The Derivative Project

Senate Republican Testimony Pushed an Agenda that Preys on Middle Class Savings

Senate Republican Testimony Pushed an Agenda that Preys on Middle Class Savings

Senate Republican Testimony Pushed an Agenda that Preys on Middle Class Savings

Primerica’s Schneider, Brookings Institution’s Litan, and Rebalance Inc’s Puritz

Primerica's Schneider

Brookings InstitutionRebalance Inc PuritzJuly 21, 2015 Testimony at Senate Sub-Committee on Health, Education, Labor and Pensions

The highlight of the Senate subcommittee testimony this week is perhaps the title of this hearing:  Restricting Advice and Education: DOL’s Unworkable Investment Proposal for American Families and Retirees.  

How does one define “advice”?

Since the advent of 401k’s the concept of “advice” has been used as the euphemism for a sales distribution channel. No other industry has managed to hoodwink an entire American population that a manner of product distribution equates to “professional advice.”  All three gentlemen continued the charade of obfuscating the widely held misconception that a sales distribution channel is in reality but a sales force, deemed “professional, trusted advisors.”

Both Mr. Puritz and Mr. Schneider failed to address the concept of performance accountability raised by the GAO report on Managed Accounts.  How a salesman or intermediary places ETF’s or mutual funds together in a portfolio matters significantly;  it is directly correlated to overall performance of the retirement portfolio. Sales personnel, not trained investment professionals, have packaged portfolios for retirement investors since the advent of IRA’s and defined contribution plans.  New “automated advisors” are now packaging the portfolios with algorithms, with no accountability for audited performance.

The White House Council of Economic Advisors estimated earlier this year the costs of “conflicted advice” are over $17 billion annually. What are the losses resulting from the lack of performance accountability of “investment selections” made by an untrained sales force over the past forty years?  Have these costs or losses to the retirement nest eggs of the middle class been accurately measured?

The term “advice” is but a Euphemism for an Out-dated Sales Distribution Channel, rendered too costly by today’s technology and now more relevant/apparent in Today’s Low-Interest Rate Environment

Mr. Litan, non-resident Brookings Institution fellow, quoted a study funded by Capital Group, parent company of American Funds, “Good Intentions Gone Wrong: The Yet to be Recognized Costs of the Department of Labor’s Fiduciary Rule.”

It should be noted that Capital Group’s American Funds sell their investment product by paying a sales force loads on their mutual funds or “sales commissions” that average 5.25% upfront and an annual commission, 12B-1 fee of .25%.  On top of the sales commission, the retirement investor might pay an ongoing “advice” fee of 1% and the annual management fee to the mutual fund manager of 1.25%.  American Funds are also packaged in Wrap Accounts sold by the Primerica sales force.

American Funds states on its home page: “Since 1931, Capital Group has been singularly focused on delivering superior, consistent results for long-term investors using high-conviction portfolios, rigorous research and individual accountability.”

American Funds are consistent, strong performing, SEC regulated investment companies, delivering superior performance.  However, the distribution channel for their Funds is a very expensive sales force that must charge very high fees to compensate for the labor-intensive distribution model.  Their mode of distribution is outdated given today’s technology and given current economic conditions—with stagnant wages, unprecedented low interest rates and a sluggish GDP. High sales distribution costs are not a cost that main street investors can afford or should be asked to pay with better, less costly, distribution channels now available.

Not surprisingly, Mr. Litan argued for maintaining status quo with a fund distribution model, such as that used by Capital Group, that charges hefty front end loads, or sales commission, with, most likely, a biased assertion that eliminating this costly distribution method would harm the small retirement investor, given the report was funded by Capital Group.

Rebalance Inc’s Puritz puts forth the same distribution model, an intermediary that sells ETF’s and mutual funds, packaged for the consumer, based on modern portfolio theory, yet with significantly lower intermediary sales costs.  Mr. Puritz stated in his testimony, “New clients strive for the optimal balance of risk and reward, unbiased by commissions. Third, our firm provides a high level of transparency, regarding “all-in” investing costs to consumers and fiduciary responsibilities to clients.”  Rebalance’s intermediary fess are somewhat lower, than the traditional advisor, however, the flaw in their business model is the complete lack of transparency of performance, comparable to traditional advisors/salesmen. A true fiduciary provides regular audited performance at the SEC that can be compared to comparable benchmarks, ensuring full transparency as to all costs and performance.

The American consumer should not be forced to continue to accept Wall Street’s “trust me”, because we have “distinguished” academics on our team.  The only way a consumer can make an informed choice in selecting an investment product and fiduciary manager, is to have all information upfront which includes (1) all fees and expenses, including historical portfolio turnover and (2) audited performance filed with the SEC semiannually.  Rebalance Inc does not file audited performance with the SEC to offer retirement investors the opportunity to value their service, their performance, after all fees.

With Rebalance, one pays an annual fee of around .72% for a passive portfolio.  Thus, one is guaranteed to earn returns of the index minus .72%, before portfolio turnover fees.  There exist audited investment company returns with lower management fees that have outperformed the relevant index by 2-%-7% for over five, some ten years.  Is this the best option?  Provide the audited performance so a retirement investor can make an informed decision.  75% of actively managed funds may under perform the relevant index, but it is indeed possible to identify the 25%, that outperform, to compare if one is better with active or passive.

