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DOL Fiduciary Rule Hits BDs’ IT Budgets, Product Lines

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While advisors and broker-dealers are realizing there’s no one-size-fits-all solution to complying with the Department of Labor’s impending fiduciary rule, it’s the BDs that are feeling the biggest financial pinch — specifically regarding their information technology budgets and purging commission-based products that run afoul of the rule.  

“Broker-dealers have to make a lot of very difficult, and in some cases expensive, decisions” regarding DOL fiduciary rule compliance, Fred Reish, partner in Drinker Biddle & Reath’s employee benefits and executive compensation practice group, told ThinkAdvisor in a recent interview.

The Oxford Economics report commissioned by the Financial Services Institute and submitted to the DOL last fall warned that Labor has “dramatically underestimated” the cost to comply with the new rule and that smaller firms would find it difficult to stay in business once the rule takes hold, which occurs in April.

The report estimated the rule would result in startup costs ranging from $1.1 million to $16.3 million per firm, depending on firm size. BDs and investment advisors would be forced to either substantially change their current business models or navigate the challenging demands of a best interest contract exemption, it said.

While at least some of those cost predictions seem to be bearing out as advisors and BDs work to get up to speed with the final rule, released in April, industry officials opine that cost of compliance varies.

Chris Paulitz, senior vice president of membership and marketing at FSI, says that “Oxford has confirmed that nothing in the final rule would lower their cost estimates.”

(The 2016 Broker-Dealers of the Year discussed the cost of DOL rule compliance at our annual editorial roundtable.)

Ameriprise, for instance, said in its most recent earnings report that it had spent north of $11 million this year to comply with the rule, and announced earlier this year that it had devote about 400 people to compliance efforts and has increased training for staffers.

Both Ameriprise and LPL have also recently announced that they’ll prohibit sales of A-share mutual funds and bar advisors from collecting 12b-1 fees in fee-based advisory accounts. Brokers will be able to sells such shares and get 12b-1s, however, in commission-based accounts if they use the BICE.

Edward Jones announced Thursday that it would create a “grandfathered account to serve existing IRAs with investments acquired before the April 2017 compliance date, saying that “investments in existing IRAs, as well as systematic investment plans that are in place before April 10 of next year can continue as long as they remain in the best interest of your client.”

However, new investment purchases “won’t be allowed in a grandfathered account after the rules become effective with the exception of mutual fund exchanges, variable annuity subaccount reallocations, and systematic investment plans agreed to prior to implementation,” Edward Jones said.  

The firm also plans to create a transaction-based IRA option using the BICE. Initially, the IRA will include stocks, bonds, CDs and variable annuities, Edward Jones said, but “for now,” the IRA will not include exchange-traded funds, unit investment trusts or mutual funds.

“Right now, because there is such pricing variability within and between mutual funds, it is difficult to align mutual funds with the requirements” of BICE. Edward Jones believes “in the future the mutual fund industry will need to align around common pricing and common structures in order to meet the DOL fiduciary standard.”

The Oxford survey, which was based on interviews conducted with independent broker-dealer and clearing firm senior executives, estimated an average training cost of $800,000 per firm, and a median cost of $580,000.

DOL’s rule is the latest regulatory threat to the independent BD “legacy business model,” says Matthew Lynch, managing partner of Strategy and Resources LLC, and for BDs with a significant amount of commission business that involves ERISA accounts, “something has to change” in terms of compliance and coming to terms with BICE.

BDs and advisors are now having to “prove” that they’re complying, which involves not only increasing technology processes, but also developing “compliance guidelines, training and [justifying] why certain products are on your shelf.” The true difficulty for indie BDs has been in getting a handle on the BICE, he says. In consulting with financial services firms, Lynch says he’s seen compliance cost range anywhere from more than $10 million to “others getting it done for a fraction of that.” The real “evidence” as to whether a firm’s compliance process “is actually working” will come in April, however, when the rule kicks in and DOL starts assessing what’s been put in place.

