Feds Just Can't Allow People To Save And Invest

COMMENTARY Government Regulation

Feds Just Can't Allow People To Save And Invest

Nov 4, 2015 6 min read

Former Director, Center for Data Analysis

Norbert Michel studied and wrote about financial markets and monetary policy, including the reform of Fannie Mae and Freddie Mac.

Two events from last week exemplify federal officials’ refusal to let people live their own lives and earn money as they see fit.

One deals with the Department of Labor’s (DOL) new fiduciary rule, the other with the Securities and Exchange Commission’s (SEC) new rules for crowdfunding.

The 2010 Dodd-Frank Act required the SEC to study the need for a new, uniform federal fiduciary standard for brokers and investment advisers. Despite this provision, the Obama administration’s DOL announced in March that it would move ahead with its own fiduciary rule.

In general, a fiduciary standard requires financial advisers to put their individual client’s interests above their own. Although this idea seems simple, reality is more complicated.

There are actually several sets of rules that govern what investment advisers can do. That’s partly because there are different types of financial advisers. For instance, pension plan trustees have a fiduciary duty because it’s their job to protect the plan beneficiaries’ interest, but stockbrokers generally don’t have a fiduciary duty because it’s their job to sell stocks. (They have, however, been under an obligation, for the last three years, to insure that the securities sold are “suitable” for the investor).

So it’s not surprising that the DOL ended up issuing seven separate rules to impose the new standard. And it won’t be much of a shock if the new rules – assuming they’re implemented – end up causing more harm than good.

There’s reason to think a very simple disclosure rule would be a much better approach. For starters, there’s really no evidence the current rules have created a major problem. Moreover, broker-dealers and registered representatives have had to comply with a similar standard for the last three years.

What might a disclosure rule look like? The New York City Comptroller proposed a pretty good one. It would require non-fiduciaries to confirm both aloud and in writing that:

"I am not a fiduciary. Therefore, I am not required to act in your best interests, and am allowed to recommend investments that may earn higher fees for me or my firm, even if those investments may not have the best combination of fees, risks, and expected returns."

Of course, this approach would mean we have to trust people to judge for themselves whether they should seek advice from another advisor. Or, heaven forbid, that people could sufficiently educate themselves on this issue.

Last week, the U.S. House passed Rep. Ann Wagner’s (R-Mo.) bill to block the DOL’s fiduciary rule. But without similar action in the U.S. Senate, the federal government will impose the DOL’s overly complex regulations, and average citizens will likely end up with fewer investment options.

The other event last week was the SEC’s vote on new rules for crowdfunding.

These rules originated from a bill intended to simplify the process of providing capital to small startup businesses. But the SEC delivered yet another set of complex rules destined to do the opposite.

Crowdfunding is "the practice of funding a project or venture by raising many small amounts of money from a large number of people." Donative crowdfunding has long been used to raise money for charities and artists, and it even funded the Statue of Liberty.

However, since the Securities Act of 1933, it has been illegal for entrepreneurs to use crowdfunding (or any general solicitation) to raise investment capital from ordinary Americans to start a business. The 2012 Jumpstart Our Business Startups (JOBS) Act was supposed to remove this hurdle.

Title III of the JOBS Act allowed business owners to raise up to $1 million per year, in small amounts from ordinary people, via either internet-based “funding portals” or broker-dealers. This tool would allow business owners to raise capital without having to incur the high costs – which can run into millions of dollars – of going public.

On Friday, the SEC finally voted on its final rules to implement Title III. The rules are nearly 700 pages long, even though Title III of the JOBS Act is 9 pages.

Given the complexity of the rules, along with the $1 million limit, it’s doubtful many entrepreneurs will find crowdfunding worth their effort.

For those who try, they’ll have to deal with legal limits on the amount any one investor can invest. The maximum ranges from $2,000 or less for lower-and middle-income investors, to $10,000 for people with incomes over $100,000.

These so-called investor protections were part of the JOBS Act, so that falls on Congress. But SEC Chair Mary Jo White noted on Friday that the SEC’s final rule provided "stricter investment limitations intended to reduce the impact of a potential loss for investors."

Just as with the fiduciary rule, Congress seems to assume that people lack the judgment to make investment decisions on their own. One major effect of these sorts of rules, though, is to prevent lower-income people from making investments that could eventually land them in the "incomes over $100,000" category.

The root of the problem in both of these cases is that the federal government acts as though people are too weak, stupid, and helpless to determine how they want to invest. And in both instances, the federal government ends up micromanaging financial decisions in ways more likely to harm than help people. (SEC Commissioner Piwowar’s dissent points out this issue.)

Both sets of rules will put up additional barriers to entry in the financial industry, thus further disadvantaging existing financial firms’ competitors. This problem is pervasive in the financial industry, and existing firms are not shy about highlighting it.

For instance, in a recent article titled Regulation Is Good for Goldman, the Goldman Sachs CEO and Chairman Lloyd Blankfein said:

"More intense regulatory and technology requirements have raised the barriers to entry higher than at any other time in modern history. This is an expensive business to be in, if you don’t have the market share in scale. Consider the numerous business exits that have been announced by our peers as they reassessed their competitive positioning and relative returns."

Blankfein also pointed out that the more highly regulated environment provides more opportunities for large firms like Goldman to grow because “only a handful of players” will be able “to effectively compete on a global basis.”

And in a moment of candor that should make members of Congress blush, he noted that his firm is “prepared to have this relationship with our regulators for a long time.”

The pro-regulatory crowd – such as the authors and supporters of Dodd-Frank – refuses to acknowledge that all the rules they keep imposing on the financial industry further concentrates wealth and harms the very people they claim to want to protect.

We need fewer rules and regulations so that we can have more competition. That’s how free enterprise – even in the financial industry – works. Entrepreneurs figure out the best way to provide people with the products they want and need. Over time, they figure out the way to deliver goods and services at the lowest cost to consumers.

This sort of system works best for both sides of the exchange – consumers and business owners both get what they need, whether we’re talking about products, money, capital, or a return on investment.

The less government interferes with this process, the better. Of course, that doesn’t mean that this system is perfect and nobody will ever lose money or do something nefarious.

But that’s where government can actually help. It can protect property rights and prevent and mitigate fraud. It can provide the basic legal framework for a free society to flourish.

It’s not the government’s job to protect people from every possible loss or conflict that might arise. Government employees have no better insight than anyone else into which investments are safe or risky. (They sometimes have less.)

Rather than complicating our lives with ever more complex rules and regulations, policymakers would better serve the public if they stuck to strong protections for property rights and meaningful measures against fraud.


-Norbert J. Michel is a research fellow specializing in financial regulation for The Heritage Foundation’s Thomas A. Roe Institute for Economic Policy Studies. He is also a co-author of Heritage’s Opportunity for All; Favoritism to None.

This piece originally appeared in Forbes. See the original and read more at http://www.forbes.com/sites/norbertmichel/2015/11/02/feds-just-cant-allow-people-to-save-and-invest/