The Department of Labor (DOL) Fiduciary Rule is a new ruling, scheduled to be phased in April 10, 2017 – Jan. 1, 2018, that expands the “investment advice fiduciary” definition under the Employee Retirement Income Security Act of 1974 (ERISA). If this sweeping legislation (1,023 pages in length) is not delayed or stopped outright, it will automatically elevate all financial professionals who work with retirement plans or provide retirement planning advice to the level of a fiduciary, bound legally and ethically to meet the standards of that status. While the new rules are likely to have at least some impact on all financial advisors, it is expected that those who work on commission, such as brokers and insurance agents, will be impacted the most.
However, on February 3, 2017, President Trump issued a memorandum that will most likely delay the rule's implementation by 180 days. This action includes instructions for the DOL to carry out an “economic and legal analysis” on the rule's potential impact.
Breaking Down the Fiduciary Rule
- Defined-contribution plans: four types of 401(k) plans, 403(b) plans, employee stock ownership plans, Simplified Employee Pension (SEP) plans and savings incentive match plans (simple IRA)
- Defined-benefit plans: pension plans or those that promises a certain payment to the participant as defined by the plan document
- Individual Retirement Accounts (IRAs)
What Isn't Covered
- If a customer calls a financial advisor and requests a specific product or investment, that does not constitute financial advice.
- Financial advisors can provide education to clients, such as general investment advice based on a person's age or income, and it also does not constitute financial advice.
- Taxable transactional accounts or accounts funded with after-tax dollars are not considered retirement plans, even if the funds are personally earmarked for retirement savings.
History of the Fiduciary Rule
Originally, the DOL regulated the quality of financial advice surrounding retirement under ERISA. Enacted in 1974, ERISA had never been revised to reflect changes in retirement savings trends, particularly the shift from defined benefit plans to defined contribution plans, and the huge growth in IRAs.
A set of reforms was proposed back in 2010, but it was quickly withdrawn in 2011 after fierce protest from the financial industry regarding regulatory costs, liability costs and client concerns.
Five years later, the financial industry was put on notice in 2015 that the landscape was going to change. A major overhaul was proposed by President Obama on February 23, 2015. "Today, I'm calling on the Department of Labor to update the rules and requirements that retirement advisors put the best interests of their clients above their own financial interests," the president said. "It's a very simple principle: You want to give financial advice, you've got to put your client's interests first."
The DOL proposed its new regulations on April 14, 2016. This time around, the Office of Management and Budget (OMB) approved the rule in record time, while President Obama endorsed and fast-tracked its implementation; the final rulings were issued on April 6, 2016. Before finalizing the ruling, the Labor Department held four days of public hearings. While the final version was being hammered out, the legislation was known as the fiduciary standard. In January 2017 during the first session of Congress of the year, a bill was introduced by Representative Joe Wilson (R, S.C.) to delay the actual start of the fiduciary rule for two years.
Reaction to the Fiduciary Rule
There’s little doubt that the 40-year-old ERISA rules were overdue for a change, and many industry groups have already jumped onboard with the new plan, including the CFP Board, the Financial Planning Association (FPA), and the National Association of Personal Financial Advisors (NAPFA). Supporters applauded the new rule, saying it should increase and streamline transparency for investors, make conversations easier for advisors entertaining changes, and most of all, prevent abuses on the part of financial advisors, such as excessive commissions and investment churning for reasons of compensation. A 2015 report by the White House Council of Economic Advisers found that biased advice drained $17 billion a year from retirement accounts.
However, the legislation has met with staunch opposition from other professionals, including brokers and planners. Financial advisors would rather be held to a “suitability” standard than a “fiduciary” standard because the latter will cost them money – in lost commissions and the added expense of compliance. The stricter fiduciary standards could cost the financial services industry an estimated $2.4 billion per year by eliminating conflicts of interest like front-end load commissions and mutual fund 12b-1 fees paid to wealth management and advisory firms.
While the best interest contract exemptions would permit broker-dealers and insurance companies to provide plan participants with fiduciary advice while still receiving commissions, many professionals fear the conflict-of-interest yardstick would essentially eliminate commissions. This in turn would force financial advisors to create or shift fees onto individuals, and could price many middle- and lower-market investors out of the market, they argue.
Three lawsuits have been filed against the rule. The one that has drawn the most attention was filed in June 2016 by the U.S. Chamber of Commerce, the Securities Industry and Financial Markets Association and the Financial Services Roundtable in the U.S. District Court for the Northern District of Texas. The basis of the suit is that the Obama administration did not have authorization to take the action it did in endorsing and fast-tracking the legislation. Some lawmakers also believe the DOL itself is reaching beyond its jurisdiction by targeting IRAs. Precedent dictates Congress alone has approval power regarding a consumer’s right to sue.
