Interests of Financial Professionals Often Conflict With Retirement Investors, Watchdog Says

A street sign in front of the New York Stock Exchange in New York on June 14, 2022. Seth Wenig/AP Photo

Investment advisers are prioritizing their business profits over the interests of their retirement clients, according to a recent report by the U.S. Government Accountability Office (GAO).

“The interests of financial professionals and firms often conflict with the interests of retirement investors. This could create risks for millions of investors with over $18 trillion dollars in retirement savings in 401(k) plans and IRAs,” said the report released on Aug. 28.

For instance, financial professionals may favor business gains over their investors and recommend products that do not necessarily improve returns on retirement savings.

GAO found compensation schemes for financial advisers that conflicted with client interests such as promoting their company’s proprietary products instead of market alternatives. In some instances, advisers were encouraging clients to switch retirement accounts for personal profits.

The report discovered that advisers had revenue-sharing agreements with mutual funds when they recruited clients into the fund. A state securities commissioner told GAO that most retail investors, including retirement investors, “are unaware of the consequences that may occur in their accounts as a result of these compensation practices.”

GAO conducted an analysis of mutual fund performance between 2018 and 2021, finding that funds that compensate financial professionals for enrolling clients were “associated with lower average returns before fees.”

“This could reduce retirement savings’ growth over time and could make a difference of tens of thousands of dollars for investors in actively managed domestic equity funds at retirement.”

Prioritizing Personal Gains

In its analysis, GAO interviewed financial industry associations, examined disclosures from over 15,000 firms, and held undercover calls with 75 financial professionals. The agency also conducted a review of 20 conflict disclosures from registered investment adviser (RIA) firms.

Sixteen of these firms admitted to potentially benefiting when their financial associates recommended proprietary products to clients. These firms earn revenue from the sale of the products in addition to the advisory fee.

Four RIAs disclosed they had a financial incentive to recommend retirement investors to transfer their 401(k) account to an individual retirement account (IRA).

“SEC officials told us that despite such incentives (and related disclosures), firms have obligations to only make such recommendations when they are in the best interest of retirement investors,” GAO said in the report.

Fourteen RIAs had conflicts related to revenue-sharing agreements like mutual fund partnerships. RIAs would refer clients to a mutual fund which may incentivize the finance professionals with commissions.

Fourteen RIAs also had affiliate agreements. One firm disclosed they invest client funds in an affiliate bank even though these accounts offer less returns than money market accounts.

In the report, GAO determined that the U.S. Internal Revenue Service’s (IRS) oversight of financial professionals acting as fiduciaries was “lacking.” IRS has sole enforcement authority over IRA fiduciaries.

Fiduciaries are hired to put client needs ahead of their own. Unless the IRS institutes an audit process for IRA fiduciaries, “IRA investors may continue to be exposed to adverse impacts of prohibited transactions that can jeopardize their financial security in retirement,” the report warned.

The agency asked the IRS to implement a process to identify prohibitive practices between IRA fiduciaries and clients.

Regulatory Action

The government has been taking steps to counter conflict of interest among fiduciaries. In April, the U.S. Department of Labor announced a rule to protect the interests of millions of retirement savers who rely on advice from financial professionals.

The final rule requires investment advisers to provide “prudent, loyal, honest advice free from overcharges.” The fiduciaries must not make investment recommendations to their clients that favor their interests over client benefits.

Financial institutions that oversee advice providers are required to institute procedures to manage conflicts of interest and ensure the guidelines are followed.

“This rule protects the retirement investors from improper investment recommendations and harmful conflicts of interest. Retirement investors can now trust that their investment advice provider is working in their best interest and helping to make unbiased decisions,” said Acting Secretary Julie Su.

The Economic Policy Institute (EPI) applauded the final rule, noting that the protections included in the measure are “urgently needed” to counter certain professionals from taking advantage of regulatory weak spots and steer savers towards inappropriate, high-cost investment products.

EPI Senior Economist Monique Morrissey said that the winners of the rule would be retirement savers and companies selling “better products.”

Nonprofit group AARP welcomed the rule. During a White House event announcing the rule, AARP Chief Advocacy and Engagement Officer Nancy LeaMond said that the new policies formalize what Americans already expect from their financial advisers.

“AARP research shows that retirement savers assume that all financial advisors are giving them good advice, and because of this, they rely on it,” she said.