Compliance September 10, 2019

State AGs’ Lawsuit Just One Part of Broader Fiduciary Fight

There is an all-out regulatory tug of war going on between consumer groups, the brokerage industry, the states and the SEC.
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Eight state attorneys general filed a lawsuit this week seeking to block the implementation of the U.S. Securities and Exchange Commission’s (SEC)’s Regulation Best Interest rulemaking package.

The Regulation Best Interest package, finalized earlier this year, has been subject to both praise and criticism from different stakeholders across the financial services landscape. Generally speaking, advisory and brokerage entities subject to the rulemaking package have spoken favorably about “Reg BI’s” disclosure-based approach to mitigating conflicts of interest.

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On the other hand, consumer advocates and Democratic officials have called the package weak and ineffective. They suggest the Trump Administration should mirror the approach taken by the Obama-era Department of Labor (DOL), which attempted but ultimately failed to implement a strict new fiduciary standard to be enforced by the DOL through powers bestowed directly by Congress via the Employee Retirement Income Security Act (ERISA).

According to the states’ new lawsuit, filed in the Southern District of New York, Reg BI fails to meet basic investor protections that Congress demanded to be established within the 2010 Dodd-Frank Act. In a statement published alongside the lawsuit, New York Attorney General Letitia James says Reg BI is a “watered-down” conflict of interest rule that “puts brokers first.”

“The SEC is now promulgating a rule that fails to address the confusion felt by consumers and fails to remedy the conflicting advice that motivated Congress to act in the first place,” she says. “Despite the SEC’s refusal to do its job, New York will continue to lead the charge to protect the millions of individuals investing in their futures, including the millions of Americans saving for retirement.”

Indeed, the state of New York is acting in other ways to address what its political leaders see as inadequate action by the SEC and DOL. New York is among a group of at least five states which have advanced efforts to create advisory industry conflict of interest mitigation regulations despite the SEC’s finalization of Reg BI. New York’s expanded “best interest” standard took effect on August 1st for annuity contracts and will take effect February 1, 2020, for life insurance policies. In a recent decision, a New York state trial court ruled the expansion is “a rational and reasonable movement towards consumer protection.”

This interpretation is debated by some retirement industry advocates. Wayne Chopus, president and CEO of the Insured Retirement Institute (IRI), is firmly in the camp critical of the states’ individual efforts to create their own fiduciary standards. He commends the position of wanting to protect insurance, advice and brokerage services consumers from bad actors, but he warns creating “50 shades of fiduciaries” will result in significant unintended consequence. 

“The Insured Retirement Institute has long supported the principle that those who provide professional financial advice should do so in their clients’ best interest,” he says. “After the controversial fiduciary regulation adopted by the U.S. Department of Labor was vacated by a federal court last year, the SEC forged ahead and crafted a rigorous new standard, which was announced in June. Reg BI significantly enhances existing federal investor protections through substantial new regulatory requirements on financial services companies, broker/dealers, and other financial advice professionals.”

Chopus says the SEC protections and requirements have “considerable teeth because they are backed by extensive federal enforcement powers.” He also points out that, later this year, the National Association of Insurance Commissioners (NAIC) is expected to finalize similar enhancements to its standards for annuity recommendations to complement Reg BI.

“At the very least, states should assess how well Reg BI would fit within the broader tapestry of regulations governing financial professionals’ conduct before deciding if further regulatory action is needed,” Chopus suggests. “But as some states choose to ignore this recommendation, they edge closer to inviting disruption to millions of Americans who rely on professional financial services to meet their retirement income needs. While the state proposals to date have some similarities, they also include significant differences that cannot be easily reconciled. And while a handful of states may cause ample disruption, this will exponentially worsen if more states follow.”

Expert ERISA attorneys suggest this broad fiduciary battle will inevitably be won and lost in the courts. Lawsuits are already pending seeking to declare the New York (and other states’) fiduciary rule as being “preempted by ERISA.” 

In the meantime, there is some evidence emerging to show that insurance firms are finding it difficult to comply with New York’s new standards. Published reports suggest for example that Jackson National Life Insurance Co., among the highest volume providers in the U.S. of individual annuities, has suspended sales of fee-based annuities in New York. Such reports suggest other insurers are also considering ceasing annuity sales in the state.

The Markets September 10, 2019

Advising Pensions and Endowments in Rocky Markets

From 100-year bonds to sophisticated hedging, the world of pension plan investing is different from the DC plan domain.
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Art by Katherine Streeter


Given his role as head of client solutions and multi asset for Legal & General Investment Management America (LGIMA), Jodan Ledford spends more time thinking about pensions than defined contribution (DC) plans.

