1 Know the definition of fiduciary
The US Department of Labor's (DOL) final fiduciary duty rule, which was published in April, vastly expands the definition of fiduciary. Now, anyone who advises or makes recommendations to retirement plans, plan participants or IRA owners is considered a fiduciary. Even those giving advice or recommendations on transaction-based accounts, as well as those advising on rollovers and distributions, are now considered fiduciaries. Previously, professionals advising retirement clients were required only to provide recommendations that would be "suitable," which is not necessarily synonymous with acting in the client's best interest, according to the DOL.
The final ruling, however, did exempt certain types of actions from being defined as fiduciaries. Those who provide investor education without any type of product offering are not considered fiduciaries. Also, brokers and traders who simply take orders from retirement-plan clients without providing any type of advice or recommendations are likewise exempted. However, there are still grey areas that look to cause considerable confusion. One is financial advisors with clients who have multiple accounts—both IRA and non-retirement. Would "best practices" compel advisors to extend the fiduciary duty to non-retirement accounts as well? It's not entirely clear. This could lead broker-dealers, in an effort to maintain a standard level of service, to treat all clients in a fiduciary manner.
2 Business models will get a makeover
The fiduciary-duty rule has the potential to upend financial advisory business models as many firms contend with rising costs and reduced compensation. Being in compliance with the new rule means greatly boosting record-keeping and disclosure efforts, which means incurring significantly more business costs. On the compensation side, it's too early to fully quantify the rule's effects, but third-party payments such as commissions, trail fees and revenue-sharing agreements are all subject to greater regulatory scrutiny.
Given the vast changes to incurred costs and compensation structures, it's no surprise that financial advisors believe fiduciary duty rule will negatively impact their business—almost 75%, according to a recent Fidelity Investments survey. This could prompt a significant number of advisors to exit the business altogether, as happened in the UK when similar regulations were imposed in 2013. The UK banned financial advisors from charging commissions and now it's a fee-based-only industry in Britain, which has fewer independent financial advisors now than it did before commissions were banned.
3 Disclosure requirements seem endless
The enormous disclosure requirements that appeared in an earlier draft of the fiduciary-duty rule were deemed unworkable by the financial-services industry, and the DOL was wise to take note. In the final rule, the disclosure requirements were somewhat streamlined while a few others were shelved altogether. This is not to say that the final disclosure requirements are simple, but they have been improved. For instance, the disclosure requiring that advisors provide a one-, five- and 10-year history of the fees associated with any proposed investment, as well as a projection of what the fees may be in the future, has been jettisoned. Such a requirement would have completely contradicted existing Securities and Exchange Commission regulations, which expressly prohibit such projections.
Overall, however, the final disclosure requirements are still more onerous than many in the industry anticipated. For instance, there are disclosures required at the point of client contact and with each transaction, as well as a requirement for substantially more website disclosures. The new disclosures must include statements that advisors will adhere to a "best interest" standard; a description of material conflicts of interest; any fees charged by the financial institution; and information about whether and how frequently the advisor will monitor the client's investments. All of this information is also required to be maintained on an advisor's company website, and must be reviewed and updated quarterly.
4 Winners and losers under the new rule
Designed to help and protect investors, the new DOL rule could actually have the opposite effect as a shrinking number of advisors go "up-market" to find wealthier clients and higher levels of compensation. Relatively small-balance accounts, arguably the people who need retirement advice the most, would become cost-prohibitive and likely would lose access to retirement advice. The clients who do remain, however, could end up paying more as advisors pass along the rising costs of compliance with the new rule.
Certain segments of the industry, however, will find the new DOL rule to be a competitive advantage. The overriding beneficiaries will be discount brokerages, index and exchange-traded-product providers, and robo-advisors. This shift is part of a trend that has been growing in recent years, and the industry can look for it to accelerate as fiduciary-duty rule bites down on business as usual.
5 Final doesn't mean it's over
In my many discussions with ERISA attorneys, financial advisors and plan sponsors, virtually all agree that the 923-page DOL regulation is incredibly complex and subject to various interpretations. The final fiduciary rule is being closely parsed by the financial-services industry, of which major segments could sue to block the rule from taking effect. Already, the American Council of Life Insurers, an industry trade group, has retained a law firm and is gathering evidence in advance of an expected court battle.
As this complex rule is phased in over the next year, we expect to see additional guidance from the DOL as well as some answers to the substantial uncertainty that still surrounds the rule. But as lawsuits gather and the industry finds certain aspects untenable, unacceptable and downright unworkable, we will likely see that the DOL's final fiduciary rule is anything but.
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About the Author
Glenn Dial is Head of Retirement Strategy in the US with Allianz Global Investors, which he joined in 2011. He has 23 years of defined contribution experience. Mr. Dial is a co-inventor of the method and system for evaluating target-date funds, and is also credited with developing the target-date fund category system known as “to vs. through.”
Important Information
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
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