DOL Fiduciary Rule

The DOL Fiduciary Rule is a newer rule that is scheduled for implementation between April 10, 2017 and January 1, 2018. DOL, also known as Department of Labor, set forth this new rule to expand the financial advisor fiduciary definition that can be found under the Employee Retirement Income Security Act of 1974 (ERISA).

The new rule will have a significant impact on financial advisors; however, the biggest impact will be on those financial professionals who receive commissions (i.e. insurance agents and brokers). This new law was first established under the Obama administration; however, in 2017, the Trump administration tried to postpone the implemental by six months. During this time period, the DOL has also attempted to postpone the implementation of the rule, while also having received a total of roughly 193,000 letters with 178,000 of those letters opposing delay of the rule. While the delay remains in effect, significant public comments have been received indicating that they feel as though the delay is politically motivated.

Definition of a Fiduciary

The DOL’s meaning of a fiduciary requires that financial advisors provide advice that is in the client’s best interests, and to ensure that clients’ interests are put ahead of their own. This definition provides that advisors cannot hide any potential conflicts of interest, and also indicates that any dues and commissions be disclosed fully to the client. The fiduciary definition also includes those advisors who are making a simple recommendation and not actually providing specific advice. “Fiduciary” is a higher standard than “suitability” standard, which was formerly obligatory of financial advisors. Suitability merely meant that if the specific type of investment being recommended to the client met his or her needs, then the recommendation was suitable. Therefore, it gave financial advisors’ leeway to persuade clients’ into believing that a specific investment was right for them, even if it wasn’t. With the term “fiduciary” however, financial professionals have a responsibility to put the best interests of the client ahead of their own as opposed to obtaining “suitable” investments for the client.

Financial advisors who plan to work on commission with be required to provide their clients with a disclosure contract known as the Best Interest Contract Exemption (BICE) if a potential conflict of interest exists, i.e. if the financial advisor receives an additional commission for selling a particular product. In addition, all money that the financial advisor will receive must be disclosed to the client; this means including specific numbers and percentages.

Types of Retirement Plans That are Covered

Defined-contribution plan

Defined benefit plan

  • Pension plans, which are plans in which the employer contributes to the account. There is generally a vesting requirement wherein the employee is required to remain with the company for a specific period time before being able to receive the funds. If the employee remains with the company until the pension plan vests, he or she will receive the funds upon retirement. 

Individual Retirement Account (IRA)

  • People can use pretax income towards investments that can grow tax-deferred; no capital gains or dividend income is taxed until it is withdrawn.

What Isn’t Covered Under the DOL Fiduciary Rule

  • If a client calls his or her financial advisor requesting to invest in a particular product.
  • Financial advisors can offer information to clients for educational purposes, including universal investment guidance based on the person’s age and income.  
  • Accounts that are taxed or those accounts with after-tax dollars in it.

Reaction to the Rule

It is obvious that rule changes were well overdue, considering ERISA rules hadn’t been changed for 40-years since its inception. In fact, many groups are in favor of this new rule. And of course all individuals who wish to use the assistance of a financial advisor are also in favor of this rule since it will protect them fully. This new rule will ultimately increase clarity for those wishing to invest and prevent financial advisors’ from receiving such high commissions. More specifically, a 2015 report by the White House Council of Economic Advisors identified that prejudiced advice depleted a total of $17 billion on an annual basis from retirement accounts.

To no surprise, many planners and brokers have opposed the new rule. Such professionals would prefer a lower suitability standard than the higher fiduciary standard because the higher standard will provide for reduced commission and added expenses for adhering to compliance requirements. In fact, the stricter standard could increase costs for the financial services industry to roughly $2.4 billion a year.

Many financial professionals believe that the increased standard would eliminate commissions altogether for them. If receiving significantly reduced commissions, they would be forced to shift certain fees onto clients, which would prevent any middle or lower-market investor clients. In fact, 3 separate legal proceedings have already been filed opposing the rule. One of the lawsuits was filed in the U.S. District Court for the Northern District of Texas in June 2016. The suit was initiated by the Securities Industry, the U.S. Chamber of Commerce, and Financial Markets Association, and the Financial Services Roundtable, and indicates that the Obama administration didn’t have the permission to take action in endorsing the rule.

Other critics to the rule actually believe that the rule will cause additional fraud on the part of financial advisors. They specifically state that the rule will require significant paperwork, which is an easy way to hide a scam and later indicate that the customer signed the paperwork.

Immediately following the DOL’s 60-day postponement of the rule, a “Retirement Ripoff Counter” was published by Senator Elizabeth Warren and AFL-CIO President Richard Trumka. The Ripoff Report specifically identified the costs of saving for retirement without the fiduciary rule.

Therefore, we can see that there are conflicting views regarding the implementation of the rule, which will continue in the foreseeable future, and will continue if another delay occurs.

Who Does it Affect?

The recent DOL fiduciary rule is expected to significant affect the financial services industry, particularly those operating in the broker-dealer area. In turn, compliance costs will also increase thereby affecting those financial organizations as a whole. The rule could also be difficult for those smaller broker dealers because they might not have the financial ability to invest in technology and compliance expertise as large firms would. Some smaller firms may even close or be bought out by larger firms due to the increased costs. American International Group and Metlife Inc. have been sold prior to the rule’s implementation. In addition, those financial advisors who sell 401(k) plans may be unable to operate in this area because of the new compliance requirements. Most importantly, the number of financial advisors may drop drastically, which is what happens in the UK after a similar rule was passed in 2011.

Annuity vendors will also be required to disclose commissions to clients, which would limit sales in this area. This would be a problem since annuity vendors generally offer high commission rates to financial advisors who sell these products

What Does it Mean for Consumers?

There are three main considerations for consumers to keep in mind regarding the new rule implementation: oversight, cost, and timing.

Oversight: The rule itself is designed to protect consumers receiving investment inside of a qualified retirement plan or IRA.

Cost: The new rule is aimed to protect consumer’s retirement funds so that the best investment products can be utilized. However, keep in mind that the new rule will likely reduce access to professional guidance and products. Further, since the financial advisor may need to shift costs to the consumer, a consumer may see additional fees and costs associated with receiving such advice.

Timing: The rule took effect in April 2017 with full implementation to be expected in January 2017. This gives consumers’ time to prepare before changes take place.

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