The Department of Labor unveiled its final fiduciary rules in April of 2016. These rules will have a big impact on financial advisors who provide advice on retirement accounts like IRAs and 401(k)s when final implementation occurs in April of 2017.
Let’s look at the basics of the new rules and most importantly what they could mean for you as investors and clients of financial advisors.
DOL fiduciary rules – the basics
The rules mandate that advisors act as fiduciaries when dealing with client retirement assets. This means that they will need to provide advice in a fashion that is in their client’s best interests. For stock brokers, registered reps and any advisor who is compensated all or in part via commissions, this differs from the suitability standard that has been in place for the brokerage world.
The suitability standard holds brokers to a much lower standard of care and says that the financial product must only be suitable for the client’s situation. The product does not have to be the best one for them in terms of cost or any other measure. Conflicts of interest are not an issue as I understand the suitability standard.
Clients of brokerage firms and advisors who are paid by straight commission or a combination of fees and commissions have likely heard about these new rules from their brokers.
Two major financial services firms have sold their brokerage units. Met Life sold its agent sales force to Mass Mutual. Additionally, AIG sold its brokerage unit earlier this year as well. Both companies cited the pending fiduciary rules and the cost of compliance as a major factor in their decisions to sell these business units.
Many, including the Speaker of the House and financial guru Dave Ramsey, have cited the limited access to financial advice for middle income clients if these rules are enacted.
Personally, I find these and other claims by the financial services industry about the limited access to advice to be at best disingenuous and at worst maddening. First, shouldn’t all financial advisors always put their client’s interests first? Do we really need governmental regulation to ensure this? Sadly, the answer is yes.
Additionally, there are many fee-only financial advisors who work with middle income clients and provide services on an hourly, as needed basis. Check out NAPFA and The Garret Planning Network among other sources to find a fee-only advisor who meets your needs.
Changes in the brokerage world
The new rules have prompted a number of changes in the brokerage world. Giant broker-dealer LPL financial has announced that it will end its direct mutual fund business in favor of their own internal mutual fund only account. They have also announced that they will be standardizing commissions paid to brokers to comply with some of the level fee provisions of the rules.
Merrill Lynch, Edward Jones and others have also revamped the way they do business in terms of commissions in retirement accounts.
Justification for higher fees?
I’m guessing that some brokers and advisors will take the added compliance costs as an excuse to raise fees, especially on smaller accounts.
A friend relayed a story to me about being invited to a client’s meeting at the local office of the brokerage firm where he has a couple of small accounts and being told that they can expect to see costs and fees increase due to the added compliance costs associated with these new rules. And none of my friend’s accounts were IRAs or any other sort of retirement account.
A colleague shared a story regarding a call he had received from the client of an advisor with a major wire house firm who was informed that the fee for his brokerage wrap account was being increased by 65 percent due to the new fiduciary rules. I doubt the wire house’s costs are increasing anywhere near that amount, nor is it likely the increase can be justified based on better performance. Rather I think this is an attempt to gouge their client and profit from the public’s lack of awareness.
A local small business owner recently asked my thoughts about finding a new home for their small 401(k) plan in light of changes being made by the brokerage firm they had been working with.
A major aspect of the new rules will center ensuring that advice given on retirement accounts is in the client’s best interests. The major area where I see this having an impact on individual investors will regard IRA accounts.
- The fees and expenses associated with the investments suggested will come under scrutiny.
- Annuities in IRA accounts with high internal costs and onerously long surrender charges will (hopefully) become a thing of the past in IRAs.
- Recommendations for products such as proprietary mutual funds with hefty trailers and high expense ratios will also hopefully become rare.
- Rollovers from 401(k) and other workplace retirement plans will need to be justified in terms of why this is a better option for the client than leaving their money in the retirement plan of a former employer or rolling it over a new employer’s plan (if applicable for the client).
- This will impact not only advisors working all or in part on commissions but also fee-only advisors as well.
There will be an option for advisors to recommend financial products or options that may not be in the client’s best interests if they provide disclosure in the form or an agreement called the Best Interests Contract Exemption or BICE. The BICE will need to provide full disclosure as to how much money the advisor will make from this product or investing approach and will (as I understand it) need to be signed by the client.
This could slow the growth of IRA assets for many brokers, registered reps and other advisors who make their money all or in part via commissions.
Fee-only advisors who suggest that a client roll their 401(k) balance to an IRA leaving their employer could also be forced to have their client sign a BICE agreement as well if this move would result in higher costs for the client.
A move towards fees
One likely outgrowth of these new rules is a continued migration of the brokerage industry from advice based upon the sale of commissioned products to fee-based accounts.
LPL Financial has lowered their account minimums and their fees for many of their fee-based accounts. They recognize that this is the trend in the industry and kudos to them for getting out in front of this. I know nothing about the quality of their asset-based accounts, but I applaud their effort none the less.
The issue of reverse churning, where a broker or registered rep who previously relied on commission-based products moves a client to a fee-based account and then collects ongoing fees and provides little or no guidance, is likely to come into the forefront as this trend in the brokerage business continues.
Will Trump repeal these rules or delay implementation?
The president-elect has indicated that he might try to repeal these rules or at least delay or water down their implementation. I suspect a total repeal is unlikely, but he and the GOP can hinder the enforcement via underfunding the enforcement are of the DOL.
Even if this happens the move toward fees is happening. The brokerage world began down this path several years ago, and I think they realize this is the wave of the future.
My biased take
Long-time readers of this blog know that at best I have a healthy skepticism (to be kind) of the methods and motives of many advisors who make a living from the sale of commissioned financial products.
I believe that, sadly, rules mandating that financial advisors act as fiduciaries in dealing with clients are a good thing and are needed. For you the clients and potential clients of these advisors I do believe these rules will ultimately be beneficial in terms of disclosure and improving the types of services and products available to you.
Are these proposed rules the best that could be done? No, but they are a good start. As always, I suspect the brokerage industry will find a way to work these rules to their advantage. They may use the excuse of higher costs to raise your fees or to weed out smaller clients.
Has your broker or financial advisor contacted you about any changes in your fees or the way in which they will conducting business due to the new fiduciary rules? If so I’d love to hear about it. Please leave a comment or feel free to send me an email via the contact link that follows.
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