The Department of Labor’s rule to amend the definition of fiduciary on retirement accounts will cost the financial services industry close to $3.9 billion to implement — nearly 20 times DOL estimates — with projected startup costs of $1.1 million to $16.3 million per firm, depending on firm size, according to a just-released study commissioned by the Financial Services Institute.
The report, “Economic Consequences of the U.S. Department of Labor’s Proposed New Fiduciary Standard,” conducted with Oxford Economics, provides a “close reading and critique” of the DOL’s Regulatory Impact Analysis on its rule proposal.
The study also suggests that if the rule is implemented, only high-net-worth investors will be able to afford professional retirement investment advice.
FSI is a lobby group for independent broker-dealers.
The report predicts dire consequences for broker-dealers and small investors if the rule is implemented. For instance, the report says that industry consolidation will ensue, which will likely force smaller broker-dealers out of business.
Also, BDs and investment advisors would be “forced to either substantially change their current business models or navigate the challenging demands of a new best interest contract exemption (BICE).”
The rule would also result in less access to advice from advisors for small and medium-sized investors.
“This study shows that the DOL’s proposed fiduciary rule would be costly and burdensome to both the independent financial services industry and the investors that rely on the critical advice they receive,” said Dale Brown, FSI’s president and CEO, in a statement. “It also illustrates the unintended consequences the rule will have on hardworking Americans trying to save for retirement, particularly low and moderate-income investors who need advice the most.”
One unintended consequence, the report states, “may be that it will become harder for minority investors with small asset holdings to seek advice from financial advisors.”
But Kate McBride, chair of The Committee for the Fiduciary Standard, says that registered investment advisory firms "are already serving retirement plans and retirement investors as fiduciaries, in the best interests of the investors, across all account sizes, in retirement and non-retirement accounts."
Data from Great Britain, which McBride notes required "much more strict rules on advice years ago," show how the UK transition to no commissions is going. The report states that regarding the availability of advice for investors: "No significant reduction in availability of advice" and "most advisors still willing/able to take on new clients"; and the "average revenues and profitability of firms increased."
The report notes that DOL estimates firm costs imposed by the proposed rules on RIAs and plan sponsors will be only $1,000-$10,000 per year, even for large firms. However, DOL’s calculations “admit that the burden on BDs will be much larger.”
Unexpected costs will come from BICE, the report contends.
Under the DOL’s proposal, any transaction in which an advisor, or his or her firm, has a conflict of interest (i.e., would receive more compensation if the investor were to make the transaction) would be labeled a Prohibited Transaction, the report explains.
Essentially, BICE would require the advisor and the client “to enter into a contract where the advisor promises to act in the undefined ‘best interest’ of the client (including vague provisions like not receiving ‘excessive’ compensation),” the report states. “Importantly, these contracts would be enforceable through state contract law courts, opening the door to unforeseeable litigation costs.”
Making use of the BICE would also impose myriad other duties on firms, including recordkeeping and reporting requirements and forecasting investors’ cost burden over the following decade, the report argues.
In its regulatory impact analysis, Labor “never explains precisely what firms would have to do to comply with the rule. This, coupled with the Department’s creation of a new enforcement mechanism through the state courts has generated a great deal of concern.”
The proposed rule, the report argues, envisions two paths for firms: “either shift their business practices entirely to avoid any material conflicts, or bear the heavy costs of implementing BICE contracts.”
Avoiding prohibited transactions “would seem to require those firms currently operating (any part of their retirement business) under a commission structure, in which customers pay per transaction performed, to shift entirely to a fee-based compensation system, in which customers pay a fixed amount based on their assets under management,” the report states.
“It is not clear that this shift is truly in the interest of small investors even if all commission-based transactions were eliminated other firm-level conflicts would remain because of the prevalence of payments received by BDs from vendors and other product providers.”
Eliminating these payments, the report continues, “would substantially reduce the ability of BDs to fund the supervisory, training and compliance functions needed to maintain integrity in the market. Ultimately this would either restrict asset choice or raise costs to retirement account investors as firms trim their catalogs to ease compliance burdens.”
The report notes that many of the firms interviewed for the study, especially in the “independent market,” have “unavoidable conflicts relating to certain classes of assets that they sell directly from originators, especially insurance and annuity products.”
Says the report: “In many cases, these products are a core differentiator of a BD firm from its competitors, and reflect a core piece of the BD’s business, that can also involve managing clients’ other retirement, and possibly nonretirement, savings. These assets are sold today by different firms both under suitability and under existing fiduciary standards. However, they appear to be fundamentally incompatible with the Department’s proposed new fiduciary standard, and under that regime, their sale would require a BICE.”
--- Check out Don Trone Blasts DOL Fiduciary Plan: Still Wouldn’t Stop Madoff on ThinkAdvisor.