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.”
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.
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.