IRA rollovers recommended by fiduciaries including investment advisors are marred by conflicts of interest that often go undetected by regulators, according to a new report from a government watchdog that went undercover to call financial professionals while posing as investors. The General Accounting Office (GAO), which authored the report, suggested that agencies like the Department of Labor and the Internal Revenue Service need to increase their engagement when it somes to policing conflicted advice, arguing that these watchdogs are not overseeing costly advice to the degree necessary.
“Our review of 2,000 conflict disclosures [from 15,000 firms] and our calls posing as potential clients to 75 financial professionals found many complex conflicts that can be difficult to explain” in IRAs, the GAO said in the new report, entitled, "Retirement Investments: Agencies Can Better Oversee Conflicts of Interest Between Fiduciaries and Investors."
“We also found mutual funds that paid financial professionals were associated with lower returns for investors,” the GAO said.
Specifically, GAO's analysis of Morningstar mutual fund data from 2018 to 2021 found that funds that compensate financial professionals based on whether their clients invest in those funds is associated with lower average returns before fees.
The practice is “a proxy for conflicts ... that could reduce retirement savings' growth over time and could make a difference of tens of thousands of dollars for investors in actively managed domestic equity funds at retirement,” the GAO said.
The government watchdog said it undertook the study because, while “it’s a known fact that the interests of financial professionals and firms often conflict with the interests of retirement investors, this could create risks for millions of investors with over $18 trillion dollars in retirement savings in 401(k) plans and IRAs."
Across the board, IRA fiduciary oversight and the detection of conflicts is lacking, the GAO found. By law, the Internal Revenue Service (IRS) has sole enforcement authority over firms and financial professionals acting as fiduciaries under the Internal Revenue Code for Individual Retirement Accounts (IRA fiduciaries).
Right now, IRS detection relies solely on IRA fiduciary self-reporting to the IRS and paying the applicable excise tax, according to IRS officials. According to IRS officials, their practice regarding IRA fiduciaries is to enforce prohibited transactions that DOL refers to them, the GAO said.
The Department of Labor, however, “does not have authority to audit IRAs for prohibited transactions and, therefore, is generally unable to refer IRA fiduciaries to IRS for excise tax enforcement. Until IRS implements an audit process for IRA fiduciaries, IRA investors may continue to be exposed to adverse impacts of prohibited transactions that can jeopardize their financial security in retirement," the GAO said.
As a result of limitations in detecting conflicts, “the Commissioner of the IRS should develop and implement a process independent of DOL referrals for identifying non-exempt prohibited transactions involving firms or financial professionals who are fiduciaries to IRAs and assessing applicable excise taxes” the GAO continued.
More vigilant IRS oversight should include the IRS checking compliance during income tax audits of financial services firms, the watchdog argued.
The GAO also recommended that “the Commissioner of the IRS should coordinate with DOL through a formal means, such as a memorandum of understanding, on non-exempt prohibited transactions involving firms and financial professionals who are IRA fiduciaries and owe excise tax.”
The watchdog found that the conflicts of interest disclosures that firms and advisors deliver to investors are not always clear or understood.
“GAO found many conflicts associated with recommending one product over another in a review of over two thousand descriptions of conflicts of interest in required disclosures. Firms’ disclosures of conflicts are available to investors, although—based on GAO’s review of disclosures and prior GAO work—investors may not review or understand these documents,” GAO said.
“While Federal agencies encourage investors to ask professionals about conflicts of interest, but GAO’s undercover calls found that doing so may not always produce helpful information,” the watchdog said.
While the DOL ramped up existing fiduciary rules for advisors and firms who offer IRAs to investors, firm’s responses to the DOL’s 2016 fiduciary rule varied.
“To comply, some firms moved toward standardized compensation for financial professionals, and away from compensation that can depend on recommendations, according to several industry association representatives. After the rule was vacated, some firms reversed certain practices established under the rule, and other firms kept their new practices,” the GAO said.
Moreover, conflicts of interest disclosures are not always clear or understood.
GAO found “many conflicts associated with recommending one product over another in a review of over two thousand descriptions of conflicts of interest in required disclosures.” While firms’ disclosures of conflicts are available to investors, investors may not review or understand the documents, the watchdog said.
“Federal agencies encourage investors to ask professionals about conflicts of interest, but GAO’s undercover calls found that doing so may not always produce helpful information,” the GAO said.