President Trump’s flurry of executive actions since taking office is upending the established order in the nation’s capital. Financial services professionals have a huge stake in the outcome for two of them.
Those executive orders — one calling for an “updated economic legal analysis” of the Department of Labor’s fiduciary rule, the other detailing “core principles” that could gut the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 — have unsettled federal oversight of financial services to a degree unseen since the end of the 2007-2009 downturn.
For industry stakeholders, the actions bring a welcome respite from impending regulatory changes for which many were ill-prepared.
That’s notably true in respect to the fiduciary rule, which was due to be phased in beginning on April 10. The myriad requirements of the DOL “conflict of interest rule,” stretching to 1,000-plus pages, had called into question business development plans for players throughout the distribution channel.
“The executive order [respecting the rule] is a positive development because much of the industry wasn’t ready for the April 10 applicability date,” says Jason Smith, founder and chairman of Clarity 2 Prosperity, a Westlake, Ohio-based independent marketing organization. “Business partners I’ve spoken with — advisors, broker-dealers, and other IMOs — had all halted or substantially slowed their development efforts. The delay was definitely needed.”
Putting the rule on hold
The DOL filed on February 9 a Notice of Proposed Rulemaking with the Office of Management and Budget to delay the fiduciary rule’s implementation. The OMB’s review of the notice, expected to last 14 days before being approved and published in the Federal Register, doesn’t stipulate a new implementation date. But market-watchers anticipate a delay of up to 180 days, which would shift the original phase-in from April to October 2017. Whether the DOL thereafter elects to revise or repeal the rule may hinge, in part, on recent court rulings, all of which have sided with the DOL’s position on the rule under the Obama administration.
Prominent among the decisions: a February 9 opinion by Texas federal trial Judge Barbara M.G. Lynn favoring the DOL in a much-watched case brought by 9 plaintiffs. They included, among others, the U.S. Chamber of Commerce, the American Council of Life Insurers (ACLI), and the National Association of Insurance and Financial Advisors (NAIFA).
If the DOL decides on revisions, critics of the rule are hoping they’ll be significant. The desired revamp starts with an overhaul of a best interest contract exemption (BICE) under which sales commissions are allowed, but which many perceive as overly complex.
The industry is concerned about the potential for costly lawsuits owing to a DOL rule provision allowing for a private cause of action by the class action bar. (Photo: Thinkstock)
A myriad of provisions
To satisfy the BIC exemption, financial professionals advising on ERISA-compliant qualified retirement plans must acknowledge to the client their fiduciary status, give prudent and impartial advice, disclose potential conflicts of interest, and convey how they get paid — compensation that also must be judged “reasonable.”
To boot, they have to use one of four best interest contracts when engaging the client: one for advice governing IRAs and non-ERISA plans (“full-blown BIC”); a second for ERISA plans (“disclosure BIC”); a third applying to level-fee fiduciaries (“streamlined BIC”); and fourth “transition BIC” for those not ready to adopt the full-blown BIC.
“The fiduciary rule is so complex,” says Chris Chen, an advisor at Insight Financial Strategists. “It’s hard to know what one must to do. The rule should definitely be simplified — and the paperwork lightened.”
Adds Mark Germain, an advisor and principal of Beacon Wealth Management: “The DOL fiduciary rule is the foundation of independent financial advice. I don’t believe blanket repeal makes sense, but regulation that is redundant and expensive [also] makes no sense.”
Of greater concerns to the industry is the potential for lawsuits against advisors, broker-dealers or IMOs alleged to be in violation of the fiduciary rule. The reason: a provision therein allowing for a private cause of action by the class action bar, to which the DOL has effectively outsourced enforcement of the regulation’s best interest standard.
Advisors will bear some of this litigation risk, though Chen notes that financial institutions with deeper pockets — IMOs, broker-dealers and life insurers — may be more tempting targets for plaintiffs.
Regardless, the heightened prospect of class actions suits, if not addressed during the DOL’s review, is likely to drive up the cost of compliance, including errors and omissions (E&O) insurance. Upshot: Advisors unwilling to navigate the BICE’s legal minefield could abandon the qualified plan space — leaving retirement savers with a smaller pool of financial professionals to consult.
“This is the scariest thing about the rule,” says Herbert Daroff, an advisor at Baystate Financial. “Every class action attorney will be displaying a billboard saying, ‘If you’ve ever lost money in the market, call this number. We’ll get it back for you.’
“In an attempt to stop some small percentage of the brokers from offering substandard advice, the DOL is laying the foundation for tort liability litigation on a gigantic scale,” he adds. “The DOL definitely needs to replace the rule’s private right of action with an arbitration provision.”
If that doesn’t happen, keep an eye out for some big, multi-party lawsuits. Morningstar Senior Equity Analyst Michael Wong pegs long-term class action litigation settlements stemming from use of the BICE at $70 million to $150 million. Factoring in a “bearish scenario,” such legal settlements could reduce advisory firms’ operating margins for commission-based IRA assets by 24 to 36 percent.
And these numbers don’t even account for a jaw-dropping $20 billion revenue dip that market research firm A.T. Kearney estimates will result from the DOL rule’s phase-in. Uday Singh, partner of the Americas, at A.T. Kearney’s Financial Institutions Practice, attributes the precipitous drop to several factors, including:
An expected decline in commissions as advisors drop low-balance retirement accounts that will no longer be profitable to serve;
A slowdown in IRA rollovers from 401(k)s and other employer-sponsored retirement plans; and
A shift among retirement savers to low-cost exchange-traded funds.
Absent changes, the DOL rule could shake up sales of qualified retirement plan products, including variable and fixed indexed annuities subject to the rule’s BIC exemption. (Photo: Thinkstock)
Two standards for different plans
Costs aside, a major concern of observers is the rule’s limited scope. Whereas the rule governs qualified plans, a lower product suitability standard applies to non-qualified plans, such as executive bonus arrangements, deferred and compensation plans; as well as other non-qualified taxable investment accounts (stocks, mutual funds, exchange-traded funds, etc.) beyond the DOL’s purview.