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Regulation and Compliance > Federal Regulation > DOL

How Wirehouses, Experts View DOL Rule

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On April 6, the Department of Labor released its final version of a new fiduciary rule, which requires financial advisors to meet a fiduciary standard rather than a suitability standard when making investment recommendations for clients’ retirement accounts, including 401(k) plans and IRAs.

While registered investment advisor (or RIA) firms previously had to abide by a fiduciary standard as defined by the SEC, registered representatives (i.e., commission-based brokers) had no such standard, equity analyst Christopher Shutler, CFA, of William Blair explains in a recent report. “Therefore, while all advisors will be affected by the new rule, registered representatives will on average see more significant changes to their business models,” Shutler explained.

On the plus side, “We view the rule as less draconian and disruptive than the preliminary rule proposed last April for the financial advisor and active asset-management industries, as it provides advisors with greater product flexibility, a longer implementation time frame, and less burdensome disclosure requirements,” according to the analyst.

According to the Blair analyst, LPL Financial could be “somewhat better positioned on the DOL issue relative to previous expectations as non-traded REITs are permitted under the best interest contract exemption (BICE), and disclosure requirements (i.e., costs) are lower than the initial proposal,” he added.

Nonetheless, Shutler and other observers expect advisor productivity and recruiting “to remain weak in the near term, and the DOL rule is still a negative — it is just a little less of a negative than anticipated.”

Industry Shifts

The DOL rule “has already been disruptive,” according to Morningstar analyst Michael Wong, CFA. “We’ve seen the exit of foreign banks from the U.S. wealth-management landscape, such as Credit Suisse, Deutsche Bank and Barclays,” he said during a recent videotaped interview.

“We saw MetLife and AIG kind of spinning out or selling off their retail advisory businesses; the restructuring of RCS Capital [which owns Cetera Financial Group] and Waddell & Reed changing its platform,” Wong explained.

“So, we’ve already seen that this rule is disruptive, and definitely even if they kind of made the rule a bit more lenient, this will really change the operational kind of workflow of all of the wealth-management firms and the people that sell into the wealth management channel, so the product manufacturers,” he added.

The emphasis of the final rule is to require that all advisors look out for the “best interest of their clients” to give clients legal recourse if this best interest standard (BIC) has not been met. “This will undoubtedly lead advisors to use fewer high-priced products such as non-traded REITs and variable annuities,” stated Shutler.

“Advisors will be have to up their game when it comes to documenting investment rationale and will continue to migrate to fee-based accounts and passive products,” the Blair analyst explained, “although the DOL made it clear that commissions are OK — and perhaps preferred for some accounts — and that the lowest-fee product is not necessarily the best one …”

The overall impact from the new regulatory framework, he says, includes: (1) greater use of model portfolios and fewer “stock picking” advisors, (2) continued consolidation in the industry, particularly among smaller broker-dealers; (3) the departure of more advisors or further movement of advisors toward a fee-only RIA business model; (4) greater adoption of automated (“robo”) advice with “level” fees; and (5) harmonization by the SEC with the DOL rule.

Morningstar analysts have collected data for a few quarters to assess the financial impact on the industry. They “still believe that the rule primarily affects around $3 trillion of full-service, wealth-management client assets, and that there’s roughly $19 billion of revenue related to these assets,” Wong said.

“We also still believe that our $2.4 billion prohibited transaction-related mutual fund front-end loads and 12b-1 fees [figure] is still in the right ballpark, and that as much as $600 billion of full-service, wealth-management client assets may switch to investment services channels such as towards the discount brokerages or robo advisors following the full implementation of this rule,” he stated.

Wirehouse Woes?

Bank of America-Merrill Lynch executives are upbeat on what lies ahead when it comes to complying with the DOL rule — though they acknowledge that the effect definitely won’t be benign over the coming years.

“If you look at roughly the $2 trillion of … client assets we have outside of deposits and loans, we think the Department of Labor will probably impact less than 10% of that,” said BofA CFO Paul Donofrio, on a recent conference call with equity analysts. “And certainly given the implementation schedule, we wouldn’t expect to see much of an impact, if any impact, in 2016.”

Asked if the firm anticipates a limited revenue disruption, rather than a major one, based on the final rule as written, Donofrio responded, “Yes, that’s correct.”

Bank of America CEO Brian Moynihan told analysts that the firm has been preparing for the new rule. “It’s not a hugely substantial cost, and … we’ve spent a lot of time educating our teammates about doing it. There are operational cost[s], but I don’t think [they’re] material in the grand scheme of things,” he explained on the call.

Merrill Lynch Wealth Management’s investment advisory program, Merrill Lynch One, and its mass-affluent Merrill Edge offering include professionally managed portfolios and both have single-fee schedules, according to the firm.

These efforts “should help us comply with possible fiduciary requirements regarding level fees. The fact that we have a robust self-directed channel in Merrill Edge also provides us and our clients with additional flexibility,” Merrill Lynch explained in a statement.

Donofrio reiterated this view while speaking with equity analysts after the bank released its first-quarter earnings: “I think from the very beginning we supported the fundamental objectives of the Department of Labor. And if you look at our goals-based strategy, it delivers a lot of what they are getting at with that rule in terms of the best interest standard.”

According to the CFO, the Merrill Lynch One advisory platform, onto which the company “successfully completed the transition of a lot of clients this quarter … [is] a great example of how we’ve been up front to create an experience that is really transparent, [has a] single-fee schedule, etc. That’s a significant investment. And we’re guessing that that investment is really going to pay off here in terms of implementing this rule.”

Meanwhile, Morgan Stanley CFO Jonathan Pruzan says the firm has been “preparing for this eventuality for a while now, and we’ve been investing for this eventuality. When we put out our 23–25% margin target for next year, we had this in mind,” he told analysts on a recent conference call.

The wirehouse also has “the largest advisory platform in the industry, as well as significant investments in our digital platform. So we think we are well positioned here… The overall impact to both our clients and our financial results are very manageable,” Pruzan said.

The focus of the new standard “is consistent with where we are going,” Chairman & CEO James Gorman stated on the call. “But it’s one of many things that are going on in that business … including the growth in the bank, the expense saving, the digital strategy that we’re putting in place.”

As for managed accounts, this business continues to grow, according to Pruzan. The firm has about $800 billion in these accounts, representing roughly 40% of assets.

For advisors looking to get more info on the DOL rule, Morgan Stanley says it has set up a dedicated website, which it will updated regularly. In addition, it will share news with advisors via e-mail and conference calls as needed.

In Wong’s view, the rule — though more lenient than expected — is still disruptive and “still definitely has teeth, because it has that best interest contract …,” he said during an interview led by his Morningstar colleague Jeremy Glaser.

Financial services firms “will really have to use much more data services or compliance services and retraining of those financial advisors in order to comply with the rule,” he says. “Otherwise, they are just leaving themselves open for much more liability.”

When advisors are speaking with clients, they “are going to have to justify their fees. So, they have to keep the best interest of their client in mind, they have to prove through some substantive means that they actually acted in the clients’ best interest, and they have to justify why they are charging the fees that they do to those clients,” Wong explained.


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