A Reignited Debate About Protecting Investors
Thursday, February 26, 2015

Two events in Washington, D.C., this week reignited the debate about the responsibilities of those giving investment advice or operating retirement plans. The outcomes could influence what standards are used to determine if investors’ interests are being placed first.

On Monday, President Obama proposed tougher standards on brokers handling retirement funds. He called for requiring “retirement advisers to put their client’s best interest first, by expanding the types of retirement investment advice subject to ERISA.” ERISA is the Employee Retirement Income Security Act and expanding it would be mean stricter standards for brokers. Among the stricter standards that are part of Obama’s proposal is making advisers “abide by a ‘fiduciary’ standard.”

On Tuesday, the U.S. Supreme Court heard arguments in Tibble v. Edison International. The case centers on Edison’s failure to replace higher-cost funds in its 401(k) plan with lower-cost versions. Specifically, the plaintiffs accuse the company of keeping higher-cost retail class shares of certain mutual funds in the retirement plan when identical but lower-cost institutional share class shares were available.

The lawsuit is of interest for anyone who has a 401(k) or a similar type of workplace retirement plan for two reasons. First, it centers on ERISA’s six-year limitation of when claims can be filed against a plan sponsor for alleged failure to act in the interests of employees. SCOTUSblog described the issue as revolving around “whether the fiduciaries of an ERISA plan have a continuing duty of prudence that requires periodic monitoring of investments, or is the duty instead measured at the single point in time when the investment is made.” Secondly, news reports imply the court’s justices seemed hostile to the argument that making changes to investment plans would create confusion for employees. Justice Elena Kagan was quoted as saying, “The day when you get from your mutual funds a notice that says, by the way, you’re a preferred investor, we’re switching you, it’s the exact same fund under a different name, now you don’t pay fees—that’s a red-letter day for an investor.” (A red-letter day is a day of special significance.)

Notably, the Supreme Court appeared to show caution in terms of defining who should fall under the fiduciary standard. In reporting on the case, Reuters said, “Justice Stephen Breyer indicated that he favored sending the case back to the lower courts, saying ‘there is a problem with me suddenly, or any of us, describing this fiduciary duty, the nature of it, whether it's violated here or not’ when it was not fully addressed earlier in the litigation.” If the case is sent back down, a lower court could potentially expand the definition of which professionals must follow the fiduciary standard.

The word ‘fiduciary’ is not one the financial services industry takes lightly. Among the responsibilities the Labor Department lists with being a fiduciary are “acting solely in the interest of plan participants and their beneficiaries” and keeping plan expenses “reasonable.” The Securities Industry and Financial Markets Association (SIFMA) says a fiduciary is required to “act in the best interest of the customer, and to provide full and fair disclosure of material facts and conflicts of interest.” The CFA Institute says “Fiduciaries owe undivided loyalty to their clients and must place client interests before their own.”

While expanding the classification of who should have to adhere to the fiduciary standard to any adviser, planner or broker seems like a logical step, the industry is fighting any expansion of the standard. For example, SIFMA quickly followed Obama’s proposal with a warning that “the new regulation could limit investor choice, cause inconsistencies as different regulators would apply different standards to the same retirement accounts, prohibit access to investor guidance, and raise the costs of saving for retirement.” Simply put, the industry is worried about the increased financial and resource costs associated with the stricter standard. Expanding the fiduciary would make more advisers and brokers accountable for their recommendations and thereby potentially expose their firms to increased liability that comes with greater responsibility. It’s worth noting that the financial industry has pushed very hard against previous attempts to expand the definition of who is required to adhere to the fiduciary standard.

I cannot emphasize enough that expanding the fiduciary standard will not stop malfeasance from occuring or result in better advice being given. It will, however, hold financial professionals to a higher standard and should make them more accountable for their actions. To the extent it does, I personally support expanding the fiduciary standard. (As a CFA charterholder, I would be required to put the interests of any client ahead of my own interests were I to manage money for individuals or institutions. As a nonprofit, AAII is not licensed to manage money on behalf of our members.)

