Originally published in Investment News

By Mark Hurley

One way to see that difference is to compare the Wall Street Reform and Consumer Protection Act, better known to most skeptics as Dodd-Frank, to a very modest 1979 tax rule change — Rule 401(k).

The Dodd-Frank legislation was designed to reshape and reform the financial services industry dramatically. But the law of unintended consequences will likely have more influence on the end results. As the 800-plus-page law ballooned into more than 14,000 pages of new regulations, the chances of Dodd-Frank working as intended became smaller and smaller. Complex capitalist systems are extraordinarily difficult to design from the top down.

Why? Because the law of unintended consequences is far more powerful than the ability of any regulator’s powers of prediction. Thinking that bureaucrats can control every possible reaction within a pulsing market is an arrogant fallacy.

A CRUCIAL TWEAK

By contrast, small and thoughtful changes have spurred incredible innovation and societal benefits. The regulatory tweak of Internal Revenue Service Rule 401(k), made as part of the implementation of a 1978 tax reform bill, simply allowed workers to save certain amounts of money for retirement tax-free. It went largely unnoticed and unused for its first few years of life. But a savvy Pennsylvania pension consultant named Ted Benna spotted the rule and came up with the idea of pairing employer matching contributions with the employee’s own, and the concept took off.

Clever and forward-thinking tax planners and accountants began to understand that the 401(k) created a surprisingly easy path for shifting the obligation for the financial well-being of long-tenured retiring employees from the company to the employees themselves. The popularity of the plans began to soar.

Meanwhile, at a relatively small investment shop in Boston, a visionary chief executive watched the rise of the 401(k) plans and saw an opportunity.

Edward C. “Ned” Johnson III had been in charge of the firm his father founded, Fidelity Investments, for only a few years, but he was savvy enough to recognize that the 401(k) plan, with its need for separate record keeping for each individual’s investment account, would require much more intensive information management competencies than did traditional defined-benefit pension plans.

In that early 1980s mini-computer era, Mr. Johnson bet his company on developing a technology platform that could handle the 401(k)s’ demands, and then proceeded to give away the technology to plan sponsors in return for getting their asset management business.

Mr. Johnson’s act of visionary genius recognized that employers had to pay for the cost of their 401(k) plans’ record keeping; providing it to them for virtually nothing saved employers millions of dollars annually. At the same time, he knew that the money managers and the information technologists at his competitors were typically two separate departments, each with their own profit-and-loss sheet. Getting IT departments integrated into the offense was a stretch most money management outfits couldn’t easily replicate.

Moreover, because the technology industry was at the same time undergoing its own revolution, sustaining an attractive 401(k) IT platform required massive continuous reinvestment. Mr. Johnson could see that internal politics would make it very difficult for these companies to provide a bundled offering similar to Fidelity’s.

With its powerful employee- and employer-pleasing financial IT platform, Fidelity drove a steady stream of clients (and a gigantic stream of assets) under its umbrella. The result, of course, is the behemoth that today administers more $4 trillion worth of assets for more than 20 million investors.

Fidelity’s strategy (which many other large firms ultimately emulated) also made it much easier for companies to adopt 401(k) plans. The detachment of retirement savings from a single employer changed the fundamental liquidity of U.S. labor markets: Switching jobs no longer meant leaving pensions behind.

Talented people could now change jobs and careers as better opportunities arose, and startup companies could more easily compete with large ones for the best employees. Many companies founded in the 1980s and “90s are today some of our country’s most successful and productive enterprises.

But the ripples from Rule 401(k) didn’t stop there. A second industry — the wealth management business — also took wing as employee-directed retirement investments took off.

Historically, the only option that consumers had for financial advice was to go to retail brokerages — organizations that traditionally did a fine trade in hot stocks and overpriced bonds. But because the shift to 401(k) plans now made individuals responsible for their own long-term financial well-being, there quickly arose an immense demand for comprehensive, holistic advice.

This demand was filled by a cottage industry of small firms that provided sophisticated, customized advice. Today, many of these firms manage billions of client dollars as part of a multitrillion-dollar industry. More importantly, the quality of financial advice available to the average investor is geometrically better than it was only two decades ago.

No one could have imagined these vast changes would take place due to that one small, well-thought-out change made 34 years ago. It created both opportunity and certainty — the surest possible recipe for spawning more consumer-benefiting innovation.

Policymakers need to better appreciate the idea that less is often more. And in complex systems such as the American financial services industry, throttling “control” will only lead to market-distorting, inefficiency-inducing work-arounds that benefit no one but the lawyers and accountants hired to manipulate them.

Mark Hurley is founder and chief executive of Fiduciary Network, a private bank specializing in the wealth management industry.