Big news recently from the Department of Labor (the DOL): the financial advisor who is making recommendations on your retirement accounts will soon have to adhere to a fiduciary standard, meaning they have to put your financial interests ahead of their own.
You’re probably thinking one or more of the following:
Um. They weren’t already?
Essentially, no. Financial advisors (and there are many, many different interpretations of that term) were not required to be fiduciaries when providing investment advice for retirement accounts. Registered Investment Advisors (regulated by the SEC) have always been subject to the fiduciary standard, while brokers (regulated by FINRA) have been subject to the suitability standard. The difference: under a fiduciary standard, the advisor must make recommendations that are in your best interest; under the suitability standard, the advisor can choose to recommend a product that is right for you, but not necessarily the best/least expensive option. Starting next April (with a transition period lasting until the end of 2017), any advisor making recommendations for IRA’s will be subject to the higher standard.
Why is this coming from the Department of Labor?
The DOL governs workplace retirement plans under ERISA (the Employee Retirement Investment Security Act of 1974). Those rules were put in place to provide a standard of conduct for advisors assisting plan participants. But those rules haven’t changed since 1975, and of course, the world of retirement investing has changed a lot since then, away from defined benefit plans and toward IRAs and 401ks. So this is a way of ensuring the same rules continue to apply regardless of what form your retirement savings take.
Over the coming months, financial institutions will begin implementing Best Interest Contracts, or BICs, with their clients. (This will be a contract between the client and the institution, not the client and their advisor.) Without this contract in place, no commissions will be able to be earned. The contract stipulates that even though commissions are being earned, the best interest of the client must be upheld, compensation must be reasonable, and information about the products and compensation must be disclosed. For example, an advisor would need to ensure this is in place before recommending that a client roll over a 401k to a new IRA for the advisor to manage. In practice, this is likely to be integrated into current client agreements rather than presented as a separate document.
If the client and the institution have the BIC in place and its rules are followed, that constitutes a BICE - a Best Interest Contract Exemption; basically, an acknowledgement that the advisor is acting in a fiduciary capacity and will adhere to best-interest conduct standards; and that the institution has policies and procedures in place to ensure compliance and will not incentivize advisor conduct contrary to the standards.
Other institutions will qualify as Level Fee Fiduciaries, meaning they are compensated via a level fee, disclosed to the client, calculated as either a level percentage of Assets Under Management (AUM) or a set fee that doesn’t vary by investment, as in the case with retainer fees. Advisors that qualify for this exemption will still have some regulatory requirements: a statement of fiduciary status must be provided, and likely will just be made part of the client agreement, the standards of impartial conduct must be met, and reasons for recommending a rollover (for example) must be clearly documented, including a comparison of the costs of each option. But for many fee-only advisors, this will not represent a significant change to how they were already operating.
That all sounds pretty good, but what about non-retirement accounts?
It’s true, the new rule only applies to advice given on retirement assets. Most people have non-qualified (or taxable) accounts, real estate, debt, and savings for other goals. And many assets may be earmarked for retirement, but for the purposes of this rule, and investing in general, “retirement assets” refer to those in a qualified account or plan (like an IRA or employer plan). And everyone has planning considerations relating to home purchase, education funding, cash flow management, and insurance needs. None of those are covered by the new rule; the DOL would have no authority over that.
Yes. It’s possible that an advisor can provide fiduciary-standard advice for your IRA while still only having to meet the suitability standard for your other assets, and satisfy the rule.
So what now?
We're already seen some changes: some big firms like MetLife and AIG have given up their advisory business altogether; Charles Schwab will no longer sell mutual funds with sales loads.
Actual enforcement of the rules is envisioned to begin in April 2017. Between now and then, advisors will adapt new policies and procedures to ensure compliance with the law. Overall, this is definitely a step in the right direction. But there’s no guarantee that the rules won’t be weakened later. So take the opportunity to find out some things about your advisor (or to look for one, if you’re searching).
During the transition, a good idea is to check in with your advisor to get their thoughts about how the rule change impacts them. Industry pushback against the rule (from large broker-dealer firms primarily) was significant, and a future in which the small investor could no longer be serviced was held out as the nightmare scenario if the rule was passed, with the reason given that it would become too expensive and cumbersome from a regulatory perspective to assist smaller clients. While this is likely just industry posturing, it brings up important questions to ask:
- Will this be a significant change in how your firm operates?
- Have you been a fiduciary all along?
- Once the change comes, will you be a fiduciary for all the advice you give me, or just for the official retirement assets?
- How will your compensation change?
Obviously, the easiest/least complicated/most likely way to get yourself unconflicted advice 100% of the time is to work with a currently fee-only advisor, who under the rule will be operating under the Level Fee exemption but who already meets the standard sought anyway for all advice given, not just that pertaining to retirement assets. My sense is that eventually, everyone will move to that standard, but that will take a lot of adaptation in an industry not known for being nimble. I really think that long-lasting, true change will come only when demanded by the public.