Timothy Hauser, chief operating officer of DOL’s Employee Benefits Security Administration, has warned broker-dealers and advisors at industry conferences to get in touch with DOL if they have questions about compliance. Firms “should not be spending enormous amounts of money on compliance systems if you don’t know how to comply” with the rule, he said at an IMCA event in mid-July. “We very much encourage firms to come and talk to us and raise issues. …You shouldn’t be afraid to ask the question and get the answer. Better to get the answer than spend the money and find out we’re not happy.”

Hauser said at the event that DOL has “drafted” further guidance in question-and-answer form and is “working on” such guidance, but couldn’t provide a timeline on when it would be released.

Indeed, David Lyon, founder and CEO of Oranj, adds that compliance “comes down to the overall cost of doing business for [broker-dealers] — you’re seeing BDs getting out of specific lines of business because it’s too costly to put the IT controls to maintain that business line.” That’s where the rule is having the “greatest impact” now.

FSI recently added three DOL fiduciary rule compliance tools to its existing BICE template and compliance guide. The group now offers a negative consent letter, IRA rollover form and a website disclosure template.

Paulitz says the “well over 80 firms” that have more than 100,000 advisors affiliated with them have ordered the BICE template. 

Granted, Lyon agrees that further compliance measures will likely need to be put into place after the April compliance date kicks in.

BDs are “having to increase their back-office IT to properly catalog, archive and encrypt the information they’re requiring advisors to provide, like the “process of placing a client into a solution product or investment portfolio,” Lyon says.

There is “additional information that they need now under the rule — additional types of reports, adding in more steps to an already lengthy process. It’s ultimately driving up their IT costs,” he continues. “Technology is not a one-time cost; you have to maintain and adopt and make changes over time. So [BDs] are weighing the compliance risk of staying in [a certain] business line.”

Broker-dealers that have “proprietary products, affiliated mutual funds and insurance products,” Reish says, “almost have to go under the best interest contract exemption because they can’t really do level fee; … the fees have to be level, not only for the individual advisor but for the BD and all related parties — including the insurance company and mutual fund manager.”

He adds: “It’s almost impossible to levelize compensation for the whole corporate family if you have mutual funds or insurance products.”

Affiliated companies that want to distribute their affiliated products will “have to use the BICE, and that involves levelizing the fees of the individual advisor or basing compensation of individual advisors on neutral factors. I don’t think a lot of people really grasp the concept of neutral factors yet,” Reish says.

Neutral factor means, for example, “that it can’t be based on the commission paid to the broker-dealer. And it has to be based on things like how much work it is for the advisor and how complex the product is to explain and educate to the investor,” Reish explains. “Those concepts are alien to what has historically been a transaction-based business.”

Another “big issue” for registered investment advisors and broker-dealers is rollovers, Reish says. Under DOL’s rule, recommendations on rollovers fall under fiduciary advice.

The “typical BD has half of the money under management in IRAs, and the primary source of IRAs is rollovers, when you’re talking about dollars.”

RIAs, on the other hand, “vary a lot” in terms of their IRA business, Reish adds. “Some RIAs I work with focus on mid- and large- market 401(k) plans; they won’t accept rollovers, they view it as a conflict of interest and will flat out not handle rollovers.” But for “other RIAs that fashion themselves more as wealth managers … rollovers are a great source of business for them.”

While the larger BDs with “substantial legal staffs and compliance personnel … are pretty far down the line and are working hard on” compliance, Reish says he worries about the BDs without such resources. “This [compliance] work is very difficult and somewhat expensive, and the smaller RIA firms … might not be seeking legal advice, and they need it. They can’t just rely on going to conferences.”

Reish is quick to add: “There’s no one-size-fits-all solution.”

Lynch adds that BDs’ CEO really need ensure “someone fully understands” the overall impact of the rule on their business. “We’re almost into September; if a firm doesn’t have a pretty clear idea what their approach is at this point, they need to allocate resources to figure it out.”

— Check out Facing Off: The 2016 Broker-Dealers of the Year and

Hundreds of Thousands of 401(k)s Up for Grabs After DOL Fiduciary Rule on ThinkAdvisor.