The Department of Labor’s new fiduciary rule that was released in its final form on April 6, 2016, promises to bring major changes to the retirement planning industry. It will hit brokers and planners who receive commissions for their services especially hard, as they will have to provide substantial additional disclosures to their clients that outline the amount of money that they will make on each transaction.
Registered investment advisors (RIAs) will have to make some changes in how they do business as well. One of the key provisions of this bill requires all brokers, planners and advisors who work with retirement plans to provide their services to clients at a reasonable cost. However, the bill does not define precisely how this is to be calculated, which essentially leaves many industry professionals in the dark about how to meet this criterion.
Read on for more about the new rule. (For further reading, see: What the DoL's Fiduciary Policy Means for Advisors.)
The Scope of the Rule
The new rule is designed to lower the costs and fees that are borne by consumers who own retirement plans and accounts. This is partially accomplished by elevating the status of all financial professionals who work with retirement accounts or provide advice regarding them to the status of a fiduciary. This status will require those professionals to unconditionally put their clients’ best interests ahead of their own.
It also mandates that professionals keep the costs that their clients are paying to a reasonable level. Of course, the question then arises as to what a “reasonable” cost is. This concept was originally written into the language of the ERISA provision back when it was incepted in 1974, and advisors who work with retirement plans and act as fiduciaries according to the SEC’s definition have had to work under this standard for the past several decades.
But brokers and those who work on commission may get tripped up by this definition at least initially as their preferred method of compensation may not meet this definition in many cases. And the hard truth of the matter is that there is no formal definition of reasonable cost anywhere in the language of the new rule.
Former deputy assistant secretary of the DoL Michael Davis confirms this fact. “There's no hard-and-fast rule,” he said. “What's reasonable for one engagement might be completely unreasonable for another. The Department doesn't typically prescribe numerical targets.” Davis also adds that the DoL purposely left this element of the rule somewhat vague in order to protect itself from opponents who may wish to contest the validity of this definition in court. (For related reading, see: How Advisors Can Plan for Fiduciary Rule Changes and How Advisors Must Ramp Up Tech for Fiduciary Rule.)
An Ongoing Issue
Although the DoL’s new rule brings this issue to the forefront for many brokers and planners, the concept of overcharging clients for services provided is hardly a new one in the financial industry. A slew of lawsuits targeting 401(k) plan providers are currently underway, and plan providers are being charged with failure to uphold their fiduciary responsibilities by charging too much for their services or by providing poor investment choices with high fees and sales charges.
The fees that many annuity contracts charge along with the high commissions that brokers earn from selling them are additional reasons why the DoL bill was introduced, even though the use of these instruments was appropriate in many cases. (For related reading, see: How the Fiduciary Rule Will Impact Annuity Sales.)
What Planners Can Do
Planners who want to ensure that their compensation meets the reasonable standard put forth by the DoL rule can begin by creating a concrete, step-by-step plan that they use to determine what they charge clients and how. A concise breakdown of their fee structure can show regulators that advisors are providing specific services for specific fees that they charge.
Planners should also carefully document the planning process that they used to determine their fee schedule, so that they can show this to both clients and regulators who may question why they are charging what they do. The bottom line is that planners should always be able to articulate to clients why their fees are reasonable and why it is in the client’s best interest to pay them as opposed to leaving their money in their 401(k) plan or elsewhere.
Factors such as the quality and amount of advice that is provided can be used to determine fees as well as the nature and level of service that the client receives. Other issues include the level of expertise of the advisor and how often he or she meets with the client.
The Bottom Line
It will most likely take some time for brokers and planners to discover exactly what the DoL considers to be reasonable costs for clients. This issue may ultimately be decided in court in several different instances, and advisors need to be ready to adjust their business models accordingly. (For further reading, see: DoL Fiduciary Rule: RIAs See Negative Impact.)