As the Department of Labor phases in its new fiduciary rule, advisors operating in the retirement arena will be facing twin challenges to their practices: (1) a compression and overall reduction in commissions paid on product sales; and (2) an increase in DOL-related compliance costs. Keeping these changes to a manageable minimum may well depend on business partners — insurers, broker-dealers and independent marketing organizations — from whom they’ll be sourcing product.
One IMO that’s endeavoring to provide a seamless transition to a post-fiduciary regime is a Futurity First Financial Corp., one of six (out of more than 350) IMOs that have applied to become a financial institution with the DOL’s Office of Exemption Determinations. To learn more about preparations underway at the company to prepare for the phase-in, and what the internal changes will mean for its 4,000-plus advisors, LifeHealthPro interviewed Futurity First President and CEO Michael Kalen. The following are excerpts from this 3rd conversation in a series of Q&As with IMO executives and stakeholders on the DOL application process.
LifeHealthPro: When did you initiate your application? What was involved?
Michael Kalen: We submitted our application after meeting with DOL staffers in late June. During a two-hour meeting, they outlined their thoughts, took our questions, and allowed us to submit a thoughtful application, which we filed in mid-July.
We’re generally in favor of regulatory changes that help customers get better financial advice. In respect to the DOL fiduciary rule, the devil will be in details — how the BICE regulations will be implemented so as to allow everyone to do business on an efficient basis.
The DOL is now working actively to publish clarified regulations that provide a path for IMOs to become financial institutions. To that end, they’ve taken input from us and other IMOs that have applied. There's nothing else for us to do until they issue these clarified guidelines.
LHP: Will Futurity First have to make changes internally to satisfy the DOL's requirements to qualify as a financial institution?
Kalen: If the clarified guidelines are published in the way we think they'll be, we will have to make substantial changes to our operations.
We expect, first, that we’ll have to create a suitability desk for acting in a fiduciary capacity, accepting compensation that meets the new guidelines and making product recommendations to clients. The desk will be charged with training advisors and reviewing cases to ensure that everyone is complying with both the spirit and letter of the new regulations.
We're bucketing our DOL platform into two parts: (1) the full BICE contractual requirements for any advisor taking a commission; and (2) so-called BICE lite requirements for advisors charging a fee. Most of our work will be around the full BICE requirements, including guidelines establishing what constitutes reasonable compensation and commission schedules that don’t favor one product over another.
LHP: At last June’s Million Dollar Round Table, Valmark Securities CEO Larry Rybka referred to the four options for complying with the DOL rule as “4 doors ” — including the BIC, full BIC exemption and BICE Lite — plus one concerning the sale of proprietary products. Will your platform provide for this last ‘door’?
Kalen (pictured at right): We see a problem with this 4th door, as proprietary products would have a dramatically different compensation structure. We don't see an easy, viable path to compliance, but if there is one, we'll accommodate that door.
LHP: What other internal compliance changes will the fiduciary rule entail in terms of additional processes, staff time or other resources?
Kalen: We’ll be setting up a senior policy committee composed of top executive at the company to ensure that all processes meet the fiduciary standard. We think it's very important that senior management be held accountable for compliance with the rule.
We’ll also be establishing contractual relationships with advisors. We view this as a very positive development, as it will solidify our relationship as a financial institution with our producers.
We’ll additionally be implementing risk mitigation measures, as we're clearly concerned about the unlimited legal liability under the rule's private right of action provisions, as well as vagueness about what constitutes reasonable compensation. These measures include purchasing errors and omissions or E&O insurance, plus the drafting of disclosures and other compliance-related documentation that will be key to implementation. We're still sorting through the costs of all this.
LHP: Do you have a sense as to how much the compliance measures will cost?
Kalen: We've set aside a projected budget of $1 million to build out the compliance platform. We’re also budgeting for annual operating costs between $1 million and $1.5 million. We'll need to pass some of these costs on to our advisors in the form of a platform fee, one similar to what broker-dealers charge their advisors.
Our goal is to create as efficient a system as possible so we don't place undue financial burdens on our advisors. The platform will consist of three buckets, about half of which will comprise additional staff costs; the remainder will include technology, E&O coverage and risk mitigation steps, plus travel and training costs.
We'll need to educate agents and advisors in how to operate under the fiduciary rule. We candidly feel that the majority of our producers meet the DOL's guidelines today. But the rule will definitely change their business model, so additional training is a must.
Respecting the technology component, we envision adopting a mix of proprietary and off-the-shelf, third-party software. As to staffing, we already have a full-time compliance officer — a trained securities attorney. Going forward, we'll also be consulting with outside experts on certain parts of the compliance process.
LHP: What is it about the company's business model that makes it well-suited to a fiduciary standard of care?
Kalen: Our IMO is one of the largest in the U.S., thanks in part to acquisitions we’ve made in recent years; we believe that it takes scale and talent to thrive in a post-fiduciary world. We also have a well-rounded senior management team, a board of directors and a governance structure well-suited to the DOL rule. Not least, we enjoy very good relationships with our carrier partners and participate on their advisory boards.
LHP: How many producers are now affiliated with Futurity First? Can you also speak about your distribution strategy?
Kalen: Some 4,000 producing agents and advisors do business with us, so we're a fairly large IMO. These producers occupy one of three channels: an independent agent channel, a partner agent channel, and a broker-dealer channel. Our independent agents work directly with us. Many of them are insurance-only producers; others are series 65-licensed. This channel is a critical part of our business.
As to partner agencies, we work with some 100 other IMOs, many of which will depend on our DOL platform once the DOL has approved it so they can continue to operate in the retirement space. We will also be providing fixed product solutions to broker-dealers and banks that we distribute products through.
LHP: Do you envision any changes to your current distribution strategy in the wake of the DOL rule?
Kalen: We anticipate a large shake-out within the various distribution channels. All of the channels will still be viable, but the requirements will be different for each.
What we're concerned about is having enough time to build the necessary structure to meet the DOL's April 2017 implementation deadline. Advisors, for their part, will need to decide whether they’re prepared to adapt to the new regulations.
We think that if we can provide good training and an easy-to-use platform, many producers will be able to make the transition. The problem is they don't yet know what the transition will entail. So there remains a lot of uncertainty.
Also, many agents are affiliated with an IMO that may not become a financial institution under the rule. To continue to sell retirement investment products, they’ll need to look for a new home with a DOL-approved IMO. These IMOs stand to gain market share once the fiduciary rule is fully implemented.
LHP: Turning to legal risk, do you expect that your IMO, as a financial institution, will shoulder the larger part of exposure to class action lawsuits alleging violations of the DOL rule? Will advisors themselves bear part of this exposure?
Kalen: Everyone in distribution, both IMOs and advisors, will have to share responsibility for the legal risk, and therefore have to be protected with errors and omissions coverage. There will also have to be an increase of documentation of sales recommendations. Again, one item in our 5-point strategy is about mitigating the liability flowing from the new regulations.
LHP: Should advisors also expect reduced and/or more standardized commissions in the wake of the DOL rule?
Kalen: There will be a spectrum of compensation arrangements based both on the complexity of the products and the services provided by advisors. We do expect that commissions will be standardized within product classes. More complicated products will have a higher compensation structure than simpler offerings.
As IMOs, brokers-dealers, insurers and other financial institutions establish commissions schedules they deem to be reasonable, we also expect a modest reduction of total compensation. Carrier incentives to promote their products versus those of competitors will notably become a thing of the past.
It will be interesting to see how this all shakes out. We're hoping there won’t be a race to the bottom commission-wise. That would be harmful to advisors trying to support their practices and, ultimately, the industry.