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New World Order: How Advisors Prepare for the Final Fiduciary Rule

New World Order: How Advisors Prepare for the Final Fiduciary Rule

July 7, 2016
 

It’s finally here. After months (some would say years) of speculation, the Department of Labor (DOL) issued its final iteration of the fiduciary rule, which aims to ensure clients’ financial needs are put first. Though it’s been long in the making, experts are responding to how the changes will affect financial advisors in general – and 401(k) advisors in particular. The consensus? Opportunity for those advisors who do it right.

Some aspects of the rule surprised those who feel the final rule has emerged with less “teeth” than expected, including a longer timeline for implementation, giving advisors until Jan. 1, 2018 to comply.

The DOL rule requires “all who provide retirement investment advice to plans and IRAs to abide by a ‘fiduciary’ standard — putting their clients’ best interest before their own profits.” The result, in effect, presents a financial advisor with two paths: serve as a fiduciary under the Employee Retirement Income Security Act (ERISA); or commit to what the DOL calls a “Best Interests Contract Exemption” (BICE), which puts the client’s best interests first.

The final rule appears more flexible than expected on how and when the BIC is to be implemented – though once it is executed, it will apply retroactively to any advice given to date. Or, as the DOL states (bold emphasis added):

Advisers can usually prove they have acted in their clients’ best interest by documenting their use of a reasonable process and adherence to professional standards in deciding to make the recommendation and determining it was in the customer’s best interest, and by documenting their compliance with the financial institution’s policies and procedures required by the Best Interest Contract Exemption. This helps retirement savers get best interest financial advice while leaving the adviser and financial institution the flexibility and discretion necessary to determine how best to satisfy the exemption’s standards in light of the unique attributes of their business.

Industry expert Michael Kitces, CFP, believes that while the DOL Fiduciary Rule will be “overwhelmingly good for consumers,” there may be myriad unintended consequences from some of its key provisions, such as the BIC exemption.

“Brokerage firms will be at a crossroads, trying to find ways to comply or escape the BIC’s scope,” he says. “And it’s very possible that they will move away from retirement accounts altogether and simply focus on taxable accounts or other services.”

Kitces also sees the potential for a major overhaul to the compensation model.

“At best, upfront commissions will be dialed back and compensation will be more ‘levelized,’ which isn’t necessarily bad for the long run,” he notes. “I’d be looking at shifting clients now so you have a base of recurring fee or trail revenue in place. Then it won’t be such a dramatic compensation shift in a year or two when the rule is fully in effect.”

Don Trone, founder and CEO of 3ethos and widely seen as a fiduciary “watchdog,” still feels that the DOL proposal defines the “floor of the standard of care that should be seen as the minimum requirement for advisors in the retirement industry.”

Additionally, he says the rule may “create some levels of confusion of exactly what is required of the advisor. While it addresses fees, expenses and disclosure of conflicts of interest, it ignores other key components such as risk questionnaires, appropriate asset allocation, investment statements, etc.”

Advisors will have to handle the rule’s administrative aspects, but the effects are subjective, according to Trone.

“Advisors will have to manage how they conduct their business to ensure they are in compliance with the new rule,” the time and energy of which will result in a “cumulative drain” on practice management. He says that in order to prepare, advisors should ensure all their clients meet the highest level of fiduciary standards.

“Now is the time,” he warns. “Otherwise, you will be out of compliance very quickly.”

Kitces has cautioned that the rule is more of a threat for the broker/dealer firm than advisors.

“Broker/dealers are in an existential crisis for survival,” Kitces says. “They exist to facilitate the sale of a security for a commission. So under the new rule, advisors will sell more advice services for a fee, and fewer products for a commission. At the extreme, this eliminates the need for a broker/dealer entirely – they become irrelevant in the process.”

Both Kitces and Trone feel that the rule is a reckoning for the financial advisory industry.

“Brokerages in particular brought [the rule changes] on themselves by assuming the term of ‘advisor,’ but not living up to the obligations of being an advisor,” says Kitces. “They are getting their comeuppance.”

“It’s put the fear of God into everyone,” Trone concludes. “Every single financial services organization is revisiting its products and services to see how they measure up to fiduciary standard. This rule will bring about an industry cleansing, which is generally a good thing.”


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