With the ink still fresh on the Department of Labor’s finalized fiduciary standard for investment professionals who advise on retirement plan accounts, an industry-wide debate has begun as to whether the DOL made enough changes to its earlier draft to mollify industry concerns.
The initial assessment: The DOL proved responsive on the margins, streamlining, clarifying and postponing rules changes that advisors and insurers earlier deemed onerous. But the finalized fiduciary standard leaves the core of the new fiduciary requirements intact. The result will be changes to producer compensation, product portfolios and compliance costs that will prove transformative to the industry.
Delving into the verbiage
The DOL rule requires that advisors put their client’s best interest first by providing impartial retirement plan advice. To receive commissions on product sales, they must qualify for a best interest contract exemption or BICE. That means inking a contract with clients that: (1) commits them to providing advice in the client’s best interest; (2) warrants that the firm has adopted practices and procedures designed to mitigate potential conflicts of interest when providing advice.
The proposal also calls on brokers to “clearly and prominently” disclose conflicts of interest, including hidden fees buried in the fine print or backdoor payments. Brokers must also direct the clients to a webpage disclosing their compensation arrangements; and communicate that clients are entitled to complete information on the fees they charge.
In a departure from the earlier draft, the finalized rule does provide some relief for retirement plan advisors. The DOL lengthened, for example, the compliance timeline under the rule to one year from the original 8 months.
The final rule and exemptions adopt a “phased” implementation approach. One year after the rule’s publication, in April 2017, the “broader definition of fiduciary will take effect, but to take advantage of the BIC exemption, firms will only be required to comply with more limited conditions, including acknowledging their fiduciary status, adhering to the best interest standard, and making basic disclosures of conflicts of interest,” the DOL states in a fact sheet, released Tuesday, detailing some of the final rule’s changes.
During a press briefing, DOL Secretary Perez cited other changes the department made to streamline and clarify its conflict of interest rule. Among them: alerting existing clients to the new contract requirements by sending a “simple email” or letter in lieu of a contract.
The industry responds
The softening of the DOL’s earlier draft language met with approval from some industry associations. Among them: the National Association of Insurance and Financial Advisors. In a press statement, NAIFA said it was “pleased” that the DOL had incorporated the organizations’ suggestions respecting the effective date of the rule, grandfathering of existing clients, and time as to when signature on best interest contracts is expected. But NAIFA remains concerned about the rule’s long-term implications, both for advisors and their clients.
“We remain cautious, and it remains to be seen, how the practical application of the rule will affect middle-market consumers who need retirement planning advice and services,” NAIFA states. “NAIFA is in the process of completing an in-depth analysis of the rule and will continue to provide training and education to help our members deal with the rule’s new requirements and restrictions. We will educate our members and use our grassroots advocacy strength to push for legislation that would best serve consumers.”
See also: What does it mean to be a fiduciary?
While applauding the increased flexibility afforded by the finalized draft, analysts and industry stakeholders warn the fiduciary rule will mean big changes for advisors — starting with how many receive compensation.
According to a first quarter report of Cerulli Associates, “The Cerulli Edge Retirement Edition,” the requirement to disclose variable compensation as part of the best interest contract exemption (BICE) will likely lead to a “period of product and platform innovation.” Among other things, the report notes, broker/dealers (B/Ds) will begin serving small retirement accounts on a “flat-fee basis.” The change will prompt life insurers to reduce VA expenses and commissions so as to be consistent with compensation for other financial products, including mutual funds and other fee-based managed account platforms.
A March 23 “Sector Comment” from Moody’s Investor Services echoes Cerulli’s outlook. “The new rules will accelerate the shift from commission-based accounts toward fee-based accounts,” the report states. “Firms that already incorporate level fees or compensation that does not vary by investment recommendation, such as Principal Financial Group … are early winners, since these firms will have less need to defend their recommendations or manage the expectations of current agents/distributors.”
The Moody’s report also foresees a shift to simpler, low-cost and passively managed investment products, such as those that track major indices like the S&P 500. Jefferson National President Larry Greenberg agrees, adding that the product evolution will prompt more retirement advisors to narrow their VA portfolios to low cost products that, while charging a low flat-fee, either jettison (or incorporate into flat fee structure) popular living benefits, such as the guaranteed minimum accumulation, withdrawal and income benefits.
That would dovetail nicely with the product orientation of Jefferson National, which caters to registered investment advisors and other financial professionals with fee-based practices. The company’s signature VA offering, Monument Advisor, avails buyers of more than 350 investment options for a flat, $20 month charge.
The expected shift to fee-based and fee-like compensation once the DOL rule is fully implemented should be seamless enough for RIAs and dually registered advisors RIAs/B-Ds that operate in a fee-based world. But critics warn that the transition to fees will be challenging for commission-based advisors — not least those who depend heavily on heaped or up-front compensation to meet monthly expenses.