Warren Seeks to Silence Scholarly Debate on Investment Advice

Score one for Elizabeth Warren. Or maybe not.

The senior senator from Massachusetts and self-described champion of the middle class, who always seems to be angry at somebody for something, picked an unusual target last week in Robert Litan. Litan is a PhD economist and attorney, whose areas of expertise include regulation and finance. He has been affiliated with the Brookings Institution, a centrist Democratic think tank, in some capacity for over four decades, including a seven-year stint as director of economic studies.

Based on his research with Hal Singer, a senior fellow at the Progressive Policy Institute, Litan testified to the Senate Health, Education, Labor and Pensions Committee on July 21 that the cost of the Labor Department's proposed "conflict of interest" rule affecting retirement investment brokers would outweigh the benefits. Unhappy with the conclusion, Warren wrote a letter to Brookings President Strobe Talbott to complain - about non-substantive issues. Talbott asked Litan to resign from his unpaid position. 

If that sounds silly, it is. According to Warren, Litan's crime was two-fold: First, he identified himself as a "nonresident senior fellow at the Brookings Institution," a relationship that must be kept mum pursuant to a new Brookings rule, of which Litan was unaware; and second, his disclosure on the funding of his research was "vague."

Let's start with the second accusation. On page 1, footnote 1, of his Senate testimony, Litan states that the report on which the testimony was based was "supported by the Capital Group," which he identifies in footnote 2 as "one of the largest mutual fund asset managers in the U.S." Footnote 1 also specifies that "the views expressed here are my own" and do not necessarily represent those of Brookings or the Capital Group.

Vague? Hardly. Warren's claim that Litan used his Brookings affiliation to lend credibility to his research is a transparent attempt to discredit the research and dismiss the cost-benefit analysis that didn't produce the results she would have liked. Litan never mentioned his Brookings affiliation at the July hearing. It was Senator Pat Roberts, Republican from Litan's home state of Kansas, who did. 

What bugged Warren was Litan's message. The proposed rule would effectively eliminate commissioned brokers and, in so doing, deprive small savers of affordable investment advice. So Warren shot the messenger, along with his trusted steed, the Brookings Institution, which compromised its reputation for independent thinking by succumbing to her petty charges.

Full disclosure: I first met Litan in 1989, when we were luncheon speakers at an event in Boston. It was my first speech as a financial journalist. I was nervous. He was gracious. He accidently spilled salad dressing on my suit at lunch and offered to pay for the dry cleaning. We shared a cab to the airport.

I have spoken to Bob probably a dozen times since then, mostly on   entrepreneurship issues when he was director of economic research at the Kauffman Foundation. Our paths crossed briefly at Bloomberg.  

Affiliation and disclosure aside, Warren's gripe is with the substance of Litan's research. The DOL's proposed rule would extend the existing "fiduciary," or best-interest-of-the-client, standard for registered investment advisers to brokers who sell actively managed funds to investors for their IRAs. The current standard for commission-based brokers is that the investment be "suitable." 

To the average person, this might seem like a distinction without a difference. But not to lawyers, who happen to be Warren's second largest contributor. Requiring commissioned retirement brokers to sign a contract opens the door to class-action lawsuits if the client thinks the broker did not act in her best interest. Brokers have already said, "thanks, but no thanks," in their comments on the rule. Small investors will either have to fend for themselves or pay an RIA an annual fee, generally 1 percent of assets. 

Litan is the first to admit that all retirement investment advisers should be held to a fiduciary standard. But why impose hundreds of pages of new rules, exemptions and amendments when there is a simpler, more efficient way to accomplish the same thing?

"If there is a problem with conflict of interest, just disclose it," Litan said in a phone interview. Impose stronger and more explicit requirements on brokers to reveal the size of their commissions and any benefits that accrue to fund sponsors.

Warren had no questions for Litan at the July hearing. Answers to her written follow-up questions revealed that the Capital Group was the sole sponsor of Litan and Singer's research, for which the two economists were paid $85,000. In her mind, that means the research must be conflicted. 

"Never in my life have I accepted a consulting assignment that I don't agree with," Litan said.

Proponents of the rule cite a study by the president's Council of Economic Advisers (no conflict there!) that finds "conflicted advice" cost clients up to 1 percent annually, an estimate that ignores the ongoing decline in commissions from competition. The DOL study pegs the cost at 25 basis points a year. Neither study considers the benefit of broker advice, especially during periods of market turmoil when small investors are apt to panic and sell at the lows. Nor did they survey actual investors or offer empirical evidence. Vanguard, the leader in low-cost indexed-funds that would benefit from implementation of the DOL rule, estimates that an adviser may enhance returns by up to 3 percentage points in a given year.  

As proposed, the DOL rule is certain to be challenged in the courts, Litan said. Under ERISA, or the Employment Retirement Income Security Act of 1974, "the DOL does not have the authority to extend fiduciary status to brokers." The rule may also be challenged for being "arbitrary and capricious," Litan wrote in a Fortune article this week. 

Earlier this year, Warren torpedoed the nomination of banker Antonio Weiss for a top Treasury post. She was one of many Democrats to argue against the nomination of Larry Summers for Federal Reserve chairman. Having orchestrated Litan's departure last week, Warren redirected her wrath at Mel Watts, director of the Federal Housing Finance Agency, for dawdling over mortgage relief for struggling homeowners.

Warren likes to shake things up, regardless of the unintended consequences of her actions. She wants brokers to take a pledge of allegiance to their clients, even though it will limit small investors' access to advisers and raise their costs. 

Maybe it's time for Warren herself to take an oath to protect the middle class, which is her professed goal. I would suggest one that has served medical practitioners so well over the years: First, do no harm.