In its first comment letter to the Labor Department on the substance of the agency’s fiduciary rule, Morningstar explains its support for the rule but offers an alternative to the Best Interest Contract Exemption (BICE) and enforcement by way of class action lawsuits.
The letter responds to the latest request from the Department for public comment on the rule, whose implementation has been delayed for 60 days, until June 9.
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The agency is seeking comment on issues raised by a presidential memorandum including whether the rule will reduce access to certain retirement savings offerings and advice, disrupt the retirement services industry in ways that could hurt investors and retirees, or increase litigation and the prices investors and retirees pay for retirement services. The comment period ends Monday, April 17.
“The early evidence suggests the rule will be positive for ordinary retirement investors,” writes Aron Szapiro, director of policy research at Morningstar and author of the firm’s comment letter to the DOL.
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Among the benefits for investors, according to Morningstar, are:
- Lower costs for wealth management as firms move from a commission-based to fee-based model, which reduce potential conflicts of interest for advisors
- Cheaper investment products as mutual funds add new share classes such as T shares, which typically cost half the price of current load fund shares, and as advisors focus more on low-cost ETFs and index funds and less on more expensive actively managed funds
- More digital advice solutions, which fill “the gap between no-frills discount brokerages and full-service wealth managers”
Morningstar refutes the argument that the rule will shortchange small investors because fee-based advisors will deem their assets to be too small to be worth their time. Instead, it anticipates that those investors will receive advice through a digital channel from their current advisory firm or a different one.
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An estimated $250 billion to $600 billion of assets could eventually shift from full-service wealth management firms to robo or hybrid advisors, which use both digital and human advice, according to Morningstar.
One of the more controversial components of the DOL rule is the Best Interest Contract Exemption, which allows firms to continue to offer commission products in retirement accounts as well as other services, such as IRA rollover advice, so long as the firm and investor sign the contract. Violations of the contract would be subject to class action lawsuits that, according to Morningstar, could cost the industry $70 million to $150 million annually, increasing compliance costs 5% to 10% or more.
Morningstar offers an alternative to the BICE that it argues could provide “more even treatment” of violations of the fiduciary rule than a class action lawsuit.
It proposes a “big data system” provided by a neutral third party that reviews individual portfolios for providing “best interest standard of advice,” identifying problems and fixes. Every investor’s account would be scored to identify those that don’t conform to an investor’s needs for investment quality, portfolio fit and planning value.
“Such systems would replace the likely or potentially skewed samples used in lawsuits or standard audits, which sample a subset of accounts,” according to the Morningstar letter.
Beginning after Monday’s deadline, the Labor Department will review the latest comments on the fiduciary rule and if, according to the president’s memorandum, it concludes the rule is “inconsistent” with empowering Americans to make their own financial decisions, or negatively impacts their ability to save for retirement or finance “typical expenses such as buying a home, paying for college” or withstanding emergencies, it can rescind or review the rule “as appropriate and as consistent with law.”
If the department decides to rescind the rule, Szapiro expects asset innovations such as mutual fund T shares and clean shares — they carry no fees in addition to the advisor's fee — will no longer be available.
It’s still unknown what the department will decide about the fiduciary rule, but after the last public comment period about a 60-day delay period ended with 92% opposing the delay (178,000 out of 193,000 comments), the agency chose to postpone it anyway, until it had received and reviewed comments on the president’s set of questions.
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