The charade that everyone needs their own personally designed portfolio is a sham to hide performance accountability of the firm taking the annual assets under management fee.  Fiduciary money managers, that manage assets in investment companies under the Investment Company Act of 1940, are trained and experienced to make these decisions for most middle class investors, not a salesman or computer algorithm.  Regulated investment companies provide audited performance against industry – accepted benchmarks.

Gouging the Little Guy’s Retirement Savings?

Finally, Mr. Schenider of Primerica, pushes the most expensive distribution model for Main Street.  Primerica’s stated target market is individuals earning between $30,000 and $100,000.  Primerica uses a very costly distribution sales force, with embedded high profit margins for their firm.  This distribution model is not only more costly, on a percentage basis, for those that can afford it the least; the investment products for Main Street by Primerica may deliver substandard returns.  With a history of poor supervision of this sales force, main street retirement investors have also lost significant sums to Primerica advisor Ponzi schemes and other regulatory breaches.  One can learn more from FINRA Broker Check and the SEC IAPD.  Here is a picture of regulatory fines revealed through Primerica’s SEC-file ADV:

Primerica SEC Filed ADV


Primerica contends that the middle class needs their sales force to learn the importance of savings. Public schools can instruct that.  Public service messaging can instruct that.  Bona fide, independent employee workplace education can instruct that.  Automatic enrollment in defined contribution plans seems to also eliminate that role.  Primerica contends that the middle class needs their sales force to learn when and how to rebalance.  SEC investment companies under the Act of 1940, take care of the rebalancing in their balanced funds or target date funds.  Primerica contends their sales force educates the middle class on basic investment concepts, yet have failed to demonstrate such.

Primerica’s Wrap Account Charges, Annual Advice Fees and Sales Fees, such as Class A Loads (5.25%) and Annual 12 B-1 Fees (.25%) Based on their SEC Filed ADV

A $100,000 middle class rollover into a Primerica recommended mutual fund, would charge, on average, the retirement investor over 4.8% the first year.  Most reasonable folk would deem that “gouging” the middle class, who are struggling to get by, when there is better performing product that they can access directly for .65%, saving them over $4150 in the first year alone, on a $100,000 401k rollover to an IRA, for example.

One finds it unfathomable that an educated, informed consumer would voluntarily select a more expensive option that delivers less growth in their retirement savings.

The most basic investment concept is how to select the base core retirement SEC filing investment company and compare its expenses, its investment objectives, its audited performance, over a minimum of five years.  Would a retirement investor, close to retirement, earning $30,000 annually, who has saved $100,000 for his retirement, choose to pay a Primerica salesmen 1.75% annually, plus a $50 annual custody fee to Primerica, plus a 1.48% upfront load to purchase a Class A mutual fund, if he was aware of how to purchase a better performing fund, historically, for no up front load and no annual “advice” fee?

Primerica’s Schneider’s testimony decried the costs of Wrap Accounts to main street investors, while Primerica has filed at the SEC,  one of the most expensive Wrap Accounts in the industry.  Through our analysis, the average main street investor would pay Primerica and their selected fund companies, combined, over 4.8%, to purchase a mutual fund, such as Black Rock’s BREAX, an option in their Wrap Account portfolio.

Basic investment education on fees, transparency and performance is mandatory.  The main street investors that Primerica says they are educating can only be deemed misleading, conflicted education and in the best interests of Primerica.

In sum, the most critical issues that the Senate Subcommittee did not address at this Hearing on July 21, that the Department of Labor has proposed and should be instituted immediately:

  1. Eliminate the five part test for what is deemed “advice” – that it must be “mutually agreed to” for IRA’s.  This is a small print disclosure that allows firms, such as Primerica, to sell a mutual fund in a wrap account, charge an annual fee, charge sales commissions and have no other duty to monitor the sale, yet take in an annual advice fee.
  2. Allow a private right of action for IRA’s and put an immediate end to mandatory arbitration in any retirement brokerage account.

We propose the most crucial item for this Subcommittee to address is:

  • Given today’s technology, what is the most cost effective distribution system for retirement funds, organized under the Investment Company Act of 1940?  What other more cost-effective solutions are now available to the middle class that also reduce taxpayer regulatory burdens to manage financial intermediaries?

Technology is Changing Industries and Eliminating the Need for Costly Personnel

The financial services industry is lobbying hard to continue their outdated distribution system, a profit model, rendered obsolete by technology.  The question for the subcommittee is not the role of “advice”— should it be “fiduciary or not”.  The question is what is the most cost effective manner, given new technology, to match the best SEC regulated investment company product, core retirement mutual funds, with every American’s retirement account, IRA, SEP or 401k?  The old-fashionned salesmen for retirement investment product is a thing of the past.

Individuals need term insurance, estate lawyers, accountants— they should go direct to the source. But do they really need to pay a salesman over 3% or their retirement assets annually, to hold their hand and tell them the market goes up and down, do not panic.  They can go direct to the product source and let the Investment Company manage the ups and downs of the market, knowing full well, retirement assets should not be touched until retirement, just like the old-fashioned pension.

It is time that both the Department of Labor and the financial services industry accept the new premise that using human beings to sell investment product is not only too costly to US taxpayers to monitor, but an outdated distribution model that serves to take hard-earned dollars from the middle class, without adding any value.

The harm to all Americans is an industry that obstructs an informed citizenry, which thus prohibits them from making an informed choice, both at the polls and for their retirement savings.