Morningstar Magazine - April/May 2018 - 19

elderly investors "have an even greater lack of
investment knowledge."3 In a forthcoming
report, Morningstar's Ray Sin and Ryan Murphy
find that many investors are still unresponsive
to fee disclosures in exchange-traded funds, even
when these fees are prominently featured as part
of the decision-making process.
Unfortunately, some disclosures are sent to
individual investors but are not given to third
parties, which further hampers the effectiveness
of disclosures in helping investors make
informed decisions. Investors often rely on the
data collected by third parties, who can
in turn contextualize the information. (For example,
Morningstar helps investors compare similar
mutual funds.) In cases where there is
limited or no disclosure data for third parties to
access, ordinary investors who lack context
are hurt.
For example, the paucity of public disclosure is
a problem when retirement savers try to determine
if rolling over an old 401(k) into an IRA or a new
401(k) is a sensible idea. Figuring out the strengths
and weaknesses of one's 401(k) is difficult.
Sure, an investor can look at the plan's fees and
investment disclosures, but because that
information is not public, she cannot put it in
context to reveal whether a new employer's 401(k)
is better than an old employer's.
Regulating Advice

Finally, the government regulates the advice that
broker/dealers and Registered Investment
Advisors can offer to ordinary investors, to better
protect and advance these investors' interests.
Regulation is something of an amorphous
term, used to describe a variety of government
actions. For the purposes of this column, we define
it based on political scientist Peter J. May's
chapter in The Tools of Government: Regulations
are "rules that govern expected behavior and
outcomes, standards that serve as benchmarks for
compliance, sanctions for noncompliance,
and an administrative apparatus that enforces
rules and administers sanctions."4

The U.S. government regulates advice unevenly,
with three regulators-the Department
of Labor, the SEC, and the Financial Industry
Regulatory Authority-applying different
standards. The spectrum runs from a fiduciary
standard-wherein an advisor must put the
client's interests first-to the suitability standard
aimed at ensuring that clients get products
appropriate for their investment situation and are
treated fairly by advisors.
The Labor Department regulates investment
advice for most employer-sponsored retirement
plans (such as 401(k) plans) under the strict
fiduciary standards of the Employee Retirement
Income Security Act of 1974. In addition,
under ERISA, retirement investors can use the
court system as remedies for breaches of fiduciary
duty. This provides a strong incentive for
retirement-plan sponsors to take their fiduciary
duty seriously and offer workers retirement plans
without excessive fees. In recent years,
lawsuits against employers who have breached
their ERISA-mandated fiduciary duty have returned
millions of dollars to retirement investors.
The SEC directly regulates RIAs and ensures their
compliance with the Investment Advisers
Act of 1940, largely through mandating disclosures
RIAs must make with some attention to the
process advisors use to generate recommendations. RIAs are fiduciaries, but the standards that
apply to RIAs are not as strong as those that
apply to fiduciaries under ERISA. In particular,
individual investors cannot sue in court for
breaches of the advisers act, unless they can prove
an unsuitable recommendation was made
intentionally. Further, under ERISA, the default is
that fiduciaries must refrain from engaging
in conflicted transactions; the Advisers Act instead
mandates that "material conflicts of interest
shall be disclosed" and prohibits fewer
transactions by default.

funds and other products to retail investors.
It enforces a lower standard for financial advice
meant to ensure that recommendations
are "suitable for the customer" based on "the
customer's investment profile." Financial advisors
working for broker/dealers can operate
more similarly to salespeople rather than impartial
advisors, if the recommendations they make
are suitable and they follow standards of fair
dealing with customers.
Mixed Results

The government relies on three primary avenues
to help investors, each with mixed results. Tax
incentives are helpful to many investors, but more
tax incentives are unlikely to increase retirement
savings or broaden access to retirement
plans. Financial disclosures have effected change,
but disclosure regimes could be more robust.
Making nonpublic disclosures more readily
accessible to the public would hugely benefit
investors and those trying to serve them.
Finally, regulating advice has been a controversial
topic for years. The Labor Department finalized
regulations to expand the number of fiduciary
advisors to include most people working
with clients' IRAs, but the enforcement mechanism
is on hold. Still, there seems to be growing
consensus in the industry that regulators should
better align the standards advisors follow in
various contexts. The chairman of the SEC sent out
a request for information on May 31, asking
for input on approaches the SEC might take. We
will see what happens next, but there is still
room for the government to change the way it uses
this tool to help ordinary investors. K
Aron Szapiro is director of policy research with Morningstar.
Jake Spiegel is a senior research analyst, policy research,
with Morningstar.

Finally, the SEC has also delegated authority
to Finra, a so-called "self-regulatory organization."
Finra regulates broker/dealers who sell mutual

3 Ibid.
4 May, P.J. 2002. "Social Regulation." In The Tools of Government: A Guide to the New Governance. Edited by Lester M. Salamon (New York: Oxford University Press).

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Table of Contents for the Digital Edition of Morningstar Magazine - April/May 2018