Yes I am a fiduciary... for all accounts... today
You may have read about a new fiduciary rule rolled out by the Department of Labor last week. This rule requires brokers and advisors of retirement accounts to act in the client’s best interest. What gets lost in the jargon and over-hyped news flow is that advisors are already working under a fiduciary standard - for all your accounts, not just IRAs and 401ks. This blog post will explain the new rule and its impact.
What’s the difference between brokers and advisors?
Registered Investment Advisors must follow the rules of the Investment Advisors Act of 1940 which includes acting in a fiduciary capacity for all their work. Brokers for financial companies have only been held to the suitability standard.
What is a fiduciary? How does it differ from the suitability standard?
A fiduciary must put the client’s interest first. This means if there is a product or security that is better for the client over a similar product that may pay the advisor more compensation, the fiduciary advisor must recommend the better product for the client. The less stringent standard is suitability which only requires a product be suitable to the client’s needs, not necessarily the best one. This may allow a higher cost product to be recommended by a broker.
Does this new rule apply to all investment accounts?
No. It only applies to retirement accounts. This will be a big change for brokers working on these types of accounts but for an existing fiduciary advisor, they are already working in this capacity - for all investment accounts.
Does this mean all investors were being taken advantage of by brokers?
Not necessarily. We all must pay for a valuable service. Investors need to know the cost to help them determine the value of the service. Advisors specify their fees directly to clients which are paid directly. Brokers are typically paid in the form of a front-end commission or annual fees by the funds or companies they recommend. The key point is asking the broker before the trade – either in the colorful language from the scene in ‘The Big Short’ or asking for a simple explanation. I am ok with different business models - I prefer fee-only - but the key is transparency.
When does this rule take effect?
April 2017 for brokers on retirement accounts. However, fiduciary advisors are already doing this on all your accounts. And nothing is preventing you from asking your broker today how they are compensated.
What is a “best interest contract exemption” (BICE)?
This is a new requirement that clients must sign if the broker will be receiving a commission on the products or securities recommended. This may also be required for both brokers and advisors for any 401k rollover. More details on the fees and costs involved must be disclosed. Again, nothing is preventing you from asking your broker for this now. The difference is brokers are not required to provide it today. You are also not required to work with them if they don’t provide it.
Are there any securities impacted more than others?
The final rule will still allow brokers to receive commissions provided the client signs the best interest contract. So while limiting the really high cost funds and annuities, they can still be used if the client agrees. Variable annuities and indexed annuities (the latter a surprise) will be subject to more complex BICE standards.
Why did the Department of Labor (DOL) issue this rule and not the Securities and Exchange Commission (SEC)?
It's complicated. The logical area would have been the SEC. However, the Dodd-Frank Act of 2010 did many things, two of which were 1) explicitly authorized the SEC to issue a fiduciary standard, and 2) motivated the DOL to expand the definition of fiduciary in the 1974 ERISA law to comply with the law. There was not agreement at the SEC if an additional regulatory oversight measure was necessary or what the true costs would be - to both advisors and investors. The DOL was more open to proceeding and had fewer roadblocks. The SEC may issue their own fiduciary ruling but it may not be consistent with the DOL given the different mandates. This also explains why the fiduciary rule only applies to retirement accounts - the accounts for which the DOL has oversight.
There are over 1,000 pages in the final ruling and more details will emerge over time. There will likely be court challenges to attempt to stop some measures from going through - so more to come. In the meantime, consider working with an advisor who works under the fiduciary standard today, for all your accounts.