Executive Summary
On April 6 of 2016, the world of professional financial advice took its first step into the future with the issuance of a Department of Labor (DoL) fiduciary rule, declaring that brokers can no longer earn commissions and other forms of conflicted advice compensation from consumers, unless they agree to do so pursuant to a Best Interests Contract (BIC) agreement with the client, which commits the advice-provider to a fiduciary standard of giving advice in the “best interests” of the client, earning “reasonable compensation”, and providing appropriate disclosure and transparency about the products and compensation involved.
Fiduciary advocates have lamented that the Department of Labor conceded several major points in its final DoL fiduciary rule, including shifting a number of key disclosures to be provided “upon request” or via the Financial Institution’s website (but not outright to the client), incorporating the Best Interests Contract into existing advisory and new account agreements (rather than as a separate fiduciary agreement), and not adopting a “restricted asset list” and instead keeping the door open to everything from controversial illiquid products like non-traded REITs, high-commission products like some variable and equity-indexed annuities, and companies that implement their own proprietary products as the “recommendation” at the end of every financial plan.
However, it appears that in reality the DoL fiduciary rule concessions were a brilliantly executed strategy of conceding to the financial services industry the exact parts that didn’t actually matter in the long run (while still reducing the risk of a legal challenge), yet keeping the key components that mattered the most: a requirement for Financial Institutions to adopt policies and procedures to mitigate material conflicts of interest and eliminate incentives that could compromise the objectivity of their advisors (or risk losing their Best Interests Contract Exemption and cause all their advisory compensation to be a Prohibited Transaction), and a second requirement that clients can no longer be forced to waive 100% of their legal rights and accept mandatory arbitration, instead stipulating that while an individual client dispute may be required to go to arbitration, consumers must retain the right to pursue a class action lawsuit against a Financial Institution that fails to honor its aggregate fiduciary obligations.
In essence, then, financial services product companies claimed that they can offer often illiquid and opaque, commission-based, and sometimes even proprietary products to consumers, while also receiving revenue-sharing agreements, and simultaneously still act in the client’s best interests as a fiduciary. And so the Department of Labor’s response became: “Fine. If and when consumers disagree, you’ll have a chance to prove it to the judge when the time comes.” In other words, while the DoL fiduciary rule didn’t outright regulate what Wall Street can and cannot do, it did change the legal standard by which all of Wall Street’s actions will be judged, and ensure that eventually the courts will have the opportunity to rule on these fiduciary conflicts. And in the long run, that will be a world of difference.
In the meantime, though, the clock is ticking for the onset of an incredibly far-reaching new fiduciary rule, and one that will impact not just broker-dealers, but RIAs as well (albeit to a lesser extent), insurance companies and annuity marketing organizations that sell variable and equity-indexed annuities, and more. The key provisions of the rule will take effect on April 10, 2017, with a transition period through January 1, 2018, by which time the last of the detailed disclosure and other policies and procedures must be put in place.
In this article, we provide an in-depth look at the keystone of the new fiduciary rule as it pertains to advisors working with individual retirement accounts: the new “Best Interests Contract Exemption”, which most broker-dealers and insurance companies will rely upon in their future attempts to provide conflicted advice to IRAs for commission compensation, and the creation of the new “Level Fee Fiduciary” safe harbor, that may (and I strongly suspect, will) eventually become the standard by which all retirement advice is delivered.
Of course, the biggest caveat is that all the new fiduciary rules apply only to retirement accounts, and not any form of taxable investment account or other investment purchased with after-tax dollars… which means the new DoL fiduciary rule will likely ultimately drive the SEC to step up on its fiduciary rule as well, as it’s clearly untenable in the long run for advice to retirement accounts to be held to a fiduciary standard, while everything else remains the domain of suitability and caveat emptor!
(Michael’s Note: The new Department Of Labor fiduciary rule is likely to go through several rounds of interpretations, with potential guidance updates by the DoL, in the coming months. This post will be updated as new interpretations come to light and new guidance is made available, to remain a resource on the Best Interests Contract Exemption (BICE) and the requirements for completing a Best Interests Contract (BIC) agreement with clients.)
Key Sections Of This Guide: What Is A Prohibited Transaction? | Introducing The Best Interests Contract Exemption (BICE) | Key Points Of The BIC Agreement And BICE Requirements | Enforcement Of The Best Interests Contract (BIC) | BIC Exception For a "Level Fee Fiduciary" | Execution Of The BIC Agreement | BICE Grandfathering Provisions | When Do The New Best Interests Contract Exemption (BICE) Requirements Apply? | To Which Products Does DoL Fiduciary Apply? | Deadline For New BICE Requirements And What Advisors Must Do | Implications Of The New DoL Fiduciary Rule
Prohibited Transactions For Untenable Fiduciary Conflicts Of Interest
On April 6 of 2016, the Department of Labor (DoL) issued its final “Conflict Of Interest Rule on Retirement Investment Advice”, after more than 6 years of proposals, re-proposals, and ongoing public comment periods and industry debate.
The new rule not only updates the existing fiduciary standard for employer retirement plan investment advice under ERISA from its 1975 roots (when the world of retirement planning was very different from its 401(k)- and IRA-centric reality today!), but more importantly (in the context of financial advisors) expands the scope of fiduciary duty for retirement accounts to include IRAs as well as employer retirement plans.
The essence of the new rule is the idea that when a fiduciary provides advice, it must be in the “best interests” of the client (not for the benefit of the advisor and his/her own compensation), and advisors must manage and mitigate their conflicts of interest that may taint their client-centric advice. In addition, the fiduciary rule recognized that some conflicts of interest are so severe, it is simply best to outright prohibit them altogether.
Notably, the concept of “prohibited transactions” for fiduciaries – requiring them to avoid untenable conflicts of interest – is not new. The rules pertaining to both IRAs and employer retirement plans have long prohibited a list of transactions between fiduciaries and their clients, that are viewed as being too rife with conflicts of interest to be allowed at all, including a ban on “self-dealing” transactions (where a fiduciary invests client dollars into his/her own ventures), a limitation on other forms of transactions between a fiduciary and the investment account that he/she is overseeing, and a prohibition on exercising discretion in a manner that provides the fiduciary higher compensation (e.g., shifting client investments into higher-paying investment selections).
While these rules have long been in place for employer retirement plans subject to ERISA, the Department of Labor’s new fiduciary rule extending to IRAs both the fiduciary reach, and the scope of prohibited transactions, is new territory. And doing so creates several “problems” for the existing landscape of financial advisors and brokers serving individual retirement accounts.
After all, in a fiduciary context, the receipt of a payment from a third party – i.e., a commission – would generally be a conflict of interest that is prohibited, as would revenue-sharing agreements with investment providers that can inappropriately incentivize the financial advisors to recommend some investments over others. In theory, even just the act of soliciting a client to roll money out of an existing retirement account, and into one managed by the advisor, can be a conflict of interest – albeit the most fundamental one for anyone in the “business” of being a fiduciary – given that the fiduciary advisor is not paid on the existing account but would be paid to provide fiduciary advice to the recommended new one.
Of course, in the extreme, prohibiting a fiduciary from even soliciting business as a fiduciary, because of the implicit conflict of interest, could grind all fiduciary engagements to a halt (which isn’t necessarily productive for society!). In addition, some conflicts may be minor enough in certain instances to realistically be manageable.
Accordingly, the Department of Labor has the legal ability to provide “Prohibited Transaction Exemptions” that effectively state “notwithstanding that this transaction might normally be prohibited for fiduciaries, it is in the interests of consumers for the DoL to allow it – to grant an exemption from the prohibited transaction rules – if certain requirements are met.”
And it is within this framework – that the manner in which most financial advisors engage consumers is rife with conflicts of interest that should be prohibited, except where otherwise allowed under a prohibited transaction exemption – that forms the basis of the new DoL fiduciary rule.
Introducing The Best Interests Contract Exemption (BICE)
Under the new Department of Labor fiduciary rule, financial advisors in practice will face three core scenarios that trigger prohibited transactions, which would otherwise bar the financial advisor from engaging the client in a (conflicted) advice relationship, including where the advisor recommends:
- Shifting from a 401(k) or IRA account with a lower fee into a new IRA with a higher fee (e.g., where the advisor already manages a low-cost 401(k) plan and recommends a rollover to an IRA with higher costs);
- Rolling over to an IRA that would allow the advisor to earn a fee that he/she wasn’t previously earning (because the advisor had no relationship to the prior 401(k) but will now get paid for advising on the IRA); and
- Switching a client from a commission-based account to a fee-based wrap account (for which the advisor will now earn ongoing fee revenue that wasn’t previously being earned).
