DOL Fiduciary Rule

Todd Washburn |

DOL Fiduciary Rule

This past Wednesday (4/6/16), the Department of Labor (DOL) released the final version of its new Fiduciary Rule.  It’s been working on it since at least 2010.  It’s gone through several iterations, numerous comment periods, and four days of testimony.  I’m betting most folks have no idea what it is or that it was even being developed.

So why is it important?  First a little background information.  While most things financial are regulated by the Securities and Exchange Commission (SEC), there’s one area where the DOL rules the roost.  That’s in the realm of retirement accounts and plans.  Back in 1974 Congress passed the Employment Retirement Income Security Act (ERISA) and charged the DOL with enforcing it.  ERISA was designed to protect employees investing in retirement accounts, and by most measures it’s been effective.  Complying with ERISA rules is considered quite important given the amount of money involved and harsh penalties for non-compliance.

In the world of investment advising there has been since the 1930’s two standards of “care” for customers/clients.  One standard is “suitability” and the other “fiduciary.” The former typically applies to those who receive compensation from a third party for the sale of a product.  In other words- commissions.  In today’s world that might apply to some investment people, insurance agents and possibly others.  Under the “suitability” standard the advice or product recommended has to be suitable for the person- meaning it’s a reasonable fit.  But it doesn’t have to be the best option (i.e. it pays a higher commission than a similar product). The fiduciary standard tends to apply to persons or firms that are paid directly for their advice by their clients.  In today’s world that might be a fee-only advisor, or maybe even an accountant or attorney if giving investment-related advice.  The fiduciary standard requires the individual or firm to put the client’s interest first.  In the parlance of the new rule, this is the “Best Interest” standard. Many believe that while neither compensation system is completely free of conflicts of interest, the commission-based one (suitability) is probably more prone to such conflicts given that similar but different products can have different costs and pay different commissions.  The White House Council of Economic Advisors estimates these conflicts of interest may cost investors as much as 1% per year in returns.  That would equate to about $17 billion.  Given that the majority of retirement plans are managed or advised by people/firms working under the suitability standard, the DOL set out to address this (the SEC is still working on its expanded fiduciary standard as authorized by the Dodd-Frank Act).

The DOL proposed to impose a fiduciary standard on any person or firm providing retirement advice (i.e. regarding 401k plans, rollovers to IRAs, to companies with plans for their employees).  It’s a big deal because it means many companies providing such services now have to switch to a fiduciary standard of care. This hasn’t been without controversy- particularly from firms who will have to change their business model.  They claim it’ll raise the cost of doing business (i.e. compliance costs) and make it unprofitable to serve smaller customers.  At first look it appears the DOL has tried to work with them on this, but there are going to be changes., They will probably cost money, and perhaps some folks will be priced out of receiving advice as they have been.  However, the hope is the vast majority of investors will be better protected and served and that alternative services will emerge for the others.

So what’s the long and short of this?  Implementation of the new rule will start in the next year and is required to be fully implemented by January 1, 2018.  Prior to opening a new investment account, a customer/client will need to enter into a “Best Interest Contract” with the adviser where the adviser pledges to put the customer/client’s interest first.  Not everything consumer advocates had hoped for ended up in the rule.  Commissions are not being banned (as they were in England a few years back in a similar effort) but must fall within the Best Interest Contract Exemptions (BICE).  Some products, like complex annuities are still being allowed.  Some notifications may be posted on websites rather than given directly to consumers.   

Is this new rule a good thing?  Probably.  It will make everyone providing advice a fiduciary.  The devil, as always, will be in the details and the loopholes.  Another big factor will be enforcement.  Will the fiduciary standard be enforced?  It’s also important to remember that this only applies to retirement accounts where the DOL’s jurisdiction lies.  Non-retirement accounts are the SEC’s responsibility.  As things evolve, I’ll keep you posted.