In Litan Scandal, It Isn't the Money, It's the Economics

Robert Litan, director of Research for Bloomberg, speaks during the Bloomberg / 2012 Tampa Host Committee Economic Developmen
Robert Litan, director of Research for Bloomberg, speaks during the Bloomberg / 2012 Tampa Host Committee Economic Development Series Panel: Regulation and Restraint inside the Bloomberg Link during the Republican National Convention (RNC) in Tampa, Florida, U.S., on Tuesday, Aug. 28, 2012. Mitt Romney secured enough delegates to officially win the Republican presidential nomination at the party's convention in Tampa. Photographer: David Paul Morris/Bloomberg via Getty Images

Robert Litan resigned his position as a nonresident senior fellow at the Brookings Institution earlier this week after it was discovered that he misused his Brookings credentials to promote an industry-funded attack on the Department of Labor's (DOL's) conflict of interest rulemaking. His sudden departure came after Massachusetts Sen. Elizabeth Warren raised questions about his "highly compensated and editorially compromised work on behalf of an industry player seeking a specific conclusion."

If the controversy stays focused on what Litan has described as "a minor technical violation" of Brookings rules, he is likely to emerge with his reputation tarnished but not destroyed. That industry groups pay experts to give their propaganda a veneer of legitimacy is hardly news in Washington's policy circles, after all. He may even be viewed as a victim in some quarters.

But if people actually take time to read the study, which Litan coauthored with Hal Singer of the Progressive Policy Institute, it is not clear how the authors' reputations can recover. Because what is most shocking about this particular bit of industry funded "research" is just how poor the quality of the analysis is. Really, for $85,000, the Capital Group had a right to expect a more convincing document.

Litan and Singer's argument hinges on two key points: 1) that industry will follow through on its threats to stop serving smaller accounts if the rule is adopted and 2) that investors will lose access to important benefits, which the authors value at roughly $80 billion, as a result of losing access to human advisors. The first point is based on a fundamental error about the rule of such magnitude that it alone is enough to discredit the report. The authors offer theories, but no evidence, to support the second point.

In building their case, Litan and Singer rely heavily on a 2011 Oliver Wyman study, also funded by industry rule opponents. Published before the rule was reproposed, that study assumed that commissions would be prohibited and concluded that small savers would lose access to advice if a ban on commissions were adopted. Litan and Singer chide the Department of Labor for its "too facile" dismissal of the study "on the grounds that brokers can continue collecting commissions," noting that "only firms, but not individual brokers, would be able to receive commissions" under the reproposed rule.

It is difficult to say where they got this notion. Perhaps they mistook the restrictions on differential compensation for a restriction on commissions, though that would suggest a rather startling lack of familiarity with the issues the rule is intended to address. Or maybe they just read industry talking points and never bothered to read the rule. But it is a verifiable fact that, under the rule, individual brokers as well as broker-dealer firms could be compensated through commissions if they abide by the terms of the best interest contract exemption.

The rest of their "analysis" on this key point -- a point on which their entire argument depends -- consists of simply regurgitating industry talking points about the burdensome nature of the rule requirements. Even if one accepts, as Litan steadfastly maintains, that these represent his own views and not just those he was paid to embrace in accepting the commission from Capital Group, one would expect an economist of Litan's reputation to adopt a little more analytical rigor in reaching those views.

Litan and Singer's analysis of the benefits that brokers offer is more elaborate, but equally flawed. Indeed, while the study devotes a great deal of space to a discussion of the purported benefits of broker-dealers, it fails to provide any evidence that brokers actually provide the benefits the authors ascribe to them. One benefit they tout, portfolio rebalancing, depends on ongoing portfolio supervision and account management, something brokers disclaim any obligation to provide. The "evidence" for their other chief broker-dealer benefit -- coaching investors to stay in the market during downturns -- is taken from an analysis of target-date funds, with no basis for concluding brokers offer similar benefits. The point is not to suggest that broker-dealers offer no benefits, rather that there is simply no basis for Litan and Singer's estimates of any such benefits.

And, while Litan and Singer spend a great deal of time discussing broker-dealer benefits, they spend no time at all discussing the conflicts of interest the rule is intended to address. Indeed, it is not apparent from the study whether they understand that these go beyond simply earning commissions and other sales-based compensation. They manifest no recognition that brokers can earn vastly different amounts selling essentially comparable investment products, and that this can have the effect of encouraging them to recommend investments that put their own financial interests ahead of those of the customer.

And that fundamental lack of understanding of the problem the rule is intended to address may explain the most egregious failing in the study, which is that the authors seem to have completely missed the point of the regulatory impact analysis they are seeking to rebut.

Litan and Singer claim, mistakenly, that "the entire evidentiary rationale for the rule ... depends on individual brokers no longer receiving commissions." On the contrary, the regulatory impact analysis is premised on the notion that, if brokers serve their clients under a best interest standard and place reasonable restrictions on practices that conflict with that standard, it will encourage recommendations of lower cost, higher quality investment options. As a result, investors who turn to brokers should see higher returns. But that has nothing to do with moving brokers away from earning commissions, as Litan and Singer mistakenly assume.

There are any number of other problems with the study, but these three go to the heart of its credibility, or lack thereof.

Litan and Singer are certainly entitled to their opinions, no matter how ill-informed. And industry has every right to seek to influence regulations by hiring "experts" to help them make their case. But no one should mistake what Litan and Singer have published for actual economic analysis. No one who actually reads this report is likely to make that mistake.