How Department of Labor’s “Fiduciary” Rule Could Cripple IRA Choices

Last week, President Obama called on the Department of Labor to “update the rules and requirements that retirement advisors put the best interests of their clients above their own financial interests.” At a speech at the American Association of Retired Persons, the president proclaimed, “You want to give financial advice, you’ve got to put your client’s interests first. “

Yet, if the regulation the DOL is set to introduce at the president’s behest is anything like the “fiduciary” rule it proposed in 2010—and withdrew upon a groundswell of protest the next year—the government’s definition of “best interest” will likely not be in the best interest of individuals who wish to pursue alternative assets from gold to peer-to-peer loans to crowdfunding in their IRAs.

The last time around, the DOL tried to reclassify a broad swath of financial professionals and business as “fiduciaries” even if they did not provide regular investment advice. Not only were broker-dealers covered, but so were directed custodians of IRAs, even self-directed IRAs in which investors don’t rely on any “fiduciary” advice. Once again, the freedom of self-directed IRA holders to invest in assets of their choosing, including crowdfunding ventures, may be at risk.

Self-directed IRAs can invest in a wide range of assets. As worries about monetary policy have been on the rise, gold and silver have found popularity as IRA holdings. Real estate has long been a staple as well. The growth of peer-to-peer lending has stemmed in part from the ability to put the loans created by Prosper and Lending Club into IRAs.

And as CrowdFund Beat and others have reported, self-directed IRAs serving accredited investors now have access to crowdfunded startups available through SEC Rule 506(c), which legalized general advertising of investment of non-public companies in 2013 pursuant to the Jumpstart Our Business Startups (JOBS) Act. When Title III of the JOBS Act or new congressional legislation legalizing equity crowdfunding for ordinary investors is finally implemented—and hopefully that will be soon—there should be no barriers to self-directed IRAs serving the masses providing access to these exciting new investments.

Yet, much of this progress in lifting barriers to crowdfunding could be short-circuited if a broad, restrictive “fiduciary” rule comes to fruition. Last time, the proposal specifically included “appraisers” in its definition of fiduciaries, a category that included directed custodians of IRAs.

Tom Anderson, board manager of Pensco Trust, a San Francisco-based IRA custodian that is now one of the leaders in offering crowdfunding options, wrote in comments to the DOL in 2011 that imposing a fiduciary standard “would result in higher costs and potentially fewer service providers to self-directed IRAs,” which “in turn, could result in fewer investment choices.” Anderson’s comments were written on behalf the Retirement Industry Trust Association, a trade group for custodians of self-directed IRAs, who helped successfully shelve the first DOL rule.

Although it may be another month before the new revised rule is unveiled for public comment, several “red flags” indicate that it will be as bad for investor freedom as the previous DOL rule, if not worse. The first “red flag” is that although the previous fiduciary rule garnered opposition from more than 100 congressional Democrats—including then-House Financial Services Committee Ranking Member Barney Frank (D-Mass.), members of the Congressional Black Caucus, and even Vermont’s independent, self-proclaimed socialist Sen. Bernie Sanders—its most prominent supporters included sworn enemies of crowdfunding such as the AARP (to whom, as previously noted, President Obama announced the new rule) and Consumer Federation of America. 

These groups almost torpedoed the JOBS Act as it was going through Congress and have been trying to undo it ever since. So, in endorsing enthusiastically a revised “fiduciary” rule, they would no doubt welcome any gutting of crowdfunding that may result from the new regulation.

The second red flag is that the DOL appears to be formulating this regulation without consulting the Securities and Exchange Commission, the primary regulator of broker-dealers and investment advisors. Unlike the SEC, which is an independent agency (though with the majority of commissioners from the president’s party), the DOL is an executive department that operates directly under the authority of the president. Thus, its decisions are often much more political, and the department has been particular politicized under this administration. Witness former Secretary of Labor Hilda Solis’ headlining of an Obama campaign fundraiser in 2012 while on an official government trip paid for by taxpayers, as The Daily Caller has reported.

And the most important flag are the paternalistic statements from Obama administration officials about investors in 401(k)s and IRAs. “Like your doctor or your lawyer, your retirement advisor should be required to do what is best for you,” said White House Senior Adviser Valerie Jarrett on her LinkedIn page and the White House blog. Secretary of Labor Thomas Perez told reporters, “You don’t want your doctor telling you what’s suitable for you; you want that doctor to tell you what’s best for you.”

Jarrett and Perez don’t seem to get something informed patients and investors know well: that there is not one answer of what is “best for you” in either medicine or retirement saving. Patients should be able to choose their doctors—a right Obamacare is taking away from them—and savers should have the freedom to weigh the potential risk and return of various investment plans.

President Obama was right when he told the AARP last week that retirement “rules that existed 40 years ago haven’t caught up to the realities of most families today.” The solution however, is not to go back to a time of fewer choices, but to create policies that expand the saving choices we have today to include crowdfunding and many other options.

Note to readers: CEI Senior Fellow John Berlau, a contributing editor to CrowdFund Beat, will be moderating a panel on IRAs and crowdfunding on March 5 and discussing public policy issues in crowdfunding March 6 at the CrowdFund Beat Silicon Valley Crowdfunding Conference at the Computer History Museum in Mountain View, Calif.