To allow financial advisors to still engage in the above “prohibited transactions”, the Department of Labor has created a “Prohibited Transaction Exemption” (PTE) that stipulates the advisor may still engage in (and be compensated for) such recommendations.
Specifically, the new PTE is called the “Best Interests Contract Exemption” (BICE). The BICE effectively states that the fiduciary advisor must sign a “Best Interests Contract” (BIC) with the client, stipulating that the advisor will provide advice that is in the Best Interests of the client. If the advisor engages in a BIC agreement with the client, and follows its required stipulations, the otherwise-prohibited transactions – e.g., where the advisor recommends a rollover that he/she will then manage and be paid for – are now allowed.
More specifically, to gain the PTE protections of the Best Interests Contract Exemption, the Financial Institution overseeing the advisor-client relationship must:
1) Acknowledge fiduciary status with respect to investment advice to the Retirement Investor
2) Adhere to “Impartial Conduct Standards” which requires the fiduciary advisor to:
- Give advice that is in the Retirement Investor’s Best Interest;
- Charge no more than “reasonable compensation”; and
- Make no misleading statements about investment transactions, compensation, and conflicts of interest
3) Implement policies and procedures reasonably and prudently designed to prevent violations of the Impartial Conduct Standards
4) Refrain from giving or using incentives for Advisers to act contrary to the customer’s best interests; and
5) Fairly disclose the fees, compensation, and Material Conflicts of Interest, associated with their recommendations
In practice, the first two points would be captured in the Best Interests Contract (BIC) agreement with the client, while the remaining three become an obligation of the Financial Institution itself to follow (or lose its eligibility for the BICE).
Key Points Of The BIC Agreement And BICE Requirements
Relative to the current landscape for financial advisors, there are several important points worth recognizing about how the Department of Labor has structured the requirements of the BIC agreement, and what the Financial Institution must implement to be eligible for the BICE PTE to earn conflicted compensation:
- The fact that the advisor must explicitly acknowledge fiduciary status eliminates, once and for all, the classic broker “defense” that the person who previously claimed being an advisor was still technically just operating as a salesperson and not actually acting in a fiduciary capacity. There will no longer be an opportunity for the broker to give advice to a retirement investor and then claim the fiduciary standard for advice shouldn’t apply after the fact.
- Despite all the buzz about advisors being required to act in the client’s “Best Interests”, and the debate about whether an advisor even can feasibly act perfectly in the client’s best interests at all times (does that mean we have to search the ends of the earth just to find the one product on the planet that is cheapest/best, no matter what?), the DoL rule clarifies that the real expectation is that the advisor’s advice be prudent advice (not actually the difficult-to-define “best”). Specifically, the DoL rule states that “Prudent advice is advice that is based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution, or their Affiliates, Related Entities, or other parties.” The prudence standard draws upon ERISA Section 404, which in turn states that a fiduciary is required to act “…with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character with like aims.” In other words, the “best interests” standard is meant to determine whether a similar prudent professional in a similar role would have given a similar “best practices” client-centric recommendation.
- The Impartial Conduct Standards of the BICE will also require that the advisor earns “reasonable compensation”, which again is predicated not on the “lowest possible” compensation, but “reasonable” compensation. In essence, this means that the advisor does not have to be the cheapest, but simply that compensation must not be excessive based on the going market value for services rendered. Thus, similar to the “best interests” standard, the determination of reasonable compensation is based on prevailing best practices in the marketplace and a comparison to common peers, not simply an arbitrary regulator’s view on what an advisor “should” earn. Notably, such a standard is actually very accommodating of advisors providing a wide range of services, for a wide range of costs; it simply means that the costs must be commensurate to the going rate for such services. Or as DoL fiduciary Fred Reish stated it at the recent Fi360 fiduciary conference (which coincidentally got underway the day the DoL fiduciary rule was released!): “you can charge Walmart prices for Walmart service or Tiffany’s prices for Tiffany’s services, but don’t provide Walmart services for Tiffany’s prices [which would be excessive and not reasonable compensation for services rendered]!”
- The requirement to make no misleading statements may significantly increase the scrutiny on sales disclosures and illustrations, particularly for certain products that were not previously subject to such scrutiny but will be now (e.g., equity-indexed annuities, as discussed below). Of course, “sales illustrations” have long been common in the financial services industry, but it’s crucial to recognize that this isn’t just business as usual; they may be the “same” illustrations, but they will be subjected to a higher level of scrutiny, which may bring different and more harsh consequences than the past.
- The policies and procedures requirement appears to be a meaningful attempt for drive financial services institutions to change their entire culture (at least, for their subsidiaries that actually deliver financial advice). Financial Institutions will be expected to create policies and procedures that the DoL itself will review and retain jurisdiction over. If the firm does not create the proper environment by establishing mechanisms to police its own conflict of interest, the Financial Institution can lose its Prohibited Transaction Exemption under BICE, which instantly renders all of its activity a prohibited transaction breach. Firms will not want this to happen to them, and it will drive them to create a more fiduciary culture to avoid the severe ramifications of failing to do so (out of the simple self-interest preservation of what happens if they don’t).
- While some fiduciary advocates have lamented the fact that the final DoL fiduciary rule relegated many of the key disclosures to only be provided “upon request of the client” or on the advisory firm’s website (as opposed to being handed to the client directly), the depth of the disclosures is still significant. To meet the BICE requirements, the Financial Institution must disclose all “Material Conflicts of Interest”, adopt measures to prevent those conflicts of interest from causing violations of the Impartial Conduct Standards (and disclose what those measures are), and name a person responsible for addressing and monitoring this process (the Chief Conflict-Avoidance Officer!?). In essence, this means that a Financial Institution will be required to publicly announce both its Material Conflicts of Interest and its policies and procedures to handle them – which means if the process isn’t up to fiduciary snuff, the Financial Institution will effectively have handed a roadmap for a class action lawyer to sue them!
- Notably, a key aspect of the policies and procedures requirement is that Financial Institutions will be barred from having “quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or would reasonably be expected to cause Advisers to make recommendations that are not in the Best Interest of the Retirement Investor.” This may cause a substantial reform to how many financial services institutions compensate their brokers in particular, as it potentially bars a wide range of common practices, from quota requirements to validate a sales contract, to bonuses for certain sales volumes, to incentives for selling one particular line of products over another (leading to differential compensation), etc. And the fact that the rules look not only at the compensation of the Advisor, but also the Financial Institution, its Affiliates, and Related Entities, means that even behind-the-scenes differential compensation (e.g., a wide range of common shelf-space and revenue-sharing agreements) will likely be barred under the new policies and procedures requirement. (Though notably, not all differential compensation is completely barred, as substantively different products with differential compensation can co-exist, as long as the Financial Institution can show it not inappropriately influencing advisor recommendations.)
Enforcement Of The Best Interests Contract (BIC)
In order for regulation to have impact, it must be enforced, including having a means for enforcement, so it’s worth recognizing how the new DoL fiduciary and BICE requirements will be overseen.
For any fiduciary advice pertaining to ERISA plans, the Department of Labor itself can continue to enforce as it has in the past, in addition to the fact that harmed participants have the right to sue in court (and in fact, ERISA-related lawsuits have had a significant impact on the employer retirement plan space in recent years).
For fiduciary advice pertaining to IRA accounts, the Department of Labor itself cannot enforce the prohibited transaction rules directly; technically, the DoL can write guidelines to define a “fiduciary” under both ERISA, and IRC Section 4975 of the Internal Revenue Code (which governs IRA accounts) under the Reorganization Plan No. 4 of 1978, but the enforcement of those rules generally falls to the IRS. And the IRS can potentially apply significant penalties - from 15% to as much as 100% of the value of the account under IRC Sections 4975(a) and (b). However, the IRS has not been active in enforcing against fiduciary prohibited transactions in retirement accounts. As a result, the Department of Labor has required those providing fiduciary investment advice recommendations to IRAs to sign the BIC… which creates the potential for the advisor (or at least, the Financial Institution) to be sued for failing to adhere to the BIC as a fiduciary, even if the IRS won’t enforce directly.
In other words, if advisors fail to follow their fiduciary obligations with respect to IRA accounts and rollovers, the DoL itself cannot enforce a proceeding against the advisor for failing to adhere to fiduciary duty, but the DoL did ensure that consumers have legal recourse by forcing Financial Institutions to leave the door open for the client’s attorney to sue instead.
