Recently, the U.S. Department of Labor (DOL) finalized a new standard broadening the definition of who constitutes a “fiduciary” under the Employee Retirement Income Security Act (ERISA).
This controversial move is causing insurance and other financial services brokers to rethink their business models as well as the way they communicate with their customers.
Before the new rule, which has an applicability date of April 10, 2017, financial advisors for 401(k) plans and IRAs who are considered “brokers,” defined as registered representatives of a broker dealer paid commissions by the investments they recommend, have been held to a “suitability” standard when it comes to the duty they owe clients. This meant that when a broker recommended that a client buy or sell a particular security, the broker must have a reasonable basis for believing that the recommendation is suitable for that client. The suitability standard allowed brokers to recommend an investment product that paid them a higher commission as long as it was suitable for the client, even though it may not be the optimal choice from the client’s perspective.
The new DOL rule places brokers under a “fiduciary” standard, which means they must put their client’s interests ahead of their own in recommending investments. That is a big change.
The new standard puts brokers in the same camp as investment advisors registered with the Securities and Exchange Commission or individual states (Registered Investment Advisors), who were already held to a fiduciary standard. The change strikes at the heart of the business model of brokers, who typically get paid through commissions, unlike registered investment advisors, who are paid a percentage fee based on the amount of plan assets under management.
The new standard strikes at the heart of the business model of brokers, who typically get paid through commissions, unlike registered investment advisors who are paid a percentage fee based on the amount of plan assets under management. (Photo: iStock)
Multiple business challenges
Compensation isn’t the only challenge brokers face with the new rule. The heightened duty will apply to any information brokers provide to customers, in print or digital form, that might be deemed a “recommendation” under the rule.
A factsheet provided by the DOL describes a “recommendation” this way:
“A ‘recommendation’ is a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action. The more individually tailored the communication is to a specific advice recipient or recipients, the more likely the communication will be viewed as a recommendation.”
In other words, every broker customer communication will now need to be audited to determine whether it constitutes a recommendation, and modified if it would violate the new standard. That won’t be an easy task.