A new standard for advisers and investors is quickly approaching.
On April 6, 2016, the Department of Labor (DOL) released a new regulation pertaining to the duties owed by financial advisors to their clients. The new rules are expected to have a major impact on how Americans save for retirement. In essence, the regulation extends to individual retirement accounts a revamped version of the “fiduciary” standard that governs corporate retirement accounts like 401(k)s.
In the future, advisors will have to act in the best interest of their clients when providing investment guidance. What standard applied before, you might ask? Prior to the DOL’s new regulatory changes, financial professionals—other than Registered Investment Advisors—were only required to have a “reasonable basis” for believing the recommendation was suitable for investors. Since the recommendations were required to be only suitable, critics say at times this encouraged some advisors to sell high-fee products that pay them high commissions, which was completely legal at the time.
Change Is Coming
The new rule, which does not take effect until April 2017, allows those who can afford a financial professional to receive more transparency, particularly the assurance that their broker is not selling them products that enrich him or her at their expense. It will take time for the general public to feel—or for that matter, understand—the new rule. “Regular consumers have no idea that this is even happening,” notes Jamie Hopkins, retirement income professor at the American College of Financial Services.
Five years in the making, the regulations center on individual retirement accounts (IRAs) and the financial professionals who advise investors rolling over their former company 401(k)s into an IRA, or setting up a new IRA from scratch. According to a report from the White House Council of Economic Advisers, IRA investors are particularly vulnerable to conflicted financial advice, which collectively costs retirement savers approximately $17 billion a year.
The new regulations do not ban commissions outright, but they do require financial professionals who accept them to disclose the terms of their compensation to the client. That requirement may cause a few awkward conversations, to say the least. In addition, it may prove to be arduous in practice, causing firms to move away from commission-based models—but that remains to be seen.
“From what we have heard and read and the conversations we have had with the Secretary and others, I think the [Labor] Department has made sincere efforts to streamline the original rule, make it easier for the industry to accommodate the rule, and minimize the unintended consequences and cost of complying,” said Christopher Jones, chief investment officer at Financial Engines, Inc. to the Wall Street Journal. “The core elements remain focused on making sure anybody who is providing advice in a retirement context does so as a fiduciary. We think that’s an unqualified win for the public and will ultimately benefit the industry as it realigns to be more consumer-friendly.”
Time Will Tell
In theory, the DOL’s new regulation requiring a fiduciary relationship between financial professionals/advisors and their clients is a sound, intelligent concept. On the outset, it provides those who can afford it an unofficial guarantee that their paid financial professional is working in their best interest. However, this is a disadvantage for the well-rounded, savvy investor who understands investments better than a typical new client. Specifically, he or she would have already been in a fiduciary relationship with their advisor, and that savvy investor is now going to be punished with higher costs for others’ lack of knowledge.
There are also concerns with the new regulation. As the DOL fiduciary rule is vague—with no definition of “best interest” or “reasonable compensation”—there is little doubt that attorneys will head to the courts on behalf of aggrieved customers when investment recommendations turn south after a few years. Additionally, the added cost of compliance may force those who most need the investment and financial advice out of the market. Lastly, the new regulations will come with more paperwork and the opportunity for regulators to impose sanctions or fines on smaller broker-dealers, who are already subject to an ever-increasing regulatory burden.
While the new regulation will be viewed as an overall success for the common man and a win for investors, the benefits remain to be seen as they unfold over the next few years. Like it or not, change is coming for investors and advisors. iBi