Last Wednesday the U.S. Department of Labor made a change to how brokers and financial advisers must treat retirement accounts by forcing them to live up to a so-called fiduciary standard. The industry has one year to comply with the rule, which may turn out to be an advantage for firms that have already been using technology to make client onboarding more efficient. For firms that don’t, it might be time to consider model portfolios or other solutions that create off-the-shelf portfolios for new customers.
Previously, brokers and advisers only had to meet a suitability standard, a slightly lower bar that simply requires an investment product to be good enough to invest in. That gave these parties leeway to recommend products with higher fees or other bonuses for their business, even if an offering wasn’t doing much for a client portfolio.
The fiduciary standard, which takes effect next April, says that products not only have to be good enough; they must also be in the best interest of a given client’s investment goals. According to a White House fact sheet on the change, the Obama administration estimates that the difference between these two benchmarks costs Americans $17 billion in fees and losses each year.
“I think what we ended up with was a watered-down version of the original proposal, and DoL was politically motivated to do it so it would withstand challenges, and so they could get it done,” says Brian Menickella, managing partner and co-founder of Beacon Group of Cos., a King of Prussia, Pennsylvania–based firm that provides financial services and advice on insurance, investing and employee benefits.
Menickella is an advocate for the rule and for a uniform fiduciary standard across financial services. The change came from the DoL as a result of inaction by the Securities and Exchange Commission, he says: “The SEC was already supposed to be working on a fiduciary standard, but they haven’t yet, and it is clear something needed to be done.”
It took the DoL just over 1,000 pages — what it calls a streamlined rule — to outline exactly how brokers and advisers will be liable in court if they give advice that results in more fees but not necessarily better investments. Even with all that ink, some observers say the changes to the fiduciary rule could be stronger.
As a provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the SEC was given discretionary authority to create a uniform fiduciary standard for financial services. This part of the law has been used as a cudgel by critics of the DoL’s action, like the New York–based Securities Industry and Financial Markets Association, which has accused the department of overreach and said that the industry should wait for the SEC to take action. Last year SEC chair Mary Jo White, who supports a standard, said the commission is working on its own rule.
The final DoL policy makes many concessions when compared with the original proposal, released in April 2015. Those compromises include delayed implementation: Financial services professionals will now have one year to make the business changes they need to comply.
Also, a list of investments that advisers weren’t allowed to talk about with clients, such as nontraded real estate investment trusts, has been removed, and existing accounts can carry on without a new contract or a look-back at previous investment decisions. (The DoL has released a detailed chart of all of its givebacks to the industry.) In a press conference announcing the change, Labor secretary Thomas Perez said that his department had listened to the initial round of feedback from market participants and wanted to make a workable rule.
Erin Sweeney, of counsel at Washington-based law firm Miller & Chevalier, which specializes in retirement law, is familiar with how the DoL reviews comments, having worked on writing regulations in her prior role as a senior benefits law specialist with the agency. Sweeney thinks some of the concessions needed to be made, but she also has concerns about how brokers and advisers will be able to disclose that they are required to use a fiduciary standard.
“As written, advisers and brokers can put the new, required disclosures as another page in account-opening materials,” she explains. That could make the standard less obvious to new investors or to those who think such a rule is already in place. In an age of blindly signing off on legal agreements that come with everything from iTunes to Facebook, it’s not a stretch to think that these new requirements might get lost in the shuffle.
Despite such concerns, the new rule will benefit investors and even the industry. A new report titled “New Year, New Fiduciaries?” from Cerulli Associates, a Boston-based analytics firm, suggests that it could usher in a new era of technology, product and platform innovation in the wealth management business.
Just ask Jean-David Larson, director of regulatory and strategic initiatives at $242 billion, Seattle-based Russell Investments. Although the new rule may require more up-front effort to show why certain decisions were made or advice was given, it’s also a chance to boost operational efficiency, he notes.
“I think there is room for firms to use technology to make the client intake process more efficient, or to create model portfolios and use products that already encompass what is in the model portfolio,” he says. “I don’t think we have to start from scratch every time.”
Beacon Group’s Menickella also believes that technology could play a role in how financial services firms respond. “The industry is very innovative; it will evolve to meet the new rules,” he says. That could mean new products or even investment platforms.
Given that firms have just one year to comply, Menickella warns them against delaying changes to see if the rule sticks after November’s election.
“By the time a new administration is in place, we are going to be so far into that timeline, I don’t see legal or policy challenges holding up,” he says. “It’s also a very hard argument to make that you don’t want to act in the client’s best interest, which is what the fiduciary standard requires.”