DOL Fiduciary Rule: Though Complex It Moves Investment Advice Model in Right Direction
After more than a year of posturing, agonizing, and distress, the US Labor Department (DOL) has finally released its conflicts of interest and fiduciary rules for personal retirement accounts, including IRA rollovers. While the rules steadfastly maintain their requirement for a best-interests contract for most arrangements between investors and nonfiduciary advisers, the federal agency relented on a number of troublesome implementation matters, thus making it more palatable and implementable. Whether that will assuage the brokers and insurers who will be hardest hit is unlikely, but CFA Institute is pleased that the rules continue to move the business of advice in the direction of putting investors’ interests first.
To be sure, the rules are still complex and will be a pain to implement for those who aren’t already operating under a fiduciary duty requirement. They may even prove troublesome for those who already operate under a fiduciary duty, despite assurances to the contrary. Nevertheless, complexity is all but certain given the difficult task assigned to Labor, namely to assure that nonfiduciary practitioners give unconflicted advice to their retirement investor-clients. CFA Institute has long held that a simpler, more effective solution to investor confusion over these issues of standards of care would come from restricting the use of the term adviser — including its derivative using an “o” rather than an “e” — to those who must adhere to the Investment Advisers Act. Everyone else would call themselves a broker or salesperson. But that is a solution requiring action from the Securities and Exchange Commission (SEC), and therefore a matter for future advocacy.
Jim Allen, CFA, head of Americas capital markets policy, breaks down the DOL fiduciary rule in this short video.
In the following list, we note some of the most important changes DOL made to the final rule. The complete final rule can be found here.
- Proprietary products: These products received a “greener” light in the final rules than originally proposed, though they still don’t sanction the use of high-risk, low-volume, or bespoke proprietary instruments in retirement accounts. In particular, the revisions appear to permit firms to offer and sell only their products under a best-interests contract exemption (BICE), without having to offer competing options to clients.
- Longer Implementation: The phased-in implementation will now take up to 21 months to complete, as compared with the unreasonable and unworkable eight-month period originally proposed. This was seen by some as a sop to industry — indeed, it could be used to the advantage of those hoping to derail the rules. Ultimately, though, the longer lead time should give brokers time to adapt their delivery models and adjust how they do business with retirement customers.
- Alerting Existing Clients: Firms won’t have to secure contracts with existing clients now. Rather, they can convey the change to the standards of care by email. The channel used to convey this information doesn’t really matter, though. What really matters is that the service provider will have to adhere to the best-interest standard. Because of that, we don’t believe getting the message to clients will be a problem, as service providers will want to hype how they are working on behalf of clients’ best interests. A lingering concern is that that spirit may not carry over to conversations about nonretirement investments, though that is a matter for the SEC to address.
- New Customer Accounts: Service providers will be able to include the best-interest contract as part of the stack of documentation clients must sign to open an account under the final rules. That eliminates the potential fiduciary liability that could await service providers for marketing to potential new clients, regardless of whether they become clients.
- Marketing of Plan Roll-Overs: The final rule will require a fiduciary duty beyond just recommendations about how to invest client money. In particular, recommendations about whether clients should take money out of a retirement plan such as a 401(k) now become fiduciary in nature.
- Education: The final rule clarifies and grants greater leeway on educational exemptions. This is particularly useful to companies wanting to ensure employees in their defined-contribution plans receive basic investment information. The exemptions are much stricter, however, when they apply to individual retirement accounts, as DOL will treat references to specific investment options as advice rather than education.
- Appraisals: In 2011, CFA Institute objected to the DOL’s original proposal, which sought to expand the definition of fiduciary well beyond those with direct discretion over the investment of client/beneficiary assets. Last year’s proposal eliminated most of those objectionable elements, but retained a proposal to impose a fiduciary duty on appraisals, which we also opposed for third-party appraisers. The new rule deferred a final decision on this for a separate rulemaking effort.
- Low-Fee Products: Many financial service providers complained that the original proposal favored low-fee and low-cost products. CFA Institute expressed similar concern, arguing that such instruments were not always applicable to specific investor situations; that the proposal didn’t assure a low-cost investment; that it did not ensure a fiduciary standard of care; and that the proposal ultimately could lead to less-than-optimal outcomes for investors. The final rule helpfully clarifies that service providers do not have to recommend the lowest-cost investment option if a more appropriate option that better suits the clients’ needs is available. The best-interests requirement still carries the day, but enforcement, again, will be key.
- Grandfathering of Existing Arrangements: DOL decided to let service providers continue to conduct business with clients under agreements signed before the rules become effective. This will include compensation from recommendations to hold and systematic purchase agreements. Advice provided post-implementation, however, will have to meet the DOL’s best-interest and reasonable compensation requirements.
- Insurance Products: The BICE will allow advice relating to insurance products, and the disclosure requirements will be more compatible with the way that insurance products are sold. The changes also include a “streamlined exemption” for recommendations relating to fixed-rate annuities, but not for variable-rate annuities.
While the waiting for the final rules has ended, a new waiting period begins. This new period will be in anticipation of the legal challenge to these rules. It is unclear at this point whether the complaints will come from the securities brokerage or insurance industry. In that sense, the phased-in implementation concession allows opponents more time to file for legal delays before the industry starts to comply in earnest.
That will mean more posturing, agonizing, and distress for everyone.
If you liked this post, consider subscribing to Market Integrity Insights.
Image Credit: iStockphoto.com: Kerstin Waurick