In fact, extending this requirement, the BIC explicitly requires that a Financial Institution cannot require consumers to fully surrender their rights to compensation for damages or require them to fully waive their rights to pursue action in court. Instead, while the rules do allow the BIC to require that individual disputes may go to the industry-standard mandatory arbitration, consumers must retain the right to pursue a class action lawsuit in court. Which means if a Financial Institution systematically fails to adhere to appropriate fiduciary policies and procedures and implement them accordingly, the Institution faces a high likelihood of a class action lawsuit in the future, for which the required disclosures will provide a roadmap to the plaintiff’s attorney to pursue!
In addition, the Department of Labor still retains the right to evaluate a Financial Institution’s policies and procedures themselves, and has already vowed that it will be “closely monitoring” Financial Institutions as they roll out their new policies and procedures in the coming year. If the policies and procedures themselves are not up to snuff, the Department of Labor can potentially declare that the Financial Institution has failed to meet the BICE requirements – which would render the firm ineligible for the necessary Prohibited Transaction Exemption, causing all of its advisors and conflicted compensation to be in violation of DoL rules, a potentially catastrophic outcome that Financial Institutions will desperately wish to avoid!
The BIC Exception For Level-Fee Fiduciaries
In the world of fiduciary advice, it has long been recognized that earning level compensation which does not vary by the product being recommended (e.g., ongoing level AUM fees, rather than upfront commissions) is an effective way to mitigate many conflicts of interest. In fact, the Pension Protect Act included a level-fee prohibited transaction exemption to help facilitate otherwise-conflicted advice in employer retirement plans a decade ago.
Along these lines, the final DoL fiduciary rule includes an alternative (and “streamlined”) way for advisors who receive level fees to qualify for the Best Interests Contract Exemption, without actually being required to complete a full Best Interests Contract, by instead qualifying as a “Level Fee Fiduciary”.
The “Level Fee Fiduciary” (LFF), and the idea of providing an easier exemption for those who were already fiduciaries that were simply shifting clients from one form of level compensation to another, was a concept put forth in Comment letters to the 2015 version of the fiduciary rule proposal, most notably and thoroughly by the American Retirement Association (though also supported by the Financial Planning Coalition comment letter as well).
In the final rule, the “Level Fee Fiduciary” qualifies as such “if the only fee or compensation received is a ‘Level Fee’ that is disclosed in advance to the Retirement Investor.” The DoL states that such levels fees could be either calculated as a (level) percentage of AUM, or as a set fee that doesn’t vary at all with the particular investment (e.g., a retainer fee).
Notably, to be eligible as a “Level Fee Fiduciary”, the advisor would not need to already be an RIA receiving level AUM fees. It could be a broker who receives level fees via 12(b)-1 fees, or as compensation for a fee-based wrap account. However, to be eligible for the Level Fee Fiduciary exception, the advisor – and the Financial Institution, and its Related Parties and Affiliates – must receive only that Level Fee, and not any other commissions or transaction-related compensation. Thus, adding 12(b)-1 fees on top of level fee compensation would be problematic, as would other types of revenue-sharing agreements (disqualifying the engagement from eligibility for the Level Fee Fiduciary exemption, and forcing the firm to follow and rely upon the whole Best Interests Contract instead).
For advisors and their Financial Institutions that do qualify for the LFF exception, the firm is still required to provide a written statement of fiduciary status (which could be part of the client agreement), must still comply with the required standards of impartial conduct, and must still document the specific reason and validation for doing the rollover transaction and that it was in the interests of the client (e.g., document both the costs of the plan, the new costs of the advisor and his/her chosen investments in the IRA, differences in the level of services [such as whether it is investment-only or includes financial planning advice as well], etc.).
If these requirements are met, though, the firm does not have to comply with the full scope of completing the BIC agreement and the full extent of the policies and procedures disclosure requirements for the Financial Institution (since, presumably, there would be less in the way of material conflicts of interest to disclose for the Level Fee Fiduciary in the first place).
In the long run, it’s entirely possible (and I think, likely!) that most/all advisors will end out pursuing the path of being a Level Fee Fiduciary, to avoid both the BIC agreement obligation and the associated policies and procedures requirements. In other words, similar the rules for RIAs that have custody, an investment adviser can have custody of client assets, but is subjected to significant additional scrutiny by doing so, such that in practice most RIAs simply avoid custody altogether to avoid the additional custody compliance requirements. The Level Fee Fiduciary safe harbor will likely have a similar impact over time.
Execution of the BIC Agreement
In what was viewed as a significant concession to the industry, the actual execution of the BIC agreement itself (for those who provide fiduciary investment advice and are not Level Fee Fiduciaries) was greatly expedited in the final rule.
While the prior proposal of the rule would have required the BIC to be a separate written contract, that the advisor would have had to deliver and get signed before even talking to a prospect about something that could have been deemed “advice” or a “recommendation”, the final version of the rule stipulates that the BIC doesn’t have to be signed until the client actually opens an account. In addition, the BIC can be incorporated directly into the paperwork of a client advisory agreement or account opening document, rather than as a standalone separate contract to sign.
Notably, the final rule also stipulates that the BIC will generally be a contract between the client and the Financial Institution (not “just” the advisor). To some extent, this was done to accommodate firms that have multiple advisors serving a single client, so that a new BIC doesn’t have to be signed each time a new/different advisor interacts with a client (which would have created issues for everything from when a new advisor takes over the clients of a prior advisor, to “call center” firms that may have multiple advisors who respond to a client inquiry).
Notwithstanding the timing of when the BIC will be signed, though, and that multiple advisors may have interacted with the client along the way, the final rule also requires that all recommendations of the fiduciary advisor are subject to the BIC, retroactively including the recommendations that were made to the client leading up to the transaction for which the BIC was ultimately signed. Thus, even though the BIC won’t be signed until the implementation phase with the client, it will still cover all the advice recommendations leading up to that recommendation being implemented.
BICE Grandfathering Provisions For New DoL Fiduciary Rule
Given that many advisors will be transitioning into fiduciary status for the first time – and thus becoming subject to the prohibited transaction rules and the requirement to obtain a prohibited transaction exemption by following the BICE requirements – the DoL provided several “grandfathering” provisions to provide relief transition for those who have a large base of existing commission payments coming in.
First and foremost, the final DoL fiduciary rule outright grandfathers any ongoing commission payments that continue to be received for advice that was provided prior to the effective date of the new rules (which will take effect in 2017, as discussed below). Thus, brokers will not be required to give up existing 12(b)-1 fees and other trailing commission payments.
In addition, any ongoing client contributions that were already committed to as part of a systematic plan will also be permitted to continue (even if it triggers new/ongoing commissions), without being newly subjected to the BIC requirement.
However, any new recommendations to an existing client, including a recommendation to make new additions to existing commission-based investments (that would trigger a new commission or other additional compensation to the advisor), will require a new BIC agreement once the new rules take effect. In addition, existing clients will ultimately need to be transitioned into the BICE exemption once the new rules take effect, which can be done with a “negative consent” procedure (sending a letter to clients informing them of the new agreement and giving them the option to leave if they don’t want the new arrangement for some reason, but otherwise defaulting them into the new fiduciary engagement).
And of course, any new clients and new advice after the applicability date (discussed below) will be subject to the new BICE obligations.
When Do The New Best Interests Contract Exemption (BICE) Requirements Apply?
One extremely important aspect to the new BICE requirements to act in the best interests of a client as a fiduciary is to know when the advisor actually has a fiduciary obligation to the client – a threshold which is critically important to define in the first place.
First and foremost, it’s important to recognize that the fiduciary obligation under the final DoL rule, and the related BICE compliance requirements, only apply in the case of advice provided to “Retirement Investors”, which is defined as participants and beneficiaries of an ERISA plan, IRA owners, and those who are acting as fiduciaries for an IRA or ERISA plan (e.g., plan sponsors).
Thus, advice outside the scope of a retirement account – whether pertaining to an individual brokerage account, a bank account, or non-investment-account alternatives purchased with non-qualified dollars (from a non-qualified annuity to a direct-purchase non-traded REIT) – is not subject to the new rules. Notably, though, the DoL acknowledges that a Health Savings Account (HSA), Medical Savings Account (MSA), and Coverdell Education Savings Account (the so-called “Education IRA”) would be subject to the new fiduciary rules (as they’re part of the same prohibited transaction requirements under IRC Section 4975(e)(1) that apply to IRAs as well).
If a Retirement Investor is involved, the next question is whether “Investment Advice” is being provided. Investment advice is defined as advice for which the advisor receives a fee or other compensation (directly or indirectly) for providing a recommendation on either:
- The advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, or a recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA; or
- The management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g., brokerage versus advisory); or recommendations with respect to rollovers, transfers, or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer, or distribution should be made.
