U.S. Department of Labor
September 23, 2015
Page 5

found that “non-traded REITs which had listed, been acquired by or merged with a
listed REIT or had updated per share values average 6.3% annually compared to 11.6%
returns earned over the same period in traded REITs. The economic magnitude of the
underperformance is over $45 billion.”"8 This underperformance raises serious
questions as to whether the non-traded REIT sector attracts capital on its merit or its
ability to bias intermediaries by paying above-average fees. To the extent that it attracts
capital by biasing intermediaries, other issuers suffer and attract less investor capital
than would be expected on the merits of their offerings.

To be sure, the Proposal’s limitations and protections for retirement investors
will make it more difficult for certain issuers to attract capital by paying more
compensation to intermediaries.‘ Yet these limitations should benefit other issuers
offering more attractive opportunities by reducing the incentive for financial
intermediaries to steer retirement compensation elsewhere in exchange for enhanced
personal income. This may shift the competition more toward the individualized merits
and risks of particular offerings.

I thank the Department for its leadership on this issue and for the opportunity to
comment.

Very Truly Yours,

Benjamin P. Edwards

Assistant Professor of Law

Barry University

Dwayne O. Andreas School of Law
6441 East Colonial Drive

Orlando, Florida 32807

38 BRIAN HENDERSON, PHD, CFA, JOSHUA MALLETT, CPA, AND CRAIG MCCANN, PHD, CFA, AN EMPIRICAL
ANALYSIS OF NON-TRADED REITs, SECURITIES LITIGATION & CONSULTING GROUP 1 (2015), available
http://www.sleg.com/pdf/workingpapers/Henderson%20Mallett%20McCann%2onon-
traded%20REITs.pdf.

19While I have spotlighted some of the issues with non-traded REITs above, other high commission
products also likely divert capital from more productive uses.


U.S. Department of Labor
September 23, 2015
Page 4

intermediaries to put client interests first. This may change intermediary behavior by
increasing the likelihood that they will recommend products with better expected
outcomes, reducing the market imperative for issuers to compete for capital by paying
larger commissions. This alteration may free issuers to compete on the merits and risks
of their offerings instead of competing over how to bias financial intermediaries. While
this will not solve the problem entirely, it will result in a different market equilibrium
for issuer efforts to bias intermediaries than would occur absent regulation.'3

That the Proposal may alter the current market equilibrium for retail capital
allocation may be inferred from the vociferous opposition raised by certain issuers of
high commission products. Consider, for example, the objections raised by non-traded
Real Estate Investment Trusts, a sector that has generally opposed or sought to modify
the Proposal.14 The Department should expect similar opposition from other oversold,
high-commission alternative investments.

In any event, reductions in the amount of high-cost alternative investments sold
to retirement investors may reduce investor exploitation by limiting opportunities to
take advantage of them. Consider, for example, the enforcement issues associated with
non-traded REITs. Both “FINRA and State Attorneys General have brought
enforcement actions against broker-dealers for abusive practices in the sale of non-
traded REITs to unsophisticated investors.”5 Unsophisticated investors may be
targeted because of the rich offering fees to be obtained. One recent study found that
these non-traded REITs average upfront fees amounting to “13.2% of invested capital.”6
These particular products may tempt more financial intermediaries to betray their
clients because the actual fees and expenses involved can be more easily misrepresented
to customers since customers do not ordinarily pay the larger commissions directly,
rendering the true cost opaque until and unless one reads and understands the fine
print..7

In addition to harming investors, low standards for personalized financial advice
also harms capital allocation process by diverting capital to less productive uses. For
example, not only do these non-traded REITs cost retirement investors more, the
products have significantly underperformed comparable publicly-traded REITs—
indicating that the capital would have been more productive elsewhere. One analysis

+3 For more on the economics of manipulations and deception, see GEORGE A. AKERLOF & ROBERT J.
SCHILLER, PHISHING FOR PHOOLS: THE ECONOMICS OF MANIPULATION & DECEPTION 8 (2015) (arguing that
manipulation and deception will occur “as long as there are profits to be made from” it).

«4 Along with letters submitted by many others, the Public Non-Listed REIT Council of the National
Association of Real Estate Investment Trusts (the “Non-Listed REIT Council”) submitted an eight-page
letter seeking changes to the Proposal.Letter from Executive Committee, NAREIT PNLR Council, to the
Office of Regulations and Interpretations, U.S. Department of Labor (July 21, 2015), available
http://www.dol.gov/ebsa/pdf/1210-AB32-2-00638.pdf.

6 Barbara Black, Curbing Broker-Dealers' Abusive Sales Practices: Does Professor Jensen's Integrity
Framework Offer A Better Approach?, 48 WAKE FOREST L. REV. 771, 778 (2013).

