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Dana Muir
  Dana Muir

More Risk than Reward

4/17/2009 --

It's time to merge regulatory oversight of financial system and pension system.

ANN ARBOR, Mich.—Financial market reform is a top-of-mind issue these days, as can be expected after a historic collapse in the global economy. It is particularly top of mind for average Americans whose retirement accounts are now so tightly entwined with the financial sector -- and who have seen their 401(k)s crash, right along with the markets.

At issue is the country's retirement system, which has moved away from defined-benefit pension plans to defined-contribution, employee-controlled accounts. Tax policy has changed to encourage employees to save for retirement by way of these accounts, most of which are invested in the stock and bond markets. And the financial services industry is fueled by the trillions American workers hold in these very accounts.

But the laws and regulatory system have not kept pace with the changes. In her paper "Regulation of the Financial Services Industry: Whose Money is at Risk?" Ross professor Dana Muir lays out some broad principles for policymakers to follow as they work on a new framework for the financial sector. Better coordination and eliminating redundancies for business and government is one of her key suggestions.

The good news is that the crisis has people talking about much-needed market reform, Muir says. Not only are lawmakers making reform a priority, the public is demanding it.

"In some ways, Jon Stewart recently did my job for me on The Daily Show," says Muir, an Arthur F. Thurnau professor of business law at Ross. She points to the comedian's tongue-in-cheek news show, which airs on the Comedy Central Network. During a recent and surprisingly sober telecast, Stewart hosted -- and publicly lambasted -- CNBC personality Jim Cramer for feeding into Wall Street's cavalier attitude in the months preceding the historic economic downturn.

"Stewart's point with Cramer was that the markets and financial institutions are trading trillions of dollars, and those dollars belong to individuals in the pension and 401(k) accounts," Muir says. "He was saying, 'You're playing some game, and you have to remember that you're playing a game with our money.'

"So my point is that you can't regulate the markets and financial institutions independently of the pensions and individual retirement accounts."

The bad news is that forming new comprehensive rules won't be easy. Pension plans, 401(k) accounts, and financial firms that put that money to work are overseen by a number of different agencies administering a patchwork of rules.

"Each one is regulated by a different government agency and different regulations apply both to the accounts themselves and to the products held in the accounts," Muir says. "Sometimes, things fall through the gaps and no one is responsible. Or, there are too many regulations and nobody has the broad authority to look at the big picture."

Some examples highlight the problems. Say an employee invests $100 in his employer's stock through the company's 401(k) program and buys another $100 of the same stock through a brokerage account. Then the employee loses almost all the money when the stock's value plummets, and the employee claims the company intentionally misrepresented itself.

The employee could bring a claim under the Employee Retirement Income Security Act (ERISA) for the money lost in the 401(k) account, or a securities fraud claim through the Securities and Exchange Commission (SEC). The burdens of proof, the right to sue, and other legal matters are different in both cases, but the claim is essentially the same. The fragmented approach is inefficient for each side in such a dispute.

Another problem involves disclosure of investment products. In 1998, the SEC adopted a simplified disclosure form, a profile prospectus, for use by mutual funds. The hope was that it would give people with retirement-specific accounts the same information as those holding general investment accounts.

But it didn't happen because the Employee Benefits Security Administration (EBSA), an agency within the Department of Labor, never explicitly approved the profile prospectus for use in the most popular types of employer-sponsored retirement-specific accounts.

"What's happened is that no agency wants to lose regulatory power," Muir says.

The United Kingdom and Australia both have tried to address the problem by giving financial services industry regulators some authority over retirement-specific accounts. The U.K. has adopted a single-regulator system while in Australia; one agency handles prudential regulation and another handles consumer protection. The Australian retirement system also requires employers to contribute a percentage of earnings for almost all employees to individualized accounts.

In the U.S., the Treasury department in 2008 came up with a financial reform proposal known as the Blueprint. Muir says the Blueprint provides a good framework to begin reform discussions, but doesn't recognize how current regulations differ based on the source of funds. Broadly, the Blueprint calls for modeling a system in the U.S. similar to that of Australia, where a few objectives are set and a regulator oversees each objective. The framework for regulatory reform (released by the Obama administration in March) targets a number of similar objectives, particularly elimination of regulatory gaps and overlaps.

Muir suggests the three main principles for the Obama administration to follow are coordination, specialization, and comparing the experience in other countries.

Better coordination between regulatory agencies in areas that retirement-focused and general investment accounts have in common can reduce costs and increase efficiency for financial firms and end confusion for employees and investors. It also can help government agencies avoid duplicating effort.

Coordination also should close loopholes used by unscrupulous financial services firms to circumvent things such as fee caps or fee disclosures.

But since there are different types of accounts with different tax treatments and incentives, there still has to be some specialized, focused regulation.

"It's really a balance between coordination and specialized knowledge," Muir says. "There is value to having one entity with coordinated oversight. But pension accounts and 401(k) accounts are still somewhat special and, from a policy perspective, receive favorable tax treatment because unlike general investment accounts, the assets are specificially intended for use in retirement."

Finally, Muir recommends a deep dive into the experiences in the U.K. and Australia, both of which have taken bold moves but have continued to struggle with inefficiencies and gaps in oversight.

"If there were a single, obvious answer here we wouldn't see so much difference around the world, and we wouldn't be struggling with this in the U.S.," Muir says.

—Terry Kosdrosky

For more information, contact:
Bernie DeGroat, (734) 936-1015 or 647-1847,