If Investment Advice is being provided, the next question is whether the advice is being delivered by someone who would be expected to have a fiduciary advice relationship with the client, which means a person who:
- Represents or acknowledges that it is acting as a fiduciary;
- Renders the advice pursuant to a written or verbal agreement, arrangement, or understanding that the advice is based on the particular investment needs of the advice recipient; or
- Directs the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.
Notably, in the context of determining whether a fiduciary advice relationship exists, a key question is whether the discussion with the client actually constitutes a “recommendation”. Accordingly, a recommendation itself is defined as:
- For purposes of this section [of the DoL fiduciary rule], “recommendation” means 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 determination of whether a “recommendation” has been made is an objective rather than subjective inquiry. In addition, the more individually tailored the communication is to a specific advice recipient or recipients about, for example, a security, investment property, or investment strategy, the more likely the communication will be viewed as a recommendation. Providing a selective list of securities to a particular advice recipient as appropriate for that investor would be a recommendation as to the advisability of acquiring securities even if no recommendation is made with respect to any one security. Furthermore, a series of actions, directly or indirectly (e.g., through or together with any affiliate), that may not constitute a recommendation when viewed individually may amount to a recommendation when considered in the aggregate. It also makes no difference whether the communication was initiated by a person or a computer software program.
Notwithstanding these requirements, the rule also specifically acknowledges certain scenarios where something is clearly not a recommendation, and/or where something would be deemed a recommendation but is not fiduciary advice anyway. These scenarios include:
- Just making a platform of investment options available to participants is not deemed advice (as long as it’s just being offered openly without regard to the individual needs of the specific investors);
- General communications
- Investment education
- General financial, investment, or retirement information
- Certain generic asset allocation models to provide guidance but not specific participant advice
- Interactive investment materials such as questionnaires or worksheets that are simply meant to help people evaluate their options (but not steer towards any one in particular)
While the DoL fiduciary rule provides significant guidance already regarding these various definitions and exceptions, expect the Department of Labor to issue additional regulations and guidance in the coming year to further clarify areas of ambiguity about where the lines are drawn regarding the exact moment at which a fiduciary engagement applies.
To Which Investment (And Annuity) Products Does DoL Fiduciary Apply?
One notable distinction to the new DoL fiduciary rules is that their applicability is based on whether advice is provided to a Retirement Investor (i.e., pertaining to a retirement account), and not based on what type of product it is.
Thus, while historically, the sale of securities products was regulated by FINRA, the sale of insurance products is subject to state insurance regulators, and investment advice was regulated by the SEC (or state securities regulators), the DoL fiduciary rules cut across all of these product silos to provide a fiduciary obligation for recommendations pertaining to retirement accounts, regardless of which of these product types are implemented.
As a result, the new requirements will apply to anyone who provides a recommendation about whether to rollover an IRA, or about how those IRA assets should be invested. This means that all the fiduciary requirements, including the disclosure provisions and the requirements about appropriate illustrations that are not misleading, will apply not just to “traditional” investment products, but also annuity products sold within retirement accounts – specifically, variable annuities and equity-indexed annuities, which the Department of Labor notes are “complex” enough to merit such scrutiny and be subjected to the BICE requirements (which means insurance agents selling annuities into retirement accounts will be treated as fiduciaries for the first time ever, so no more inappropriate claims of “no-cost” equity-indexed annuities that are paying big commissions under the table!).
Fixed-rate annuities, however, will be eligible for a less stringent (but also updated) Prohibited Transaction Exemption 84-24, and not need to comply with the full BICE obligations.
Deadline For New BICE Requirements And What Advisors Must Do
Under the final version of the Department of Labor Conflict of Interest Rule, the rule will become “effective” 60 days after it is entered into the Federal Register, but actual enforcement of the new rules will be delayed to allow the industry time to adapt. Instead, the “Applicability Date” for the IRA rollover and other DoL fiduciary rules will be April 10, 2017.
Even as of the April 10, 2017 applicability date, advisors who give fiduciary investment advice to Retirement Investors will be subject to the fiduciary obligation, but the detailed policies and procedures and related requirements of the BICE obligation (and enforcement for failing to implement those requirements) will be delayed until January 1, 2018 to allow the industry a “transition period” of adjustment.
In practice, this means that advisory firms of all types have a year to figure out when/whether they are providing fiduciary investment advice to Retirement Investors (i.e., when the fiduciary rule applies), and to make adjustments to their compensation and systems to ensure that their subsequent actions are meeting the fiduciary requirements. This also provides time for firms to either affirm that they meet the requirements to be a Level Fee Fiduciary, or adjust their practices so that they can qualify as a Level Fee Fiduciary when the time comes. (Notably, this may disrupt some relatively “common” but already controversial practices of RIAs today, such as charging different levels of AUM fees for bonds versus stocks, which under the new rules would disqualify the firm from being a Level Fee Fiduciary, and possibly be ineligible for the BICE altogether, due to the conflicted compensation.)
Over the subsequent months, Financial Institutions will need to complete the implementation of their policies and procedures, and their supporting Best Interests Contract (BIC) agreements themselves, and transition ongoing advice clients into the new agreements (through the DoL’s prescribed “negative consent” default-in process).
Advisory firms should also recognize that whether they must complete the BIC agreement, or operate as a Level Fee Fiduciary, they will need to adopt a new level of scrutiny and review to substantiate any rollover recommendation they make (along with any recommendations to transition from a commission-based account to a fee-based account) after the April 10, 2017, applicability date. This is a new level of documentation that most advisory firms are not accustomed to, and while most may simply find this a minor paperwork speedbump, in some cases it may force firms to really evaluate whether their advice and value-add is sufficient to truly justify a recommendation to roll over retirement assets from an existing 401(k) plan.
In the meantime, arguably the greatest adjustment pressure will be on insurance and annuity companies, and broker-dealer firms, that will not likely qualify for the Level Fee Fiduciary exception and thus must not only engage in a Best Interests Contract (BIC) agreement with clients, but institute the new requirement for policies and procedures to both disclose and then manage and minimize any conflicts of interest. In the long run, this will arguably be the largest adjustment to the fiduciary rule, impacting not merely the brokers and insurance agents at the firm – including potentially how they’re compensated, as differential compensation and sales incentives are eliminated – but the processes and procedures and even business model and structure of broker dealers and insurance companies themselves. Not because the Department of Labor mandated which types of compensation or products can stay or go, but simply because the firms will now be cognizant that if they cannot defend their processes and procedures to the DoL – and the outcomes to a court in a future class action lawsuit – that failure to effectively comply with the new fiduciary rule could mean a fiduciary breach that could damage or put the firm out of business altogether.
Implications Of The New DoL Fiduciary Rule
Ultimately, the interpretations of the new DoL fiduciary rule will likely continue for months, and given the delayed Applicability Date and the subsequent Transition Period, it will potentially be years before the full impact of the new rules are felt.
Nonetheless, my gut having read the entire 1,000+ pages of the rule and its supporting materials, is that the Department of Labor was quite savvy in picking exactly which parts of the rule they conceded, and which remained intact.
Because a detailed look reveals that as long as the core of the rule remains intact – that Financial Institutions must disclose all of their compensation and Material Conflicts of Interest, that advisors must affirm their fiduciary duty, and that Financial Institutions that offer conflicted advice must forever leave the door open to a future Class Action lawsuit – most of the points that the DoL conceded weren’t exactly much of a concession at all.
In other words, fiduciary critics have lamented that the final DoL rule reduced the depth of up-front disclosures, allowed the BIC to simply be incorporated into advisory and new account agreements, and eliminated the restricted asset list (opening the door to both controversial illiquid products like non-traded REITs, high-commission products like some variable and equity-indexed annuities, and proprietary products). But as long as the core fiduciary rule and its enforcement remain intact, these concessions may not have been concessions at all. It simply means that instead of regulating against those products and scenarios in the first place, the DoL will force the issue into the courts through class action lawsuits, and let future judges sort out what really works and what doesn’t!
In point of fact, this is arguably the whole point of principles-based fiduciary regulation – not to prescribe a never-ending series of ‘precisely’ written regulatory rules, which just invite industry participants to push to the very limits of the line without putting a toe over – and instead creates the kind of principles-based guidance with a level of ambiguity that forces firms to shift their culture, for fear of being found guilty after the fact (coupled with the outright banning of some problematic behaviors, such as eliminating sales contests, and forcing others like under-the-table revenue sharing agreements into the light of day).
In essence, the Department of Labor has collectively said to the financial services industry “You claim that you can still offer illiquid, commission-based, proprietary products to consumers while also receiving revenue-sharing agreements, and simultaneous still act in the client’s best interests as a fiduciary? Fine. You can prove it to the judge when the time comes.”
