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February 24, 2016 at 12:00 AM
For months, advisors have been watching the slow progress of the Department of Labor’s (DOL) fiduciary rule and attempting to understand the potential effects that its expected adoption will bring. Experts say that the rule will be approved soon and many of the changes will be implemented by year’s end, which has sent ripples of concern through advisor ranks.
The DOL stated its intent to expand fiduciary provisions last year: “In the retail IRA marketplace, growing consumer demand for personalized advice, together with competition from online discount brokerage firms, has pushed brokers to offer more comprehensive guidance services rather than just transaction support. Unfortunately, their traditional compensation sources – such as brokerage commissions, revenue shared by mutual funds and funds’ asset managers, and mark-ups on bonds sold from their own inventory – can introduce acute conflicts of interest.”
The DOL’s current proposal expands the application of fiduciary protections for retirement plans to cover individual retirement accounts. Financial advisors would face strict compensation restrictions unless they commit contractually to key provisions such as putting their clients’ interests first, limiting investment choices and subjecting themselves to class-action lawsuits. The rule also calls for disclosure of compensation and conflicts of interest.
So how will advisors adapt? Bloomberg Intelligence Washington analyst Dan Barry says one option is to serve as a fiduciary under ERISA, which in essence eliminates the conflict-of-interest problem. But advisors likely would not be able to charge variable commissions under this scenario and would have to resort instead to charging a flat fee, an hourly fee or a percentage of AUM.
The other option is that advisors shed the ERISA fiduciary cloak and work under what the DOL is calling a “best interests contract” (BIC), which seeks to establish “reasonable” compensation between advisor and client and ensures that fees and conflicts are disclosed. “Under the contract, they must put clients’ interests first and warrant that they have policies to mitigate conflicts of interest. The rule would also expose firms to class-action lawsuits,” Barry says.
If this is starting to sound confusing, there is one absolute: The DOL estimates industry compliance costs related to this new rule will total from $2.4 billion to $5.7 billion over 10 years, which means firms will have to absorb the increased costs or pass them on to customers.
The rule is likely to bring changes on many other fronts as well, including overhauling compensation and compliance practices for retirement accounts. Barry says that firms will take an administrative and financial hit with the rule. “AIG, Prudential Financial, MetLife and other retirement-account advisers will see higher compliance and legal costs under this proposal,” he says. “Generally, to continue commission-based compensation, advisory firms would need to enter into BIC that makes clients’ interests paramount and only ‘reasonable’ compensation would be allowed.”
