Stoll Keenon Ogden PLLC | Advertising Material
By: Tara McGuire
After several years of proposed regulations, and a months-long ramp up by the U.S. Department of Labor (DOL) hinting at what these new fiduciary standards may contain, the DOL has finally announced sweeping new regulations that are expected to have a substantial impact on how many Americans save for retirement. These long-awaited fiduciary rules have the potential to transform the status quo of the investment industry by requiring brokers and financial advisers that handle retirement accounts to put their clients’ interests first when providing financial advice or recommendations– that is, not to be influenced by fees and commissions.
The intent of the new fiduciary rule, according to the DOL Secretary, is to better safeguard the investments of working, middle class investors by improving adviser disclosures and reducing conflicts of interest, such as when an investment firm is compensated by a mutual fund company or other 3rd party for recommending a particular investment to their clients. The White House Council of Economic Advisers estimates that conflicted investment advice costs retirement investors $17 billion each year, a figure that the DOL seeks to curb by imposing a heightened fiduciary standard on brokers and financial advisers nationwide.
The DOL’s final “streamlined” fiduciary rule creates a new standard for brokers and advisers providing financial recommendations that are considerably stricter than the prior regulations. Until now, regulations only required brokers to recommend “suitable” products to client investors, even if those products and investments may not be the client’s best option to fit their investment goals. Critics of the former standard argued that it encouraged some advisers to sell high-fee investment products that paid them high commissions, regardless of the projected or actual return to the investor.
Under the new rules, many brokers and advisers providing financial recommendations to plans subject to ERISA, to participants or beneficiaries of these plans, or to IRAs will be treated as fiduciaries of their clients, a heightened standard that will require brokers and advisers to offer only the best (or sometimes the lowest price) investment options, regardless of the commissions or fees attached to those options. Commissions-based sales will not be banned under the new rule, but brokers may have to provide explanations for why they are recommending more expensive products over cheaper options, or risk facing scrutiny for advice for which they have a conflict of interest.
Analysts predict a shift to more investments in low-cost index-based funds, which provide lower cost, lower risk and lower return options than many higher-priced investments, but may better fit the profile of the “best” option for investors under the new fiduciary standard. Investment firms also could lower their fees or move investors from commission-based accounts to fee-based accounts, where the investor’s costs for advice are structured as a percentage of the assets invested rather on the types of products sold. Clients also may be transferred to online-based accounts, which charge lower fees but forego the personalized investment advice provided with traditional investment accounts. Some industry professionals fear that the practical implications of this rule will be its deleterious effect on the relationship between the financial adviser and the client, or the loss of that relationship altogether as some investment firms may drop clients with small account balances, since those small accounts may no longer be as profitable without the higher commissions.
Almost as important as the rule itself are the exemptions from the rule. As a means to preserve what the DOL calls “beneficial business models for delivery of investment advice,” it has separately published new exemptions from ERISA’s prohibited transaction rules that will allow investment firms to continue receiving many types of fees and commissions, as long as the firms are willing to adhere to applicable standards of impartiality in the best interest of clients. The “Best Interest Contract (BIC) Exemption” is designed as a highly flexible accommodation to allow many investment advisers to continue traditional modes of servicing clients through a wide range of compensation practices. Some highlights of the BIC Exemption and the final fiduciary rule are as follows:
The Standards – The Impartial Conduct Standards require fiduciaries to: act in the ‘best interest’ of plans and IRAs; charge no more than reasonable compensation; and make no misleading statements to the plan or IRA when engaging in investment transactions.
provides a written statement of its fiduciary status to the ERISA plan investor;
complies with the Impartial Conduct Standards;
adopts policies and procedures to avoid conflicts of interest;
provides disclosures regarding investment advice; and
does not attempt to disclaim any responsibility under ERISA or unreasonably limit the ability of the investor to assert plan-related claims.