The Department of Labor’s (DOL) new fiduciary rule is making a large impact on the retirement planning industry, as it requires all financial advisors who work with any type of retirement plan or account to act in a fiduciary capacity at all times. The initial set of rules came out in April 2016, and the agency has since released two sets of answers to frequently asked questions that the DOL has received on the rule.
The first batch of answers didn’t address all of the outstanding issues pertaining to the regulations. However, it did address many key issues, and a second set of answers released in early 2017 has added more clarity. Advisors now have a somewhat clearer picture of how the rule will be implemented and enforced. (For more, see: Fiduciary Rule: Preparing Advisors for Compliance.)
Top Takeaways from the DOL FAQs
The Department of Labor released its initial guidance on the rule in the form of a 24-page document that provided answers to 34 separate questions. There are some general conclusions that can be drawn from this group of answers. For one thing, the DOL seems to favor fee-based compensation over commissions, but the rules do allow for commissions to be charged as long as certain requirements are met. (For more, see: DOL Releases First Round of Fiduciary Rule FAQs.)
It also delivers some specific pointers on the structure of pay incentives, but does not provide a concise definition of “reasonable compensation.” Although the first FAQs shed additional light on many issues, it is not perfectly clear like a set of simple directions. But some things seem to be fairly certain at this point. The April 10, 2017 deadline that was set by the DOL for the new rules to go into effect is not likely to be changed. At this point, financial advisors and retirement plans and accounts will have to start meeting the new fiduciary requirements regardless of whether they are ready or not. The full provisions of the Best Interest Contract Exemption will not go into effect until January 1, 2018.
As mentioned previously, the DOL seems to favor fee-based compensation models that align the advisor’s best interests more closely with those of their clients. Seven of the questions that were addressed in the FAQs dealt with how advisors who charge level fees can stay clear of the BICE requirements. However, the agency also cautioned fee-based advisors against the practice of “reverse churning,” where clients who trade infrequently are charged a periodic fee when no service has been provided. It also revealed that it has no problem with firms or advisors who charge both fees and/or commissions, as long as their compensation is reasonable. (For more, see: How to Explain the DOL Fiduciary Rule to Your Clients.)
But the DOL has made it clear that it wants the recruiting incentives of brokers that are based on sales to stop. One of the answers addressed the payment of “back-end awards” when a broker achieves a certain threshold of revenue or assets under management. The DOL firmly maintains that these types of practices “create acute conflicts of interest.”
Advisors who were hoping to get a clear answer from the DOL regarding how reasonable compensation is defined will have to keep waiting. The DOL failed to provide any specific parameters and merely said that this will be set by the market. “The reasonableness of the fees depends on the particular facts and circumstances at the time of the investment advices. The essential question is whether the charges are reasonable in relation to what the investor stands to receive for his or her money,” the guidance states.
Once the DOL released its second set of FAQs, the acceptable forms of compensation under the new fiduciary rule became more clear. This release explained that advisors who provide advice for 401(k) fund options, and that charge a flat, asset-based fee for that advice, can also use revenue-sharing payments. That means if an employer-sponsored 401(k) plan owes an advisor a set amount based on the total assets managed, but also ends up having to pay other costs like 12b-1 fees, those costs can count towards the flat fee the employer will owe the advisor at the end of the year.
The DOL also seems to approve of robo-advisors, which are automated programs that can perform basic money management chores, often at a fraction of the cost of a human advisor. Labor Secretary Thomas Perez has offered praise to these programs to Congressional committees. The FAQs also complimented them, saying that “the marketplace for robo-advice is still evolving in ways that appear to avoid conflicts of interest.”
The Bottom Line
Although they did not clear up all of the questions and issues pertaining to the new rules, the first set of FAQs do provide clarification in some areas. Two more sets of FAQs will be released by the DOL before the rules go into effect next year, so the industry can expect to receive further guidance before they are required to adhere to the rules. (For more, see: How the Fiduciary Rule Impacts Advisor Technology.)