Fiduciary Rule Uncertainty: How Advisors Are Adapting
The Department of Labor's fiduciary rule was set to be implemented in April 2017 but under the new President Trump administration, this regulation is in flux. In February, Donald Trump stalled the implementation with an executive order calling for a review of the rule, and the DOL later announced it's applicability will be delayed by 60 days.
Initially proposed as part of broad legislation after the 2008-2009 financial crisis, the rule requires financial advisors to act in their clients’ best interests in the management of retirement accounts. Trump has instructed the Department of Labor to conduct a full review of the impact that could come from the implementation of such standards. (For more, see: Trump Orders Review of Dodd-Frank, Repeal of Fiduciary Rule.)
Here's a look at the rule, its impact on the industry so far and how advisors can cope with its uncertain future.
Opposition to the Fiduciary Rule
In contrast with the fiduciary rule, many financial advisors work under the suitability standard. This rule requires brokers to make recommendations to the client that are suitable although not necessarily in their best interests. The suitability standard could allow a broker to recommend an investment with the biggest commission for himself or herself, instead of proposing an investment product that is best for the client.
Critics of the fiduciary rule allege that it is too complex and would ultimately increase the expense of imparting financial advice. In addition, they claim that consumers should be responsible enough to perform their own due diligence when working with a financial advisor and understand an investment and broker’s fee structure.
In some cases, the traditional commission-based compensation model, currently under fire with the fiduciary rule, is the best for a client. In particular, a middle-income client with an IRA managed by a traditional stockbroker would pay a commission to that broker when he or she makes a trade in her account. If the broker traded infrequently, then the annual management costs of the account would be relatively small. Opponents to the fiduciary rule complain that if this typical client was forced to pay an annual fee levied as a percent of assets under management (AUM) to comply with the rule, this would result in greater overall investment management costs than paying an advisor the occasional commission. (For more, see: How Trump Could Repeal, Soften Fiduciary Rule.)
Migration to Fee-Based Compensation
As the implementation date for the fiduciary rule approached, more financial advisors transitioned towards a fee-only compensation model, such as charging a percent of AUM for services. Other financial advisors have said they expect to adopt the fiduciary standard, regardless of what happens with the proposed legislation. Merrill Lynch will end commission-based retirement accounts and charge a fee according to a percent of AUM. Other large investment brokerages, such as Morgan Stanley and Wells Fargo & Co., haven’t eliminated commissions altogether but are making other changes favorable to the client such as lowering stock and exchange-traded fund (ETF) trade commissions.
Clients can request that their financial advisor adhere to the fiduciary standard and switch if their existing advisor still operates under the suitability standard. Additionally, investors can ask advisors why a specific investment is recommended, what are the associated fees and whether there is a similar product with a lower fee structure.
How Advisors Can Cope With Uncertainty
The financial advisory industry is already trending towards supplying lower fee index and exchange-traded funds. As investors become better educated regarding fees, advisors are being forced to clarify their own value. A recent study by Cerulli Associates found that 50% of investors were willing to pay for financial advice. Individual financial advisors need to understand their own value and market what they bring to the table appropriately. Many investors have financial questions and are willing to pay for advice. Advisors who adhere to a fiduciary standard, and who can demonstrate their value while helping potential clients fully understand the fees they pay, will be best positioned regardless of what happens to the fiduciary rule itself.
The Bottom Line
Whether the fiduciary rule is implemented, expires or returns in another form, the lessons learned from the proposed legislation are important. Advisors need to communicate their unique value and act in their clients’ best interests. Investors need look out for themselves, ask questions and understand who they’re paying, how much and for what product or service. Ultimately, the industry has been influenced by the fiduciary rule creating a move towards greater transparency and accountability within the financial industry. (For more, see: Can Trump Roll Back the Fiduciary Rule?)