible vesting options, pushed regulators to enact The Employee Retirement Income Security Act of 1974 (ERISA), weaving retirement income security into existing regulatory policy.
An established regulatory chassis allowed companies to play by and thrive under their associated industry rules. The rules often vary, the standards are different and over time our quagmire approach to regulation has evolved and has become more segmented. Differences in industries were not always clear. We created an industry where a banker, a registered rep, an insurance agent and an investment advisor were distinct, but were often performing an identical function: helping retirees achieve financial security.
Multiply a fragmented regulatory environment by $23.7 trillion of Individual Retirement Account (IRA) and 401(k) assets (6), add pressures to our Social Security system, and you arrive at the Department of Labor issuing the Conflict of Interest Rule in April 2016. With it came a variety of prohibited transaction exemptions and amendments.