I suppose when the time comes in a few years, we’ll see what happens. Though I suspect that many Financial Institutions, when faced with the possibility of losing a very expensive and high-profile class action lawsuit, will feel compelled to take it upon themselves and reform their own business practices, to avoid the risk of putting themselves out of business. Or alternatively, may simply decide it’s easier to switch over and become a Level Fee Fiduciary, because there’s less ambiguity and legal danger to executing the simpler and less conflicted business model. Which perhaps is exactly what the very smart folks at the Department of Labor wanted to see happen in the first place.
In the meantime, though, it seems likely that the Department of Labor’s actions will ultimately force the SEC to act as well, as we now have what seems to be an untenable conflict where an investor’s retirement account is subject to a higher standard and a greater level of scrutiny than his/her brokerage account and other non-qualified assets. On the plus side, by the time the SEC gets around to acting, the DoL rule may already be fully implemented and in force, in which case the SEC will get the political cover it needs to finally step up its own rules, if only to “conform” to the Department of Labor. Which means by sometime around 2019 or 2020, we may finally have a fiduciary standard for all investment advice!
So what do you think? Did the Department of Labor do a “good job” with its new fiduciary rule? Did it go too far, or not far enough? Are you concerned about your ability to comply with the new rule? Please share your thoughts in the comments below!
Key documents:
Department Of Labor "Fact Sheet" On The New Fiduciary Rule
Final Department of Labor "Conflict Of Interest" Rule Materials
Final DoL Fiduciary Rule
Department Of Labor Guidance On Best Interests Contract Exemption
Updated PTE 84-24 Exemption Details
Michael,
I don’t know if you read the same rule I read last week. I walked away thinking it was a bunch of meaningless chest pounding (that people could mistake for new “rules”), regurgitation of prior rules, a couple of puzzling contradictions, and annoyance at the overall childish nature of bureaucratic rule makers.
Note: I do believe after reading it that sections of the rule were developed by different people/teams and that they didn’t communicate well with each other and that created a couple of contradictions (but potentially more that I didn’t see).
1) The 3 bullets that brought up “shifting account with a lower fee into a new IRA with a higher fee” as being an instance for a BICE seems incorrect. I believe those items from the original proposal were thrown out and were specifically addressed in them passing on the “low fee exemption” section. I.e. they seem to make it clear that fee price is no longer any factor in whether a BICE is needed or not needed.
2) One of the giant contradictions in the piece is that it seems that people were writing about the “level fee comp” and the people that were talking about discretionary accounts had a completely different understanding on how the rule was supposed to work.
a) The level fee comp people (and how I originally understood it) seemed to think that the BICE is the DOL’s fiduciary rule and the goal is to basically get everything on BICE. Side note: It’s weird in practice as it effectively defines practically everything as a “prohibited transaction subject to exemption” so that they can force even current fiduciaries onto the BICE. The “level fee” group tried to give basically AUM fee practitioners some exemption.
b) When it got to those with discretionary authority (most level fee advisors have discretion) a different group had a completely different understanding. They instead said that these advisors didn’t have exemption, but (paraphrasing) “there was already a decades long standing regulatory framework for those with discretion”, and basically implies that if you’re already a fiduciary with discretion this entire rule doesn’t even apply to you. That is a wildly different interpretation and one where there are apparently categories of fiduciaries not engaged in prohibited transactions and not subject to the rule.
3) Now with both a and b it appears that AUM fee model is basically covered in one way or another.
4) Cut through the BS chest pounding and the real news is that this is basically a joke in terms of implementing anything new. All the crap you mention these firms “have to do” already basically do. The BICE pretty much plagiarized the SEC for anyone who is at least dual registered. Oh wow, we now need to link to our ADV on our website in regards to a few items (who cares). The new disclosures and the contract are buried in 10-50 pages of new account paperwork.
5) The big question before this thing was released was whether or not the rule was going to be a joke or whether all of our E&O insurance was going to skyrocket because the DOL may get rid of binding arbitration. Well it’s pretty much a joke with the exception of being able to bring class actions.
6) All it really changed was now call center employees, bank employees, etc. create (essentially) fiduciary liability to their institutions (but still mostly in FINRA court) instead of suitability standard liability and that means those institutions are going to shut down what can be said to customers. Instead they’ll just produce a website of suggested investments (robo, whatever) and have their call center employees direct them to there.
7) Lastly, this entire thing seems to be written by a few childish bureaucrats with a way exaggerated sense of outrage and even more exaggerated sense of their own importance, but then like any typical bureaucrat they got bored of this and decided to plagiarize the SEC so they could go home at 3:00 pm and catch up on some Netflix.
Also if I’m JP Morgan, Fidelity, Merrill, Morgan Stanley, Wells Fargo, UBS, etc. I know how I’m dealing with this “DOL is going to closely monitor new company disclosures and remove exemption from anyone not up to snuff”…
I would go out and hire the same consultants, attend the same conferences talking about implementation of new DOL disclosure requirements, etc. to make sure all of the big transactional BDs are on the exact same page. Then we all implement the same joke “changes and disclosures” at the same time and dare the DOL to come after all of us. When the DOL voices their displeasure at the “progress” they got vs. what their lazy naive do-gooder employees thought they were going to get, the companies will agree to throw in a couple more bones of disclosure/change so everyone can go home and watch more Netflix.
Maybe that was why the DOL included right to class action for breach of contract in their rule, maybe someone there was actually smart enough to know that they’ll eventually be left pretty powerless to effect change with nothing more than a nuclear bomb in their pocket that they ultimately can’t use.
And this is why all clients must wear a body cam to every face-to-face meeting and record every phone call. Clients will never be able to cut through all that obfuscation, deception, diversion, deflection, denial (all the Big Tobacco tactics) of Wall Street’s worst–the full-service brokerages/wirehouses.
Michael,
What is your take on how the rules will apply for an advisor who uses a level fee (AUM) model for securities, while also using commissionable fixed rate annuities (fixed deferred, immediate, longevity, QLACs)? Will there be some BD/RIA firms that allow advisors to operate under a level fee exemption and a fixed rate annuity exemption, without BICs? Would that be a strategy to reduce institutional liability?
What is your take on what insurance companies and broker dealers will do to payout grids, production based conference meetings, etc.? Will most not change much, disclose it, and plan to defend the approach from class action lawsuits?
Some conspiracy theorists believe that the new rules are basically written so that Vanguard, Fidelity, and Federal TSP funds reduce “leakage” from employer-based plans, and that there will be a series of class action lawsuits to attempt to get judgments that there is little to no justification to rollover accounts to IRAs. The conspiracy theorists suggest that the affect of the class action lawsuits will be to reduce investment selection advisory based compensation/fees to whatever robo-advisors or internal qualified plan asset allocation services charge–maybe 0.15-0.25%. Then, advisors will need to charge hourly or retainer fees instead of AUM fees for financial planning advice. What is your take on this?
Thank you for your summary.
They did a specific carve out exemption for fixed annuities and even then BICE would have only applied if you used them with qualified money.
There liability hasn’t really changed so maybe some RIAs or BDs that allow dual registration will overreact, but if they read the rule right they shouldn’t restrict business lines as a result. The reason is because they already had fiduciary liability with their current advisors.
Soft money things like production based conferences could be impacted depending circumstances and make off of advisors (if they’re all on BICE already than I doubt they’ll care, but if a substantial number of advisors in the group are successfully avoiding BICE than maybe they’ll alter?). They’ll disclose. They won’t be sued over that. That rule is basically already in place in ERISA plans and has been for a couple years. It’s also implicitly apart of your ADV as a RIA per SEC/state regulations. I doubt much change in comp structure (maybe accelerating the trend towards flatter residual comp structures with the disclosure of commissions).
Bad conspiracy theory. The fee amount rules got thrown out because of those types of complaints. Also, no one is going to bring class actions against small advisors because of inability to put together a class and there is no way in hell FINRA abritators are going to grant anyone the argument that an AUM fee is always unjustified from low expense qualified plans. The only groups that had a change in liability are the big guys like Vanguard, Fidelity, etc. because they have large call centers and branches filled with the least talented advisors in the business dispensing recommendations on their own proprietary product and they’re large enough to get a class action.
Michael, I would like to add that every client with an account with someone or something that calls itself something that implies a relationship of loyalty, care, confidence and trust–like financial advisor/adviser–must bodycam/videotape every face-to-face meeting and record every phone call so that he/she has all the information word-for-word from the so-called advisor’s/adviser’s mouth. No exceptions. I think that that type of transparency would eliminate a lot of bad behavior and might even cause some so-called advisors/advisers to “fire” his/her clients for forcing transparency upon him/her. If the advisor/adviser does fire the client, then the client has a very good idea of what kind of “advisor/adviser” or non-advisor/non-adviser he/she had in the first place, and then that client can spread the word via all means available especially social media, chamber meetings, visits to retirement homes, etc.
