The brokerage industry is disgruntled – not to mention confused and jittery – about the Department of Labor’s pending rule requiring FAs who advise on employee-sponsored and IRA retirement plans to abide by a fiduciary standard. The controversial regulation is likely to become a fact of life as soon as early April and implemented in September or October.
Rollovers will be subject to the most rigorous changes, Lou Harvey, president and founder of Dalbar, the Boston-based financial services market research company that evaluates firms and practices, told ThinkAdvisor, in an interview shedding light on the DOL rule. Dalbar conducts studies on service quality and regulatory compliance and does annual research into investor behavior.
“Success in the rollover market will almost certainly require BICE,” Harvey stresses, alluding to the DOL rule’s Best Interest Contract Exemption, which requires advisors to sign contracts with clients that indicate potential conflicts of interests concerning recommended investments.
The BICE allows advisors to retain commissions as well as 12b-1 fees, revenue-sharing agreements and noncash incentives, among other compensation, but it must include disclosures of all indirect compensation.
Violating the BICE will mean damaging lawsuits against FAs and their firms, Harvey says. Regulators anticipate that “one or two of every advisor’s clients will take the advisor to court if he/she fails to live up to the contract terms,” he writes.
How to avoid BICE? Give no advice or else forfeit traditional means of compensation. Only if advisors promise or imply to provide advice must they execute a BICE contract.
Under the rule, advisors must show written proof that their recommendations were in the client’s best interest by keeping extensive records relating to their clientele’s personal circumstances. Obtaining this information will necessitate a substantial discovery process, much more thorough than typical current efforts.
Dalbar, which is offering BICE self-study courses on the complexities of and systems for complying with the DOL rule, is conducting beta tests on an automated, cost-reducing discovery system.
The estimated cost for BICE compliance is between $600 and $1,500 per client annually, according to Harvey. So for an advisor with, say, 300 clients, that could total as much as $450,000 a year.
Who will foot this cost? Clients, says Harvey, president of the independent Fiduciary Standards Board, which focuses on expanding use of the fiduciary standard. Dalbar offers the Registered Fiduciary Certification, a non-mandatory designation that prepares FAs to comply with regulatory fiduciary requirements.
ThinkAdvisor chatted recently with Harvey, who is based in Boston. He sees the DOL rule as “a new engine for business growth,” especially for advisors who use the fiduciary standard across the board rather than limiting it to Employee Retirement Income Security Act (ERISA) plans and IRAs. Here are highlights of our conversation:
THINKADVISOR: Under the DOL rule, what are advisors’ options?
LOUIS HARVEY: The basic choice is whether financial advice will remain a core part of their business. One level is to become a fiduciary under the Employee Retirement Income Security Act [ERISA] without conflict. The second is being an ERISA fiduciary where the conflict of interest exists but is neutralized through the best interest contract exemption (BICE). The third option – and minimum standard – is pure educator, a Series 7 broker delivering no advice, in which case, you can’t say you’re an “advisor.” You can just educate customers and put things on the table for them to buy. What are some of the required disclosures on the BICE contract?
Potential conflicts of interest and indirect compensation, such as 12b-1s, the payments that mutual fund managers make to advisors for selling their product.
Results of an Eaton Vance survey of 1,000 FAs, released last month, show that 71% of FAs don’t understand the DOL rule. Only twenty-nine percent say they fully understand it.
Seventy-one percent is too low: I’ve not come across a financial advisor who has in-depth knowledge of even the [basics]. The folks who say they understand it still have more to learn.
How will the DOL rule phase in?
The first stage of the conversion is insuring that new business meets the requirements. So there’s a provision that forgives your past sins! That is, you don’t have to go back and fix every client account and move them all to BICE [if that’s the option you’ve chosen] on Day One.
But you still have to do so later?
Yes, if you want to continue earning money from them.
What’s the biggest change for advisors as a result of this rule?
Opposition has run in a number of ways. For instance, nothing is going to change or advisors will no longer be able to handle small accounts. That’s just an excuse and an unreasonable assumption. There’s no way that the investment community will sweep half their accounts out the door because they’re no longer profitable. Certainly, that’s one of the [industry’s] objections that caused rejection of its objection to the rule.
What will be impacted the most?
Rollovers, potentially the largest growth area. The conflict-of-interest portion of the regulation says if you recommend that a client move their money out of a 401(k) plan, that that is a fiduciary act. Therefore, you must prove it was in the client’s best interest. You have the burden of offering concrete proof.
It gets really tricky; for example, when the investment in the plan outperforms the rollover and the client says, “You moved me out of that plan and put me in this leveraged investment, and I lost my shirt!”
You say that the rule can increase an FA’s business. How so?
Advisors that adopt these standards fully will take away business from those that choose not to and hide in the corner. The advisors that will win business are the ones who go out and pound the pavement, telling clients, “I’m going to be acting in your best interest, and I’m asking you to consolidate your assets with me. Bring me your business because you can trust me.”
How can the rule help commission-based advisors?
It can certainly help them leverage their business. If you tell your clients, “I’m acting in your best interest, and I’m here to help you,” that’s a competitive advantage. If an [entire] account is under the client’s-best-interest standard of care and you’re selling against someone who’s limiting a best-interest arrangement to IRA accounts only, you have the advantage.
This regulation is intended to produce better investment recommendations. But who will pay for all the additional requirements?