Washington, DC has certainly been busy with attempting to micromanage the financial sector and, as a result, making life more expensive for everyday investors. Not content to leave the Obama-era “fiduciary rule” buried, the Department of Labor recently appeared to resurrect the scheme, which could saddle investment advisors and their clients with tens of billions in additional costs. Last month, three U.S. bank regulatory entities issued a rulemaking to implement heavier capital requirements in connection with the so-called Basel III “endgame” – a hasty move that could actually be counterproductive for consumers and small businesses seeking loans.
Now the Securities and Exchange Commission (SEC), fresh from its botched “top-down” attempt to regulate cryptocurrency transactions and its ill-considered rule on climate disclosures to investors, has a new crusade: shortsighted regulations for how registered investment advisors handle client assets. While the SEC claims that this latest effort is intended to protect consumers, it’s another example of overreach on the part of the SEC, as it works to expand its authority under Chairman Gary Gensler. Instead of shielding investors from bad actors, this scheme threatens to increase investment fees and lower the returns on retirement accounts for millions of Americans.
The SEC’s proposal will modify what’s known as the “Custody Rule,” which was originally enacted in the mid-twentieth century with the noble purpose of shielding individuals from fraud or negligence. Despite often mind-numbing complexity, the rule at its core requires registered investment advisors to keep client assets separate from their own. As a result, insurance companies, pension funds, and other investors rely on banks to custody funds for purposes of safeguarding assets as well as complying with legal and fiduciary obligations.
As investment types have evolved, the SEC revised the Custody Rule to keep pace. The surge of digital assets and cryptocurrency reportedly spurred this newest proposal but, rather than addressing these narrower concerns, the SEC used this as an opportunity to further its own interests.
The SEC’s proposal would:
Force banks to monitor and second-guess the decisions made between a client and their investment advisor, which could lead to delays in transaction settlements;
Make banks legally responsible for the risk associated with private investment decisions of a client and their advisor; and
Require banks to re-negotiate countless contracts made with investment advisors around the globe.
Each of these changes would, by their own accord, increase inefficiency and shift the cost to the American consumer. But the meddling doesn’t stop there. The SEC is seeking to regulate how banks handle cash deposits.
Government oversight of deposits has (logically if not always prudently) been vested in several banking agencies (i.e., the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and state banking regulators).
The SEC is therefore far outside its lane in proposing such radical Custody Rule changes, considering the Commission’s mission statement itself says “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” As noted above, the SEC’s revisions would affect not just securities and other “traded” assets, but also bank deposits, and even items such as art (!). No wonder Members of Congress, investment industry experts, and more than a dozen trade groups are expressing concern over the SEC’s rush to assert what many believe is unlawful authority. Allowing this to happen unchecked would set a disastrous precedent where bureaucrats dream up their own roles as enforcers.
Money deposited at banks is used to make loans, support economic activity, and help banks offset the cost of offering other services, such as custody services. If the SEC gets away with expanding its fiefdom to bank deposits, some banks would be forced to restructure their business models and increase fees for custody services and other similar items. These changes could make investing more expensive through higher administrative costs, which would take a chunk out of returns.
The impact of even seemingly minor fee adjustments in response to SEC’s edict could add up significantly over time for those planning their retirement, kids’ college, and other financial goals. The SEC itself acknowledges the toll that administrative costs in other contexts can take on retirement investments. It should be equally cognizant of this fact now, when the SEC could be the culprit in forcing such fee hikes. For example, an increase in expenses and fees for investment management from .25 percent to 1 percent would cost a taxpayer nearly $30,000 over 20 years assuming a starting investment of $100,000. That amounts to a $30,000 punishment for those preparing for retirement, and it could be a reality if the SEC is allowed to move forward unchecked.
Although the SEC is funded by stock exchange and broker-dealer fees mandated by the Treasury, taxpayers still have a direct interest in this issue. Making investments costlier will only leave families less prepared to plan for their financial futures and more reliant on government-funded benefit programs whose conditions are already dire. Social Security’s retirement trust fund, for instance, will be unable to pay full benefits to seniors just 10 years from now. Indeed, the continued explosive growth in Social Security and other “mandatory” costs is the primary driver of our debt crisis. Considering these alarming trends, government should be making it less, not more, difficult for Americans to save on their own.
Furthermore, as Americans for Tax Reform’s Bryan Bashur recently put it, “the significant compliance costs in the rule, such as additional written assurances and stricter legal liability for negligence, could push custodians out of the market, reduce competition and make it incredibly more expensive for RIAs [Registered Investment Advisers] to find a qualified custodian to safeguard pension fund assets owned by state employees.” Many state pension funds already face long-term instability. If the SEC’s proposal worsens this problem, taxpayers could be drawn even closer into funding multi-billion-dollar bailouts for these benefit programs as well.
Speaking of RIAs, it is important to remember that the SEC’s massive rule revision is not occurring in a regulatory vacuum. Late last year, the SEC proposed major new requirements for due diligence on the part of RIAs, whose impact is still being assessed. For their part, banks are now contending with the capital requirement proposal mentioned earlier, along with burdens from other entities that could affect them. Even the accounting profession’s normally uncontroversial body, the Financial Accounting Standards Board, has come under pressure from the SEC and others to engage in dubious ventures such as public country-by-county tax reporting.
The comment period for the SEC’s rule changes has already ended, but lawmakers concerned with fair regulatory policy towards markets must call on the SEC to abandon this misguided proposal before it’s too late. Onerous rules like these can have ripple effects throughout the economy and deal a major blow to Americans’ finances at a time when signs are starting to point towards easing inflation and even a “soft landing” after tortuous interest rate increases.
While the SEC claims it is only trying to keep up with the times and account for changes in technology, assets, and management practices, many other regulators more experienced in banking and asset management, along with Congress, are better suited to thoughtful deliberation of how policy should evolve to meet these challenges. Without concerted pushback outside of the SEC, middle-class investors and taxpayers would pay the price — literally — for this bureaucratic excess.