The long-awaited fiduciary rules for financial advisors dealing with client’s retirement money have finally been released. The Department of Labor (DOL) seems to have listened to industry feedback and the final version of the rules has been softened quite a bit from preliminary versions. Here is a look at what the rules look like, the potential impact and what will likely follow.
Implementation and Timing
The final version of all aspects of the new fiduciary standard will be effective on Jan. 1, 2018. Labor Secretary Thomas Perez indicated that the new rules would be implemented in phases beginning in April, 2017. This was lengthened from the prior draft that specified and eight-month window to implement the new rules. (For more, see: What the DoL’s Fiduciary Policy Means for Advisors.)
One feature of the new rules is the advent of a Best Interests Contract Exemption or BICE. This is a disclosure document that an advisor must provide to clients that allows advisors to offer products or strategies that would potentially have conflicts of interest and may not be considered to be in the client’s best interests. The final rules as issued have some differences in the BICE contract from what many thought they would look like.
- The final rules include a grandfathering clause covering investments that were made prior to “applicability date” of the contract. Investments and advice made after this date will be subject to the BICE provisions. In fact, there is minimal disclosure required for existing clients. They can agree by “negative consent” with no signature required. Disclosures to them can be made by letter or email and can be buried in other paperwork. In many cases it appears these clients may not receive much in the way of the information that was originally intended. (For related reading, see: How Advisors Can Plan for Fiduciary Rule Changes.)
- The final version broadened the assets and investment options that can be included in a BICE contract to include the full range of products or services that might be offered to a client. The DOL indicates on their site that their intention was to be sure that investor choices were not limited. This was also likely in response to industry feedback on a restricted list of assets that could be recommended for retirement accounts. The DOL’s intention was to steer advisors away from recommending certain alternatives and high risk products in IRAs and other retirement accounts.
- The timing of the BICE contract was changed. The original proposal called for the BICE contracts to be signed at the initial meeting with a client. They can now be signed be signed later in the process such as when the client signs the paperwork to open the account(s) where the transaction involving the assets requiring the disclosure will take place.
- The draft version called for disclosures of the one, five- and 10-year projected expenses for the products covered by the disclosure. The final version eliminates these projections as well as the requirement for an annual disclosure of these expenses. (For more, see: The Fiduciary Rule: How and Why to Outsource Your Risk.)
- The prohibitions against recommending proprietary products from the advisor’s employer included in the draft version of the rules have been removed. The thinking seems to be the DOL doesn’t want to prohibit the selling of these products if they are the best solution for the client. The final version of the rules provides specific guidance as to how advisors can satisfy the best interest standard where proprietary products are concerned.
- The final rules include language in the BICE that allow for the recommendation of insurance and annuity products and include disclosure provisions that reflect how these products are sold. The draft version put insurance-based lifetime income products at a disadvantage in that the benefits of these products are not as easily understood by some clients.
- It appears that indexed annuities will no longer be exempt from fiduciary rules as they had been thought to be in the past. Advisors who wish to sell these products will need to comply with the same BICE requirements as with variable annuities and other lifetime income products. Sales of indexed annuity products rose some 13% in 2015. Beyond commissions, insurance agents are often rewarded with perks such as vacations and other non-financial perks. (For more, see: How the Fiduciary Rule Will Impact Annuity Sales.)
- Advice provided to sponsors of small 401(k) plans will now be covered by the BICE provisions.
- Advice to larger ERISA plans and participants in those plans is now excluded from the BICE provisions.
- The final version added a provision for level fee fiduciaries. This deals specifically with recommendations that a client roll their 401(k) balance to an IRA account under a level fee arrangement. The BICE will need to document why this rollover is in the client’s best interest. This will also apply in the case where the client will be moved from a commission arrangement to a level fee arrangement.
- The final version backed off of the requirement that low fee and low-cost product and service options are mandated in the draft version. They clarified that the advisor is not obligated to recommend the lowest fee option if another product or service option is better for the client.
- The initial draft versions essentially eliminated commissions. The final version backs off of this stance and provides examples of policies and procedures that would be compatible with commissions and that would satisfy the requirements. The DOL also indicates that moving a client to a fee-based model if this is not in their best interest would constitute a non-exempt prohibited transaction. (For more, see: How SEC and DOL Fiduciary Standards Could Differ.)
Check out this page on the DOL’s site for a more complete look at the final provisions of the BICE and other aspects of the final rules in a bullet point and chart format.
The points highlighted above are first-day observations from the DOL’s release and other media outlets. There will undoubtedly be some points that require clarification. Brokerage firms and registered investment advisors (RIA) will need to sort through the final version to determine what they need to do in terms of compliance and making any changes to their business models.
Beyond that there could conceivably be legal challenges to the rules by individual brokerage firms and/or industry groups. Clients of brokers and registered reps may be contacted by their advisors to inform them of changes in their relationship arising from the new rules. I have heard stories of that happening already in some cases.
The Bottom Line
The final version of the DOL fiduciary rules were watered down a bit from some of the prior drafts based upon industry input. Regardless, these new rules promise to have a profound impact on the way financial advisors serve their clients and on the financial advisor industry as a whole. (For more, see: DOL Fiduciary Rule: RIAs See Negative Impact.)