16 BRIAN HENDERSON, PHD, CFA, JOSHUA MALLETT, CPA, AND CRAIG MCCANN, PHD, CFA, AN EMPIRICAL
ANALYSIS OF NON-TRADED REITs, SECURITIES LITIGATION & CONSULTING GROUP 2 (2015), available
http://www.sleg.com/pdf/workingpapers/Henderson%20Mallett%20McCann%20non-
traded%20REITs.pdf.

7 For a discussion of this issue, see Benjamin P. Edwards, Fiduciary Duty and Investment Advice: Will A
Uniform Fiduciary Duty Make A Material Difference?, 14 J. BUS. & SEC. L. 105, 122 (2014).


. 2
r niv 16 it 6441 East Colonial Drive, Orlando, FL 32807
ry P: 321.206.5600 | F: 321.206.5620
www. barry.edu/law
Dwayne O. Andreas | School of Law

September 23, 2015

Via Email Only

Office of Regulations and Interpretations
Employee Benefits Security Administration
Attn: Conflict of Interest Rule

Room N-5655

U.S. Department of Labor

200 Constitution Avenue NW
Washington, DC 20210

e-ORI @dol.gov

RE: RIN 1210-AB32: Conflict of Interest Rule

Ladies and Gentlemen:

I write to support the regulation proposed (the “Proposal”) by the Department of
Labor (the “Department”) to create a uniform fiduciary duty for persons providing
personalized financial advice to retirement investors. The Department should finalize
the Proposal for four reasons: (i) the harms alleged by the Proposal’s detractors have
been materially overstated; (ii) the Proposal will better protect retail investors, most of
whom lack financial literacy and means to protect their interests; (iii) it will align the
law with retirement investors’ current expectations; and (iv) it will improve capital
allocation in U.S. financial markets.

I. The Proposal’s Detractors Overstate the Possible Harms to Investors

The Department should maintain an appropriate amount of skepticism about
arguments advanced by some of the Proposal’s detractors. Much of the current
opposition falls within a long history of financial intermediaries overstating the costs
and risks of proposed regulatory measures to delay reforms. For example, many
securities firms argued against the elimination of fixed brokerage commissions before
1975, claiming that it would harm retail investors.1 Afterward, it became clear that these
concerns were largely unfounded.

The tradition of interested persons overstating the possible risks and costs of
regulatory intervention continues today. In a recent editorial addressing similar fear-
mongering over a FINRA proposal to apply data analysis to market practices, the
INVESTMENTNEWS chastised the financial services industry for stoking “fear in an effort

1 See Hans R. Stoll Revolution in the Regulation of Securities Markets: An Examination of the Effects of
Increased Competition in CASE STUDIES IN REGULATION: REVOLUTION AND REFORM, 29-48 (Leonard W.
Weiss & Michael W. Klass, eds, 1981).


U.S. Department of Labor
September 23, 2015
Page 2

to cloud or divert attention from real issues.”? It recognized that much of the opposition
to that proposal was simply groundless and argued that “hiding behind a beneficent
canard of client protection is deplorable — and ultimately counterproductive” because it
“adds to the distrust the industry is drowning in.”3

Yet a measured amount of distrust and healthy skepticism may be appropriate.
The tendency of financial intermediaries to over-emphasize the costs and risks of reform
has been identified as a mechanism intermediaries use to shape their regulatory
environments. In a recent article in The University of Chicago Law Review, Professor
Kathryn Judge of Columbia Law School argues that “the greater the economic stake of
financial intermediaries, the more skeptical policymakers should be of their assertions
about the potential costs or risks associated with a proposed policy change.”4 The
Department should keep this principle and history in mind as it evaluates the public
comments.

II. This Proposal Will Protect Retail Investors Who Lack Basic Financial Literacy

The Proposal also serves a real need because most retail investors cannot
recognize when their financial advisor has acted against their best interests. Many retail
investors may be susceptible to exploitation because they lack basic financial literacy.
Recent studies have confirmed that most do not understand basic concepts such as
diversification, investment costs, inflation, or compound interest.5 The Securities and
Exchange Commission has expressed concern that certain subgroups, “including
women, African-Americans, Hispanics, the oldest segment of the elderly population,
and those who are poorly educated, have an even greater lack of investment knowledge
than the general population.”¢

Other interventions, such as increased investor education, seem unlikely to solve
the problem. At the least, the financial literacy problem does not appear to respond to
investor education efforts.7 Financial illiteracy may persist because the financially
illiterate do not recognize their financial illiteracy. Probing the resiliency of financial
illiteracy, the FINRA Investor Education Foundation has found that despite “low levels

2 INVESTMENTNEMS, Client Protection Ruse Needs To Stop, INVESTMENTNEWS (Nov. 16, 2014), available:
http://www.investmentnews.com/article/20141116/REG/141119928/client-protection-ruse-needs-to-
stop.

