Last week, the Department of Labor issued much-anticipated final rules that impose a fiduciary duty on financial advisors to the extent they recommend investments for their clients’ IRA accounts. These final rules represent a significant improvement over the proposed rules DOL issued last year, although some fundamental concerns remain to be worked out.
In our view, the most important change is the final rules’ acknowledgement that differential compensation (including commissions) may be appropriate for the sale of different categories of investment products. For example, compensation paid for a mutual fund sale need not equate with compensation paid for the sale of an annuity. The new rules do require, however, that such differing compensation be based on “neutral factors”, such as the time or complexity of the work involved, rather than to promote sales of more lucrative products.
Thus, a firm might draw a distinction between compensation paid for sales of mutual funds and variable annuities based on the additional time needed to explain the latter investment to the client. That additional time allows the adviser to receive greater commissions in connection with annuity sales. The challenge for firms will be demonstrating that the additional annuity sale compensation fairly reflects the additional time spent and that the compensation is reasonable.
The new rules also provide that advisers may continue to receive compensation on products sold before the regulation becomes effective next April. This exception applies to advice to retain a prior investment; to adhere to an earlier established systematic purchase program; and to change investments among choices available under a product such as a variable annuity (provided the adviser does not receive additional compensation for such advice).
We are in the process of preparing a full white paper discussing the new rules.
