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Industry Spotlight > Broker Dealers

Locking horns over the fiduciary standard

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With the Department of Labor and Securities and Exchange Commission creeping ever-closer to unveiling their proposed changes to the fiduciary standard, there’s little doubt that regulators are about to unleash big changes on stock brokers and insurance agents.

The very meaning of “investment advice” for retail investors may be fundamentally altered in what promises to be a watershed moment.

While the details remain unknown, all signs point toward rules mandating greater transparency and responsibility on the part of securities brokers who work with IRAs and 401(k) plans. They’d be held to the same standard as investment advisors.

Any number of new restrictions might emerge including one preventing firms from paying their brokers or agents more for selling in-house products.

Both the DOL and SEC have received lots of pushback on their plans to amend the definition of fiduciary. The DOL’s version was expected next month but officials this week said that was no longer likely.

Regardless, the most notable complaints: that a fiduciary standard would force brokers to abandon millions of potential customers that they could otherwise serve under current, more lenient standards. And, not surprisingly, that a new standard would cost brokers the ability to earn commissions on IRA advice.

Fiduciaries, of course, must serve the client’s best interests, acting in good faith and prudently with the knowledge and judgment of an investment professional. They must also avoid conflicts of interest and disclose any facts that are material to their relationship with their clients, and they need to work to rein in costs and avoid unnecessary expenses.

Here’s a closer look at the issue, and what those in the industry might want to think about as they prepare for a new day.

The problem

While brokers and advisors operate under different standards, they both offer clients investment advice. Regulators want a common fiduciary standard for those who provide personalized investment advice to retail clients.

The Department of Labor’s proposed fiduciary rule would make it so broker-dealers, who work with IRA customers, would have to follow the same fiduciary standard as registered investment advisors who work within the 401(k) retirement market. That means that if someone is giving investors advice on which investments to make, they need to give it in the best interest of their clients, or disclose that they are receiving a commission to recommend certain investments.

Broker-dealers, banks and insurance companies want to be exempt from the new rules.

Related story: Brokers willing to pay up for fiduciary standard: SIFMA

In part, they say, that’s because they worry that lower-income clients would no longer have access to financial advice after their 401(k) accounts are rolled over into an IRA because IRAs traditionally charge more in administration fees than defined contribution plans.

“We know that the small investors who make up 98 percent of all IRA investors will simply not be able to afford the fees required under a fiduciary account,” said Lee Covington, senior vice president and general counsel for the Insured Retirement Institute. “They like working with their advisor on a commission basis and would have to move to a no-frills, no-education, no-assistance type of account.

“Investors see value in working with a financial professional,” he added. “We see investors engage in healthier savings behaviors when they are working with a financial professional. Cutting that off is extremely detrimental to the client and the financial professional.”

That may be, but critics believe there’s too much ambiguity under existing SEC rules, creating the potential for investors to be misled.   

Broker-dealers and others are already required to recommend suitable products for their clients to invest in, but the big debate has been, what qualifies as suitable?

Brokers, who sometimes call themselves advisors, receive commissions for the products they sell. Under current suitability rules, a broker could recommend that a client invest in an S&P Index Fund. Based on the client’s age and expected retirement date, that can be a perfectly acceptable investment. The problem is that the broker may be receiving a commission to pitch one fund over another and the one they are pitching could be 40 basis points more expensive than the Vanguard S&P Index Fund, said Lee Topley, managing director of the retirement plan consulting group at Unified Trust Co.

In other words, most people wouldn’t know that the investment that was chosen for them was picked not because it was in their best interest but because the person selling it to them had a stake in the game.

The SEC has been trying to close that loophole since the 2010 Dodd-Frank Act authorized the agency to impose a fiduciary standard on brokers.

Topley, for one, believes that anyone acting in an advisory capacity, be it as a registered investment advisor or broker-dealer serving IRAs, needs to be transparent about the fees they are charging or any commissions they are earning to recommend certain investment products.

“A lot of participants are rolling their retirement accounts into IRAs, but the proper disclosure of fees and what they are paying in those IRAs is not understandable,” Topley said. “There’s not the same level of requirement about what fees are being paid and what the advisor is making off that retirement plan space.”

Topley believes the Department of Labor proposal is largely driven by the fear that people are being taken advantage of when their money is rolled into an IRA. Defined contribution plan participants are accustomed to the idea that plan sponsors and financial advisors are fiduciaries and acting in their best interest. They may not know the difference between a commission-earning broker-dealer and an ERISA advisor.

No reason for despair

Before the rules take effect, advisory firms should decide which side of the fence they want to be on and start educating themselves about how to move forward once the rules are in place.

The Wagner Law Group recommends that broker-dealers should dual register as a registered investment advisor and charge level, asset-based fees.  Doing this would eliminate any prohibited conflicts of interest.

Broker-dealers, of course, could preserve their non-fiduciary status by telling clients their investment advice isn’t impartial. That obviously might have a chilling effect on client relationship.

Advisors who are not well-versed in the fiduciary rules will suffer most, Topley predicted.

“They are not educated and informed. That is not where they built their business. It is not their expertise,” he said.

Does he believe that some of these broker-dealers can learn the market and move into the fiduciary space? Absolutely. Advisors who have a solid understanding of the business and make it a core component of what they do will be attractive to plan sponsors, he said.

Skip Schweiss, president of TD Ameritrade Trust Co. and managing director of advisor advocacy for TD Ameritrade Institutional, believes there is room in the marketplace for both the broker and advisory models; those in the business just need to make the distinction between the two more clear.

Advisors need to start thinking about how they can differentiate themselves and their services from other advisors and brokers in the marketplace. If everyone is a fiduciary, then the registered investment advisor’s primary selling point is suddenly gone in terms of distinction, Schweiss said.

He recommends that everyone familiarize themselves with the fiduciary proposals. If they don’t have the time to get up-to-date, they should partner with a larger company that has the resources necessary to stay apprised of the latest regulatory happenings.

He believes advisors need to work on their branding and value propositions immediately.

“A lot of them have had great success during the past 10 to 20 years with the fiduciary distinction they carry vis-à-vis the broker down the street, but via regulation, that could go away,” Schweiss said. “Rethink that now. It is not something you could change overnight. I encourage advisors to spend head time on that and to hire marketing and branding consultants to help them with that.”

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