Regardless of whether or not the fiduciary standard is expanded, you need to realize that no one cares more about your money than you do. It is ultimately your responsibility to investigate your options and ensure your money is being managed properly. This does not exempt financial professionals from the responsibility of giving good advice, but it does mean you need to be engaged with your portfolio whether or not professional assistance is being used.

More on AAII.com

The Week Ahead

I will speak to our Phoenix chapter next Saturday, March 7, 2015. Not in the Phoenix metropolitan area? Visit our local chapters page to find an AAII chapter near you.

About 10 members of the S&P 500 will report earnings next week. Several retailers will continue to report earnings, including AutoZone (AZO) and Best Buy (BBY) on Tuesday and Costco Wholesale (COST) on Thursday.

A busy week for economic data will start on Monday with January personal income and spending, the February ISM manufacturing index, the February PMI manufacturing index and January construction spending being released. Wednesday will feature the February ADP Employment Report, the February ISM non-manufacturing survey and the Federal Reserve’s periodic Beige Book. Revised fourth-quarter productivity and January factory orders will be released on Thursday. Friday will feature February jobs data—including the unemployment rate and change in nonfarm payrolls—as well as January international trade data.

What’s Trending on AAII
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AAII Sentiment Survey

The percentage of individual investors describing their short-term outlooks for stock prices as either bullish or neutral moderated in the latest AAII Sentiment Survey. Pessimism rebounded, but remained at a low level.

Bullish sentiment, expectations that stock prices will rise over the next six months, declined 1.6 percentage points to 45.4%. Even with the pullback, this is the 25th out of the last 29 weeks that optimism is above its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined 0.8 percentage points to 34.3%. This week is the eighth consecutive week with neutral sentiment above its historical average of 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, reversed last week’s drop by rebounding 2.4 percentage points to 20.3%. Pessimism is right on the edge of what we consider to be an unusually low level. The historical average for bearish sentiment is 30.5%.

Although the major indexes rose for several consecutive days, bullish and neutral sentiment pulled back after recently setting near-term highs. As noted above, both measures continue to remain above their respective historical averages.

Keeping AAII members encouraged are the upward momentum of stock prices, comparatively low energy prices, earnings growth and sustained economic expansion. Causing other members to be cautious or pessimistic are prevailing valuations, disappointing earnings or guidance from certain companies, geopolitical events, the impact of lower oil prices on energy stocks, the pace of economic growth and worries that an even larger decline in stock prices could occur.

This week’s special question asked AAII members about their comfort level with current stock valuations. Just under half of all respondents said stocks are either overvalued (33%) or somewhat/slightly overvalued (14%). Many who thought stocks were expensive described current valuations as being high relative to historical valuations. At the other end of the spectrum, 17% of respondents said they were either comfortable with current valuations or view them as being acceptable. Several of these respondents pointed to profit growth as the reason why. Slightly more than 10% said stocks are undervalued, while 5% said the answer depends on the industry or the stock being analyzed.

A common theme across answers was a lack of good alternatives for investment dollars. Several respondents thought stocks could continue to rise as long as interest rates stay low or profits continue to grow.

Here is a sampling of the responses:

  • “I think valuations are high, but they may stay that way for a considerable time.”
  • “Not very comfortable as the price-earnings ratio seems pretty high, but there is no other game in town besides equities.”
  • “Some stocks are getting too high; need to be selective and not buy the ‘market.’”
  •  “Stocks are undervalued due to the level of profits.”
  • “I’m fairly comfortable at current valuations as I think prices reflect trends in revenues and earnings.”
  • “The Shiller CAPE ratio is extremely high.”


This week’s Sentiment Survey results:

Bullish: 45.4%, down 1.6 points
Neutral: 34.3%, down 0.8 points
Bearish: 20.3%, up 2.4 points

Historical averages:

Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!