Business as usual – New Fiduciary Ruling
White House economic advisors are arguing that Americans are losing $17,000,000,000 (that’s 17 billion dollars) per year from their retirement accounts because of excessive fees.
Yesterday, April 6, the Department of Labor (DOL) recently published the final version of its Fiduciary Rule that it proposed the beginning of last year. The new regulations is attempting to fix the 17 billion dollar problem by requiring financial advisors that render financial advice on retirement savings plans to adhere to the “fiduciary standard”. So the operative word here is “retirement”. This will pertain to your 401(k), 403(b), 457 Government Plans, Individual Retirement Accounts (IRA) and so on. It doesn’t include individual retail accounts like your joint taxable investment accounts or college savings plans (unfortunately).
The goal of this new Fiduciary Rule is to eliminate conflicted advice. Financial Advisors and Brokers will be held to a “fiduciary standard”, where they must legally act in their clients’ best interests. I think it would be wonderful if the new regulation would provide some transparency and peace of mind to investors. Financial Advisors that accept sales commission are just salespeople. Advisors would look at two similar mutual funds that you could invest in. One charges you 5x more in fees and compensates your advisor with a bigger sales commission. Ever watch the movie, “Wolf of Wall Street”? Yeah, not much has changed. It’s still all about the commission.
Advisors take advantage of the current law which says they can steer someone into a bigger product that earns them a bigger commission at the expense of the customer’s return.
-Thomas Perez, Department of Labor
I’m sure you have lots of questions as to how this ruling will affect you and your investments. Here are some of the big questions you might have:
Why is this happening?
The DOL fiduciary rule was proposed to better protect people who are saving for retirement as a result of changes in the investment environment. Over the last 40 years, the availability and importance of self-managed investments, such as IRAs and participant-directed retirement plans, has increased. At the same time, the number and complexity of investment products in the marketplace has grown, as well as the creative and sometimes questionable way they are packaged and sold.
Due to this changing landscape, the DOL has issued new conflict of interest rules that apply to retirement plan advisors and IRAs. The DOL believes that requiring all advisors who work with retirement plans to operate under a fiduciary standard will prevent advisor conflicts of interest estimated to lower participants’ returns by 1 percent a year and result in approximately $17 billion lost annually.
Why was there so much opposition to this regulation?
Broker-dealers are generally only required to meet the “suitability standard” in making investment recommendations rather than operating under the fiduciary standard. The suitability standard required broker-dealers only to recommend a product “suitable” to meet clients’ goals; the fiduciary standard requires an advisor to act in a client’s best interest. The DOL rule changes will require broker-dealers to act as fiduciaries for retirement plan and IRA purposes, affecting the compensation arrangements available to them.
What’s changed? What’s different from before?
The rule requires those advisors who work with retirement plans to do only what’s in the best interest of their clients and to disclose any conflicts of interest. Recommendations that previously would not have resulted in a prohibited transaction may now run afoul of the rules that bar financial conflicts of interest. In its final form, the rule defines who is considered a fiduciary investment advisor. Broker-dealers, insurance agents and others that act as investment advice fiduciaries can continue to receive a variety of common forms of compensation (such as commissions) as long as they are willing to adhere to standards aimed at ensuring that their advice is impartial and in the best interest of their clients.
Who will this rule affect? How?
For clients or participants in 401(k) plans, the new regulation should provide extra transparency and peace of mind in a relationship where retirement savers usually don’t have control over who their employer chooses to manage their retirement plan. We hope to see the rule result in better investments offered (and better advice given) to retirement plan participants.
On the advisor side, the main impact falls on broker-dealers. Broker-dealers frequently receive compensation that varies based on the investment options they recommend, and they will now have to comply with prohibited transaction rules designed around a best-interest fiduciary standard.
Registered Investment Advisors (RIAs) such as our firm, who already are considered retirement plan fiduciaries, do not receive compensation that varies by investment, so the impact will be minimal.
When will the new regulation take effect?
Compliance with the rule will be required beginning in April 2017 (one year after the final rule is published in the Federal Register). Exemptions will be available at that time with a “phased” implementation approach designed to give financial institutions and advisors time to prepare.
Just last November, and again in December I warned of the huge risks my clients were taking by investing in a single proprietary mutual fund company. Here we are just, what, 4-5 months later and many financial firm’s stocks have been plummeting as it became clear that the White House was moving forward with this rule. Stocks of LPL, the nation’s largest independent broker-dealer, has tanked over 40% this year alone, along with others. I don’t believe this Fiduciary Rule will fix everything. There’s a $17 billion dollar nut on the table and Wall Street firms aren’t going to give up their share of it easily. It might be perfectly legal for firms to have clients check a box saying they agree to the terms.
Mutual fund families, retirement plan architects, broker-dealers, insurance companies and the registered reps in the trenches will all sleep easily tonight. Virtually all of the products they sell, where conflicts are a given, will still be allowed under the new rule so long as additional disclosures are made and a “Best Interest Contract Exemption” or BICE is signed off on by the client. This will be no trouble at all: Just picture the speed with which you click “Agree” everytime iTunes does a software update, and you can imagine how little of an impediment this sort of thing represents. Existing clients who’ve already been sold a product that requires a BICE will merely need to receive a written notification rather than have to repaper their accounts.
The opinions expressed by featured authors are their own and may not accurately reflect those of Clear Path Financial Planning, LLC. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2016, Clear Path Financial Planning, LLC