Some critics suggest the new Fiduciary Rule makes no difference anyway. Those observers say consumers will still be subject to being cheated by “bad actors.” For example, complying with the new rule will require more paperwork. Paperwork, critics say, is a great place to hide a scam and then later say the customer signed and knew what he or she was signing. More recently, members of President Trump's advisory team have both criticized the rule and Trump signed an executive order to delay it's implementation. The DOL continued to defend the rule in multiple lawsuits going into 2017.
Who Does the Fiduciary Rule Affect?
The new DOL rules are expected to increase compliance costs, especially in the broker-dealer world. Fee-only advisors and Registered Investment Advisors (RIA) are expected to see increases in their compliance costs as well.
The Fiduciary Rule could be tough on smaller, independent broker dealers and RIA firms. They may not have the financial resources to invest in the technology and the compliance expertise to meet all of the requirements. Thus, it won't be surprising to see some of these smaller firms disband or be acquired. The brokerage operations of MetLife Inc. and American International Group have already been sold off in anticipation of these rules and the related costs.
Advisors and registered reps who dabble in terms of advising 401(k) plans may be forced out of that business by their broker-dealers due to the new compliance aspects. This could reduce the number of advisors who serve smaller plans. That's what happened in the U.K. after the country passed similar rules in 2011; since then, the number of financial advisors there has dropped by about 22.5%. Ameriprise CEO Jim Cracchiolo said, “The regulatory environment will likely lead to consolidation within the industry, which we already see. Independent advisers or independent broker-dealers may lack the resources or the scale to navigate the changes required, and seek a strong partner.”
Annuity vendors also will have disclose their commissions to clients, which could significantly reduce sales of these products in many cases. These vehicles have been the source of major controversy among industry experts and regulators for decades, as they usually pay very high commissions to the agents selling them, and come with an array of charges and fees that can significantly reduce the returns that clients earn with them.
What Sort of Investments Will the Rule Impact?
The main impact is anticipated to be connected with IRAs, since these vehicles are often handled at brokerages. In particular, rollovers from 401(k) plans to IRAs will certainly come under scrutiny. There have been many instances reported in the financial press (and likely tens of thousands more in reality) about advisors suggesting rollovers to IRAs, even though it may not have been in the client’s best interest – either in terms of moving the client’s money out of a low-cost company retirement plan that offered solid investment choices or in terms of the types of high-cost investments recommended in the new IRA.
The DOL has also released answers to common questions they've received about the new rules in the form of FAQs, which address topics from investments to advisor compensation.
More Rules from the SEC?
As if there wasn’t enough confusion among advisors and clients about the new plan, the Securities and Exchange Commission (SEC) has projected proposing its own set of fiduciary rules in April 2017. It is likely any new SEC rules would extend beyond retirement accounts and govern the way in which RIAs and brokers treat clients in all dealings, mandating that the client’s interests must come first in all cases. SEC Chairwoman Mary Jo White has indicated that she supports non-governmental, third-party examinations of investment advisors. The Financial Industry Regulatory Authority (FINRA) would be an example of such a third party.
White has expressed SEC enforcement priorities as including:
- Increased examinations of investment advisors who are regulated by the SEC.
- Enhancing their oversight of FINRA as it takes on a bigger role in overseeing broker-dealers.
- Economic risk and analysis of various investment vehicles.
- Data analytics to better focus its resources for the examination of investment advisors.
A major concern of many advisors and brokers will likely be whether or not a new set of SEC rules will be consistent with the new DOL fiduciary rules. In the event of conflicting rules, financial advisors may find it difficult to follow the proper course of action.
If advisors and their firms are now faced with a second set of rules that is decidedly different than the DOL rules, the costs of compliance and the manpower needed also could drive some smaller broker-dealers out of the business.
How Technology Can Help
The rules will likely spur development and upgrades of many technology platforms and applications that will aid independent broker-dealers in meeting their compliance challenges. There’s little doubt that the new fiduciary rules will take a bite out of advisors’ profit margins, but software solutions might help mitigate the impact.
Digital technology has progressed to the point where computers have become able to perform routine investment management tasks such as portfolio rebalancing, dollar-cost averaging and tax loss harvesting. These automated programs, or robo-advisors, are able to accomplish increasingly sophisticated tasks for clients and at some point will most likely be capable of maintaining complex portfolio management strategies that currently require human intervention.
The concept of fiduciary as it is written in the DOL bill is now colliding head on with the increasing lack of human intervention in the robo-advisor arena. Regardless of how this issue plays out, though, it seems clear that robo-advisors will ultimately profit from the DOL rule. It may soon be possible to employ robo-advisors to create trading algorithms that are always absolutely in compliance with the DOL rules, regardless of market conditions or client circumstances, and without the possibility of human error. Most of these programs already use low-cost index funds for their trading, which will sit well with regulators.