3Id.

4 Kathryn Judge, Intermediary Influence, 82 U. CHI. L. REV. 573, 635 (2015).

5 OFFICE OF INVESTOR EDUC. & ADVOCACY, U.S. SEC. & EXCH. COMM’N, STAFF STUDY
REGARDING FINANCIAL LITERACY AMONG INVESTORS (2012), viii [hereinafter LITERACY
STUDY], available at http://www.sec.gov/news/studies/2012/917-financial-literacy-study-part1.pdf.

6 Id.

7 See e.g., Lauren E. Willis, Against Financial-Literacy Education, 94 Iowa L. REV. 197 (2008)
(describing the failures of the financial-literacy approach).

8 These failures may occur because of the Dunning-Krueger effect, which occurs when people tend to
overestimate their own knowledge, skills, and abilities because they lack the information and
metacognitive skills necessary to recognize their deficits. See Joyce Ehrlinger et al., Why the Unskilled
Are Unaware: Further Explorations of (Absent) Self-Insight Among the Incompetent, 105
ORGANIZATIONAL BEHAVIOR & HUM. DECISION PROCESSES 98, 99 (2008); Justin Kruger & David
Dunning, Unskilled and Unaware of It: How Difficulties in Recognizing One's Own Incompetence Lead
to Inflated Self-Assessments, 77 J. PERSONALITY & SOC. PSYCHOL. 1121, 1127 (1999).


U.S. Department of Labor
September 23, 2015
Page 3

of financial literacy . .. Americans tend to have positively biased self-perceptions of their
financial knowledge,” a finding tending to indicate that many may invest under the
mistaken belief that they know what they are doing.? Given these problems, the
Proposal seems well calibrated to improve the quality of investment advice provided to
retirement investors.

III. This Proposal Aligns Law with Current Investor Expectations

The Proposal will also better align the law with current investor expectations.
Retirement investors now mistakenly believe that the persons providing them with
personalized financial advice are required to act in their best interests.1° When
retirement investors find their trust betrayed, they are often shocked to discover that the
firms advertising their trustworthiness defend themselves by arguing that they never
owed a duty to provide advice in the investor’s best interests. The Proposal better
aligns the law with investors’ default expectations and will make it easier for investors to
trust their financial advisor.

IV. This Proposal Will Improve Capital Formation

The Proposal offers significant benefits for the economy as a whole by improving
capital allocation by better connecting investor capital with promising business
opportunities. Currently, the lack of a consistent fiduciary standard for financial
advisors undercuts the efficient allocation of capital by rewarding issuers for inducing
financial intermediaries to betray client interests. In a market where some issuers raise
more capital by paying larger commissions to financial intermediaries, equivalent
opportunities paying lower commissions will raise less capital.12 Thus, a capital market
that rewards issuers for offering high-commission products also forces issuers to
compete for capital not only on the underlying merits and risks of the investment
opportunities offered but also on how they bias financial intermediaries and secure their
most ardent promotion efforts.

The Proposal may reduce this form of value-destroying competition and reduce
the pressure on issuers to pay excessive fees to intermediaries by requiring financial

9 FIN. INDUS. REGULATORY AUTH. INVESTOR EDUC. FOUND., FINANCIAL CAPABILITY IN THE UNITED STATES:
REPORT OF FINDINGS FROM THE 2012 NATIONAL FINANCIAL CAPABILITY STUDY 29 (2013).

10 See Arthur B. Laby, Selling Advice and Creating Expectations: Why Brokers Should Be Fiduciaries, 87
WASH. L. REV. 707, 714 (2012) (explaining that broker-dealers “have assumed a role that causes investors
to believe that brokers provide impartial advice”); SEC & EXCH. COMM’N, STUDY ON INVESTMENT
ADVISERS AND BROKER-DEALERS AS REQUIRED BY SECTION 913 OF THE DODD-FRANK WALL
STREET REFORM AND CONSUMER PROTECTION ACT v (Jan. 2011), available at
http://www.sec.gov/news/studies/2011/913studyfinal.pdf (explaining that retail investors already
“expect that both investment advisers and broker-dealers are obligated to act in the investors’ best
interests.”).

See Joseph C. Peiffer, Christine Lazaro, Major Investor Losses Due to Conflicted Advice: Brokerage
Industry Advertising Creates the Illusion of A Fiduciary Duty Misleading Ads Fuel Confusion,
Underscore Need for Fiduciary Standard, 22 PIABA B.J. 1 (2015) (documenting defenses alleging a lack
of fiduciary duty).

# Issuers do raise more capital by offering larger commissions—or at least believe that they will. If issuers
did not believe that they would raise more capital by offering higher commissions, they would not offer
them and would keep more of the offering proceeds for themselves.