Putting Your Retirement Needs FirstMonday, April 11th, 2016
The rules related to how financial professionals manage the trillions of dollars they invest on behalf of Americans saving for retirement are about to get stronger. The impetus for the pending change comes from the Securities and Exchange Commission’s Study on Investment Advisers and Broker-Dealers, which was required by the 2010 Dodd-Frank Act.
The Department of Labor (DOL) has been fighting Wall Street and the insurance industry about whether these businesses should be subject to the fiduciary rather than the suitability standard for years. A study by the Council of Economic Advisers (CEA) estimated that conflicts of interest between broker-dealers and their clients cost Americans an estimated $17 billion annually. Importantly, the regulations only relate to retirement accounts and not to other managed assets. It has been estimated that there are currently $1.7 trillion worth of IRA assets in accounts managed by broker-dealers, and, therefore, not subject to the fiduciary standard.
The rules impose a “fiduciary standard” on brokers, requiring them to put their customers’ interests ahead of their own profits. This is different from current practices whereby only registered investment advisers apply a fiduciary standard when managing money. Brokers are required to apply merely a “suitability standard,” meaning they are only required to propose products that are appropriate for the saver, given his or her age, retirement goals, etc. This causes some broker-dealers to incentivize their advisers to steer clients into products that may have higher fees (and commissions) and, correspondingly, result in lower returns for their clients.
The CEA report estimated that a typical worker who receives advice that is not necessarily in her best interest when rolling over a 401(k) balance to an IRA at age 45 will lose an estimated 17% from her account over the next 20 years. For example, if a worker has $100,000 in retirement savings at age 45, without conflicted advice (subject to fiduciary standard) it would grow to $216,000 by age 65, adjusted for inflation. However, with conflicted advice (subject to suitability standard) it would grow to only $179,000, representing a loss of $37,000 or 17%. As a result, this past Wednesday the DOL issued new regulations that will require financial advisers and brokers that manage individual retirement and 401(k) accounts to act in their clients’ best interests.
The intent of the new rules is to ensure that retirement savers receive investment advice that is in their own best interests, allowing them to better grow their nest eggs and leave them better more prepared for retirement. These rules should also level the playing field for those advisers who had already been following the fiduciary rule. As a result, retirement advisers should be able to compete on the quality of advice they give.
Unfortunately, the rules do not go as far as they could have. For example, they include certain exemptions that will allow firms to accept common types of compensation – like commissions and revenue sharing payments – if they commit to putting their clients’ best interests first (creating a “Best Interests Contract” or BIC). They also require broker-dealers to direct customers to a webpage disclosing the firm’s compensation arrangements and make customers aware of their right to review complete information on the fees charged. Existing investments may also be exempted under the BIC.
To provide firms with more time to come into compliance, the final rule and exemptions take a “phased” implementation approach. One year after the rule’s publication, in April 2017, the broader definition of fiduciary will take effect, but to take advantage of the BIC exemption, broker-dealer firms will be subject to more limited conditions, including acknowledging their fiduciary status, adhering to the best interest standard and making disclosures of conflicts of interest. The full requirements of the exemption will go into full effect on January 1, 2018.
It is expected that the new rules will require many advisers to change their business models; others may be pushed entirely out of business. Readers should know that as a Fee-Only Registered Investment Adviser, BWFA is already following the fiduciary standard. Fee-Only advisers hold a smaller, but growing share of the market (estimated to increase from about 19% today to 25% of the market by 2018).
We are pleased to see that this fiduciary standard will be extended to broker-dealers, if only as far as it applies to retirement assets. At the same time, we would have liked to see the playing field fully leveled, meaning the rules should be applicable to all advisers uniformly rather than only to certain types of managed assets.