He says the conversation about retirement readiness in the U.S. tends to focus on DC plans, given their increasingly important role as a foundation of the private-sector retirement system. However, the U.S. pension plan market remains highly dynamic and represents a great opportunity set for expert financial advisers to apply their skills.

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In terms of the investment outlook pension plans face in an increasingly volatile, late-cycle market, LGIMA has advised institutional investors to come “closer to home on risk in the fixed-income portfolio, and to focus on identifying good value when it comes through the market.”

As an example, he points to the recent issuance by the University of Pennsylvania of a 100-year bond. Press reports indicate the University successfully priced $300 million in “century bonds” at a yield to maturity of 3.61%.

“There was tremendous demand for it,” Ledford says, citing institutional investors’ thirst for safe and stable assets paying returns above those of long-dated government treasuries.

Offering some perspective on the broader marketplace in which pension plans are operating, David Chapman, Ledford’s colleague and head of multi-asset portfolio management for LGIMA, says there has been a healthy amount of debate among his colleagues in terms of what the next five or 10 years may bring.

“I would say there is lots of debate and I would not say there is a lot of consensus, but this is purposeful because it allows us to deliberate and let the best ideas rise to the top,” Chapman says. “Generally, we do agree that we are in a late-cycle economy, but how to approach this and predicting exactly how the dominoes might fall and spark a recession—that’s where the real differences of opinion are focused.”

Chapman notes that, historically speaking, equity returns tend to be very strong in the year leading up to a recession—and his firm only projects about a 25% chance of a recession in its forecast for 2020.

“So, you can see how the returns given up by reducing your equity risk too early in this cycle—it can mean you effectively achieve the same result as suffering the losses incurred once markets start to decline, if you follow me,” Chapman says. “For pensions, navigating the volatility is about focusing on the level of risk you should take given your objectives and time-frame.”

According to Ledford, 2019 has seen “a decently robust demand” for liability driven investing (LDI) strategies for pensions and other institutional investors, including strategies that include some pretty sophisticated hedging techniques. The overall demand has diminished somewhat compared with 2018, but there has been a healthy flow into custom LDI strategies, Ledford says.

“For pension plans and other institutions, market volatility can be addressed through diversification and through hedging, and through really understanding what the investment goals are,” Chapman says. “As we look forward, it is a difficult market to project. Late-cycle markets tend to have more volatility, but that fact doesn’t mean that equity markets are going to correct a significant amount tomorrow, next week or next month.”

Chapman says investment managers generally are very conscious of the tough position the U.S. Federal Reserve is in.

“The flattening and inversion of the yield curve that has happened, it is a reflection of the inflation outlook and concerns about growth which come from being in the late cycle—as well as the political environment around tariffs,” Chapman adds. “There are challenges, but none of this goes to say that institutional investors should panic and do anything rash. It’s a great opportunity to reflect on how your risk budget is allocated. If the volatility in the last month has been hard to tolerate, that might mean that the objectives for your investments should be reconsidered.”

Like their DC plan counterparts, pension plans seem to be experiencing a new normal in terms of low interest rates. Pointing to a newly updated five-year capital markets assumptions report, Bob Browne, chief investment officer, Northern Trust, expects low-growth pressures will provide an inherent interest rate relief valve in the foreseeable future. He says President Donald Trump’s assertive attitude towards trade disputes has challenged the economy’s “Goldilocks” underpinnings.

“We believe global growth, while positive, will modestly disappoint investor expectations, and we are concentrating on ‘lower risk’ assets such as U.S. high yield and U.S. equities,” Browne says. “Political impacts on fundamentals will be partially diffused through continued low rates, enabled by ‘stuckflation’ and central banks, importantly the U.S. Federal reserve, begrudgingly accepting the bond market’s messages.”

As a result of these pressures, Northern Trust-managed portfolios are overweight interest-rate sensitive assets, such as global real estate and listed infrastructure.

When it comes to risk cases, Browne points first to “inflation tariff proliferation.” He explains that subdued inflation has been a key driver of favorable risk asset returns over the last few years. According to Northern Trust’s projections, an unexpected jump in cyclical inflation would put at risk the interest rate relief valve programmed into the base case above.

“While not ideal, the U.S—and, for the most part, the global—economy can withstand a concentrated trade war with China,” Browne concludes. “Risks arise if the United States (or others) meaningfully target other countries.”

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