Clients speak about things in meetings that they want held more confidential than the things they share with their priest or therapist. They won’t consent to recordings.
Recording sales presentations is one thing.
Recording client discussions is not going to pass privacy hurdles.
Do you think all Doctor, therapist, ecclesiastical, legal, accounting, etc., etc. sessions should also be recorded and broadcast as well?
The client would be the one doing all the recoding not the “advisor” and the client would own the recordings.
If a client or patient would like to videotape conversations or record calls so that he/she has the information word-for-word, why would anyone who was working solely in the best interest of his/her client/patient object. The owner of the recordings would be the client. This would be a wonderful and helpful thing for the client or patient? As it is extremely difficult to take thorough notes when the information is asymmetrical–one party knows everything and the other knows nothing. That’s an environment ripe for client manipulation and exploitation. Clients will never be able to cut through the obfuscation and bull. They must have recordings for protection. The only other alternative is for the client to have a wealthcare advocate (like a healthcare advocate) accompany him/her to every meeting and listen in on every call. That might be expensive, but it is necessary, as the stakes are too high not to have either recordings (cheaper) or a wealthcare advocate (expensive). There’s no way around it. One of those solutions is mandatory.
It’s just too Orwellian to require investors to record, catalog and store video and audio of their most private conversations.
If investors are really that concerned about conflicted advice, they can choose to work with hourly or retainer fee-only advisors.
The DOL rules will have the affect over time of transitioning most advisors to fee-based practices, with the elimination of differential compensation and non-cash compensation for commission based products.
It’s quite possible that commissions will be charged at the broker-dealer level instead of at the mutual fund level. This will effectively eliminate selling to breakpoints and churning.
The most egregious practices of high fee variable annuities and illiquid indexed annuities will change with the DOL.
Hopefully, illiquid real estate IRAs and the ripoff precious metals IRAs will completely go away due to threat of class action lawsuits.
Unfortunately, Tony, there are bad IRA/RIAs too. The problem of asymmetric information, kangaroo court arbitration, and out-of-sight, out-of-mind fee collection will continue. The reason that people hire financial planners/advisors/advisers is because they don’t have the time, experience, or desire to spin another plate. It has taken me 2.5 years to figure out how the industry operates and to develop an obfuscation meter. Few, if any, other folks are going to do that and nor should they have to. The other problem, of course, is that non-transparent fee collection system used by nearly all in the industry. That also needs to change. If you can’t measure it, you can’t change it.
In an arbitration a picture (video recordings and “tape” recordings) can say a thousand words. Showing what goes on behind that closed door and on those phone calls would be extremely valuable protection for the muppet investor which is 98% of us.
What about QLAC’s for retirement accounts? Does that fall under the fixed annuity piece?
Yes, unless they are on an indexed or variable platform, they are fixed rate annuities.
“you can charge Walmart prices for Walmart service or Tiffany’s prices for Tiffany’s services, but don’t provide Walmart services for Tiffany’s prices [which would be excessive and not reasonable compensation for services rendered]!”
Does this take the relative value of the advisor’s time into consideration?
Let’s say there are two advisors: Young Advisor and Seasoned Advisor. Both provide the same level of services. Young Advisor has no clients and charges 1% for investment management on a $250k account. Seasoned Advisor has a healthy book and therefore charges 2% for the same account.
Young Advisor has pricing below market average and Seasoned Advisor above, but neither is necessarily pricing based on the level of the services provided — they are pricing based on the relative scarcity of their time. Does this mean that Seasoned Advisor is now at risk of getting in trouble for working with fully informed clients who think her services are worth a 2% fee?
I don’t there’s any empirical work done that reflects a ‘seasoned’ advisor outperforms a young advisor when it comes to investments. I would think you could charge more if there are additional services provided as a senior advisor that a young advisor couldn’t. In other words, you’re a seasoned pro with SS strategies, Medicare, you hold additional certifications, perhaps? I don’t believe investments alone will cut it when it comes to management as product is commodity.
You’re missing the point. Some hourly planners charge $100/hour and some charge $500/hour. I doubt there is any empirical evidence that the $500/hour advisor gives advice 5x better than the $100/hour advisor, but a professional has the right to set their own pricing. That pricing should reflect the opportunity cost of an advisor’s time (which can be very different, even when the services delivered are the same). The power to decide whether a particular price is justified ultimately belongs to the consumer.
There’s an irony in the way that some in our industry evaluate fees. Charge a client with a $250k portfolio a 2% AUM fee and you are a thief looking to fleece hardworking Americans. Charge that same client a $5,000 retainer and you can join the ranks of the holier-than-thou crusaders blazing a new path in the industry. The cognitive dissonance is astounding.
Definition of profession is a paid occupation, especially one that involves prolonged training and a formal qualification. Does financial advisor/adviser fit that definition YET?
I reject the notion that a profession can only be founded on legal barriers to entry. I think there are more tacit and emergent regulatory pressures–particularly those that arise from market participation–which can provide a proper foundation for a profession. I suspect we may disagree on this topic, but I do not believe that a lack of prolonged formal education precludes the advisory industry from being a profession.
(That’s not an endorsement of the status quo or a claim that it can’t be a better profession, but I do believe that it is a profession.)
There’s something to be said for having something to lose.
Clients stand to lose their lifelong, hard-earned, irreplaceable savings.
A Financial Advisor by disguising a sales relationship as a relationship of loyalty, care, confidence and trust and using that relationship to manipulate and exploit his/her clients stands to lose very, very little in the way of investment in himself/herself, reputation or money/assets in the financial (dis)services or insurance industries. Raise the bar for entrance into the industry, get some real regulators, get rid of mandatory arbitration and clean up The Street. Then and only then can we start talking about referring to your industry as a profession.
There are many incompetent CPAs, many incompetent college professors and secondary education teachers, many incompetent lawyers, many incompetent physicians, many incompetent chiropractors, many incompetent dentists, etc., etc.
Although it would be interesting to establish competence levels for financial professionals by the requirement of advanced designations, consumers still are ultimately responsible for who they chose with which to work.
Dentistry has an ethical standard that requires referrals to specialists if it is better for patients. Still, the majority of all root canals today are performed by lower competency general dentists than by endodontists.
If we cannot obtain complete competency for services and advice in medical, dental, tax, and legal professions, how are we supposed to obtain this with financial professionals?
Consumers have a responsibility to educate themselves of the difference between a salesperson and an advisor. They have the responsibility to educate themselves on what advanced designations and degrees correspond with higher levels of competence.
I would love it if the CFP became the same standard as the CPA is to accounting and tax, but that isn’t going to get legislated.
Really, Tony, that’s your response?
Your industry (it’s not a profession) is unique, perversely unique.
Brokers are allowed to masquerade as Financial Advisors.
– the regulators condone it
– the media condones it
– the majority of the industry condones it
– many of those in the state and federal government knowingly and unknowingly condone it
– employers knowingly and unknowingly condone it
– professionals–CPAs, tax and estate attorneys, & TPAs–condone it
And you think that consumers have a responsibility to educate themselves on the difference between a salesperson and an advisor. Have you forgotten that in your industry the two are synonymous? I believe that it was the ReformedBroker (Josh Brown) in his book, Backstage Wall Street, that said he was surprised if any investors could figure out that trick. In fact, he was surprised if those in the industry could figure it out. And you want us muppets who have never studied your industry nor worked in your industry to figure out that trick? It took 2.5 years of researching your industry to figure out the modus operandi of the financial (dis)services industry, and you expect old women, harried small business owners, medical doctors, etc., to figure out that trick. Who were Thomas Buck’s clients? They were professionals. Who were Karen McKinley’s clients? Multi-millionaires. Who were Ami Forte’s clients? One of my family members’ mothers is in her 80s. Her husband’s employer, AT&T, allowed what they called UBS Financial Advisors (they didn’t refer to them as salespersons) to come into the AT&T and “educate” and “advise” employees. Now why would any of those employees’ Salesperson Radar go on in that case? Guess who her husband started going to for his financial advice? Her husband is now deceased, but for her that man is like a god. Her son doesn’t have the heart to tell her what that guy has done to her and the money that she and her husband saved. It was only recently that her son figured out that the guy was a broker masquerading as a financial advisor/adviser, and the only reason that he found out was because another family member had her face ripped off by a wirehouse broker masquerading as a Financial Advisor. In my family I would expect that at least 7 of 9 family members have been fooled by the broker masquerading as a Financial Advisor charade, and each is with a different so-called advisor/adviser. Do you think that makes we wonder about the number of bad apples in your industry? At first glance you might think that my family members are all a bunch of dummies, but no, we aren’t, and if you think that, then you best be thinking that of 98% of investors, as that’s how many of us are muppets. And, because we are muppets and we know we are muppets, we seek out help from folks whose website and business card shingles say Financial Advisor. What a fraud! What a con job! Yes, your industry folks are professionals. They are professional con artists. Clean it up!
– Raise the bar much higher for entrance into the industry and maybe someday you folks can earn the title professional.
– Get a real regulator that bites with sharks’ teeth.
– Do away with mandatory arbitration.
– Raise the curtains and let the sunshine in or get the Clorox (bleach).
– Make brokers brokers–they do transactions period, they provide no advice– and make advisers advisers–they provide advice, they do not do transactions. Do not let one person serve as both. No one can serve two masters. No one can wear two hats.
– Get rid of the out-of-sight, out-of-mind fee collection system. Submit a detailed invoice and collect payment via a check or credit card like the rest of the universe. What’s wrong? Are you afraid that folks might question your real value?
I don’t entirely disagree with you.
I’m a professional. In addition to an MBA with an emphasis in Finance, and having completed all th educational requirements to sit for the CPA exam, I have a Master of Science in Financial Service, a CFP, and a host of other designations. I’m an expert witness, a Finance professor, and I teach CLE and CPE courses.
My model is that I charge either an hourly or project fee, and/or an AUM fee. There are some limited products I use that pay a commission that are not yet available for fee-only professionals–like fixed rate annuities, longevity insurance, QLACs, and long term care insurance.
I’d have no problem with a model where I charge a retainer fee, a smaller AUM fee, and had access to insurance products that were stripped of commissions.
So, you are sort of preaching to the choir about the need for competence and professionalism in financial services.
However, where we part in opinions is the practicality of satisfying the needs of consumers where there is already a shortage of licensed individuals. If we reduce that even further by requiring advanced designations, the market will be underserved even more.
The CFP Board does a fairly good job with their TV commercial about looking for a CFP.
Body cams and some of the other things you suggest are just not practical or viable.
The only way that we’re going to see how brokers are controlling the conversations and manipulating and exploiting clients is by videotaping those meetings that are occurring behind closed doors and recording all phone calls. I went with someone to his meeting at Merrill Lynch. I witnessed what was happening firsthand. I went into that meeting expecting to see obfuscation; the team of two Merrill Lynch brokers masquerading as Financial Advisors didn’t disappoint. I, however, was still flabbergasted. It was sickening. The meeting ended with one guy saying that he had to go and meet someone, and with the other guy pushing away from the round table and scooting his chair behind his desk and saying that he felt sick and that the meeting would have to be wrapped up. He said that the questions were getting redundant. The questions were about fees, whether they were brokers or advisors, what type of accounts the client had, why the investments were chosen, what the conflicts of interest were, etc. We received very few straight answers. We asked what time it was; we were told how to build a clock. Obfuscation, deception, diversion, deflection, and denial–we witnessed it all–all the tactics that were/are used by Big Tobacco!
I witnessed the same thing with two brokers masquerading as Financial Advisors at Morgan Stanley. Both teams–the one at Merrill and the one at Morgan Stanley–said that they work in the best interest of their clients. LOL!
So, now you know that you need to stay away from wirehouses. If any of those individuals were CFP practitioners, you would report them to the CFP Board.
Personally, I would never, ever send a friend, family member, or a client to any Merrill, Morgan, Ed Jones, UBS, RBC, etc., type of firm. Those guys focus on investment selection, not planning or advice. If they focused on advice, they would not fit into the culture, and they would have left a long time ago.
My clients tell me that the difference between me and the other financial professionals they interviewed was primarily that the first meetings with those other professionals was all about investment selection.
As a metaphor, it was like they were selling round pegs to a child’s play toy, and they wanted to make those round pegs fit into the holes in the toy, even if the holes were square or star shaped.
They told me that they were impressed that we didn’t talk about investment selection during our first couple meetings. We focused on planning, and the plan would drive the investment selection, not the other way around.
Continuing with the metaphor, I had round, square, star shaped, oval, and rectangle pegs in my toy box, and I was going to recommend to them the correct peg for the financial planning hole that they needed, and it didn’t matter to me what combination or mix of shapes of pegs they actually needed or wanted. And, I would do all this at a lower cost than the other guys–even if we were using the same shaped pegs.
100% of the industry is not the “make the investment selection fit into the plan at a higher cost” advisors. Michael shared his opinion here above that his take is that the DOL Fiduciary Rules will result in a significant transition to flat-fee advisors for retirement planning assets. This won’t guarantee competence, but at least it will reduce conflicts of interest.
The rest is really going to be education of the public of the difference between someone who focuses on investment selection and someone who focuses on planning. What you and I both want is a focus on competent planning. Neither the DOL regs or anything the SEC can do will fix this.
Even if I live 50 more years, I won’t live to see the day that the majority of this industry really, truly works in the best interest of its clients/customers. Sad but true. It will never happen if brokers aka sales people aka product pushers are allowed to continue using the title Financial Advisor or the like.
I share the general discontent with the financial services and insurance industry. Food for thought: there are plenty of book smart people out there with backwards ethics/morals that can justify anything (think politicians & attorneys)…and plenty of common sense smart people that may not be very good at taking tests but who have big hearts; so I don’t think making the entry qualifications harder is going to help much – unless you can find a way to learn about and test someone’s true character and integrity.
Unfortunately this is a problem within our whole society and not just this industry. We as a country have turned to greed and forgotten about the personal satisfaction of doing what’s right. Does no one believe in the greater good anymore? When companies stopped valuing quality (not just with products, but in how they treated their employees too) and started caring more about the bottom line no matter what, we started to see a large shift toward the “everyone for themselves” mentality. Unfortunately, this is a much larger cultural issue and can be found in EVERY industry. I’m afraid the scandalous will continue to find ways to line their pockets while those of us who already have integrity will bear the brunt of this reform (kind of like the tax system). Lets hope that the good intentions of this ruling ACTUALLY benefit the clients and it doesn’t end up like the current 10 pages of foreign language product disclosures that don’t help anyone but the attorneys that charge for the time it takes to write them. It all comes down to implementation and enforcement. Maybe holding our politicians to the same laws and ethics that they try to make us all adhere to would be a good start?
Can you tell I’m disgusted with our nation as a whole? Probably going to take a lot more than a billionaire with low emotional intelligence to “make America great again”….like a huge shift in our attitudes, normal Americans making laws, and fewer attorneys turned politicians/lobbyists/social influencers. Thanks for listening…
At least upping the investment in themselves would give them more to lose, and they could take some classes or do an internship where they actually learn how to advise/counsel clients. As is, they have zero training in behavior modification or counseling–not even any courses in how to teach. How can that be? The industry is still using a product-centric model when one considers the “training” and “quizzes” needed to become a broker aka registered representative or an investment adviser.
Also, I do think that there is some correlation between broker test scores and bad behavior. From Investment News, “More than 3,000 brokers have failed the test at least three times, the
analysis showed. Those brokers were two-thirds more likely to have
disclosure events on their record, such as complaints of excessive
trading or churning.”
http://www.investmentnews.com/article/20140415/FREE/140419947/brokers-test-failures-raise-red-flag
It’s way past time for FINRA to start listing education and test scores on BrokerCheck. If they were serious about protecting investors, they would have had that information up on BrokerCheck from the get-go.
I may be cynical, but you will never see the day when an entire profession really works in the best interest of their clients and patients–not dentistry, medicine, tax and accounting, legal, education, real estate, etc. etc….or financial services.
There will either be a conflicting profit motive, or a political motive, or a power motive, or an ego motive, or lack of motivation and ambivalence that will prevent lack of motivation and ambivalence that will prevent it.
Incompetence is everywhere. Hopefully, as consumers we get references, referrals, I read reviews, and educate ourselves to avoid the crooks and the incompetent
I didn’t say ‘entire profession.’ I said a ‘majority.’ I’m trying to be realistic. I still feel that the financial (dis)services industry and insurance industry are unique, because it is actually the employer and the product providers (sausage makers) that are perversely incentivizing the sales people (who refer to themselves as advisors) to penetrate what the sales people/”advisors” refer to as their “clients.”
The other differences are the vigilance with which the industry and its relationship managers hide fees, purposefully mislead clients, i.e., obfuscate and hide and omit important information, and inconspicuously collect payment. And then, of course, there’s the kangaroo court enforcement and punishment system. Get rid of the mandatory arbitration. I’m sorry, but it’s a joke. I think that most in the industry know why that system is used. Let’s hide all this stuff from the investors. If we don’t hide it, our clients (the muppets) might not trust us anymore. For their own protection every investor must be skeptical of the industry and their so-called financial advisor, as not being skeptical could lead to devastating consequences–loss of one’s entire lifelong, hard-earned, irreplaceable savings. And that affects everything. The most important of which is one’s health care.
I’m not missing the point. I get exactly what you mean. I would believe the ruling is based on current market rates for an advisor for services provided. Or what’s fair and reasonable. I totally agree the area of pricing is too nebulous currently and that’s because it’s so difficult for investors to understand how many get paid. A pro sets prices based on the marketplace will command. As consumers grow increasingly savvy, I would think they’d scoff at paying 2% or $500 an hour. I’m thinking the new rules will add transparency to the process. I’m thinking disclosures would place all costs RIGHT UP FRONT. Not so hidden as they are now. Ostensibly, the consumer can then make an intelligent decision and compare against others accordingly. Regardless, the next couple of years going to be interesting, that’s for sure. I’m waiting to see how the SEC will eventually deal with this.
“I would believe the ruling is based on current market rates for an advisor for services provided. Or what’s fair and reasonable.”
Let’s pretend we’re trying to actually craft a framework like this. We need to allow some variation, so what degree of variation is acceptable? Market rate +/- how many bps? Under what conditions? Who gets to decide?
Your suggestion may sound good at first glance, but we quickly realize how impossible this type of framework is. That’s why the consumer should have the ultimate authority to accept or reject services at transparent (i.e., non-fraudulent) prices. I agree that 2% is probably higher than most consumers want to pay, but if a particular consumer does find it reasonable, who am I to tell them they can’t hire the advisor of their choice at that advisor’s rate?
I should also note that 2% may be an incredibly reasonable fee — particularly relative to what some hourly and retainer advisors charge. Should we start cracking down on retainer advisors charging $10k/year to work with a client who only has $100k in investible assets (making their fee equivalent to 10% AUM!)? Of course not. So long as the fee is transparent, the advisor should be free to charge $10k for their services, even if many other advisors would happily serve the same client for $1k/year.
Here’s the real impact of the rule – 1) the ABA wins since it has been upset for years that clients had to pay their fees out of their own pockets since FINRA allowed nothing for lawyer costs of advisors acting in a disreputable fashion. More class actions suits will be filed against brokers and BD’s, leading to higher legal costs under E&O, forcing E&O premiums up and planning fees – since AUM fees will be capped at 2% – will go up to compensate. AND YET, bad advisors will not be forced out since FINRA doesn’t want to lose consistent income from fines. 2) the Equity Indexed Annuity industry also wins, since there is now nothing to stop them from selling and since purchasers already assume responsibility under disclosures that they if believe the product is appropriate for them, even if they have no clue and don’t know whether they are fully informed, they want to purchase it — then see #1 above. 3) The only loser here is the public, who may be paying a fee to an RIA or advisor for “financial planning” and thinks they are getting a fiduciary when the printout generated from ( insert name of favorite “planning” software here ) may be limited to only investments or may include some other areas but the fiduciary doesn’t deal in that nor does he or she follow through to make sure the client has taken care of that area.
Great Analysis! The early ones after last Wed were by journalists who didn’t fully comprehend the topic areas.
Thoughtful and thorough analysis I’m going to keep bookmarked. It’s going to be interesting to see what this finally looks like. Although we are fiduciaries already I’m thinking of creating a fiduciary agreement on our website along with a series of promises we must fulfill. Thanks again for your guidance and insight Michael.
Great job, Michael! I imagine the special interests will have the final rules delayed indefinitely or grossly watered down, unless Bernie Sanders gets elected! : )
Thanks, I am using this as the way we move forward.
Michael, Nice job on this article/post. Super informative as always. Thanks!
Happy to be of service Richard! I hope it helps! 😉
– Michael
Wow! Great information and details. A lot of what I’ve been seeing and reading was a cursory brush over of what’s changed from the proposal, what it means for advisors, etc. But this analysis had some real “meat!”
Thank you Michael – I’ve been waiting with baited breath for your initial perspectives and look forward to you keeping us on top of this critically important subject. One thing worth noting is that elections have consequences – the one in 2012 did, and the one this year will too! I hope the next president is as committed to the average American’s best interests the current one obviously is because future enforcement of the new DOL Fiduciary Rule will be a key to its success. With good enforcement, this new rule will be viewed by history as huge progress for investors.
Thanks again,
Kay
Hi Michael,
Am I correct in my understanding that the LFF and BICE apply to people who will receive compensation *because* the client follows the investment advice? In other words, if the advisor receives compensation from the client based on an hourly fee only, that advisor doesn’t have to worry about the DOL’s new rule? Of course, that advisor still needs to act as a fiduciary, but all the policy/procedure compliance is moot?
Thanks,
Kay
Kay,
If it’s advice to a Retirement Investor and constitutes a recommendation, it’s still subject to the DoL rules, even if the compensation is an hourly fee.
However, an hourly fee would qualify under the Level Fee Fiduciary rules, so the full BIC wouldn’t apply. Just the streamlined LFF rules.
– Michael
I’ve been getting the runaround from my step-dad’s advisor trying to get my fifth of a sizeable inherited IRA. She’s my step dad’s daughter. Long delays, asks for information and I provide it and then she needs something else. Feels to me like she’s trying to milk every penny knowing that the other three also plan on moving their accounts. Do the “in the best interest of the beneficiary” provisions of this new rule extend to those aspects? Would appreciate your insight.
I am not answering your question directly but let me help on your problem. Go to the new advisor you want to transfer the iIRA to, open the account, and fill the Transfer of Assets form. As long as you have the proper documentation, get the help of your new advisor to pull the assets from the old advisor.
thanks for your suggestion. the new advisor says that in order to request a Transfer of Assets, firts an account has to be opened at the old firm to put the assets in my name (since I’m getting a portion, not the whole IRA). That’s the hang up. I found out my step-dad’s advisor is also a beneficiary and took her share months ago while stalling ours. Seems self serving in a few ways. Again, I thank you for the suggestion.
That is correct. That account has to be opened first because the ToA is between accounts of the same registration. Here is what you can do: go to the firm where the IRA is currently under custody. Bring the death certificate and the social security number of the deceased holder and notify them that the IRA account holder has died, and that you are a beneficiary of that account. At the same time, fill in an application for the inherited IRA. Regardless of whether the IRA is currently under management through an RIA, you should be able to open that account at the retail branch level and force the delivery of your beneficiary percentage. That’s how it would work at our custodian if we were giving someone the runaround as you are experiencing. We would get a courtesy call from our custodian informing us that the IRA is being distributed to the listed beneficiaries that initiated a transfer request. Once funded, your current advisor will be able to transfer that account to your new manager. If you want to discuss further in private you can send me a message through pathfinancial.net/contact. Good luck!
Thank you, Michael!
How will an investor be able to sue in a court of law after signing a bice contract? Will invesotrs even have a leg to stand on legally after signing so many pages of disclosure information?
Elaine,
The BICE rules require that the broker affirm in their agreement that they are a fiduciary. And fiduciary duty isn’t something that can just be disclosed away with more paperwork. In other words, disclosure alone is not a sufficient defense to breach of fiduciary duty (unlike the suitability standard).
That being said, bear in mind that companies can still require individual investor disputes to go to arbitration. Consumers are only assured of being able to sue in a court of law as a part of a class action lawsuit. Which is frankly still somewhat limited relief for any individual consumer. However, it does strike real fear into the heart of large firms, because class action lawsuits can end their company with a big loss. It is a surprisingly valuable accountability mechanism in the aggregate, even if it’s somewhat limited relief for any individual consumer.
– Michael
Very insightful and well written summation of this transformative regulation. Many thanks for subjecting yourself to the torture of reading that entire document!
Thank you for the hard work on gathering this information.
In my personal opinion, this is an overreach which will result,ultimately, in uniform but HIGHER overall fees being paid. If not, the big boys would have had this defeated.
In the end, there will be higher costs for everyone involved. The lawyers and government employees will be the “winners.”
Excellent Article. I’m a Corporate Auditor for a large global bank and we’re starting a “Ready Assessment” of the bank’s new Investment Products and fee structure. This really helped me understand DoL Fiduciary Rule what questions to ask during the initial entrance meetings. Thanks again.
Happy to be of service, Terry! 🙂
– Michael
Hello!
We are a company of financial experts able to make a cash credit financing is an amount you need and with the conditions that make their various economic activities.We offer loans of any kind of 10,000 to a 1,000,000.00 3% interest and a good track your bank file.via email: [email protected] or visit our website: https://alexpeter718.wixsite.com/alexanderfinancial