Dealing with DOL’s new Fiduciary Rule is no simple matter. That’s why we’ve written a few ideas on doing just that. Let’s start with the basics.
When is the Fiduciary Rule effective?
When originally released, the Fiduciary Rule was subject to a phase-in from April 10, 2017 – January 1, 2018. On February 3, 2017, the Trump Administration tried to delay the effective date by 180 days. Then DOL issued its own 60-day delay (see Field Assistance Bulletin No. 2017-01) which delayed the effective date until June 9, 2017 and includes a transition for certain exemptions to the rule until January 31, 2018.
What does the new rule do?
The new rule made sweeping changes to the way DOL defines the term “investment advice fiduciary” which previously followed the definition under The Employee Retirement Income Security Act of 1974 (ERISA).
DOL’s new definition of “fiduciary” requires advisors to act in the best interest of their clients — even above their own interests. It also requires the disclosure to clients of all fees and commission in dollar format. The DOL expanded the definition to include all professionals making recommendations or solicitations, not simply giving advice. Before the rule change, fiduciaries meant only those advisors who charged an hourly fee-for-service or a percentage of account holdings on retirement plans.
What does it mean if an advisor is a fiduciary?
A fiduciary is held to a higher standard than financial salespeople who work with retirement plans and accounts (think brokers, agents, planners) who — up until now — were only held to the “suitability standard”. “Suitability” meant that the information or advice simply had to meet the client’s needs and goals.
Since fiduciaries must put their clients needs ahead of their own under the new rules, the change calls into question many of the commission structures common to the retirement industry. If an investment advisor wants to continue earning commissions after the effective date of the fiduciary rule, then he must issue a financial disclosure agreement (known as the Best Interest Contract Exemption) to let clients know where conflicts of interest may exist. For example, such a conflict of interest may occur when the financial advisor will receive a commission or bonus for selling a certain product. He must also spell out all compensation paid to him.
What plans does the Fiduciary Rule cover?
The new Fiduciary Rule covers the following retirement plans:
- Defined contribution plans: 401(k)s, 403(b)s, stock ownership plans, Simplified Employee Plans (known as SEPs), and simple IRAs.
- Defined benefit plans: These are retirement plans whose plan documents promise a certain payment to participants at retirement.
- IRAs (Individual Retirement Accounts).
Are Any Actions Not Covered under the Fiduciary Rule?
There are some actions that do not qualify as investment advice or do not constitute retirement plans for purposes of the new rule.
- If an individual calls an investment advisor and requests a certain product;
- If a financial advisor provides general educational information to clients, such as that based on their age/income; and
- Accounts whose contributions are after-tax dollars.
Who does the Fiduciary Rule affect?
The industry can expect the new Fiduciary Rule to disproportionately affect small, independent brokers and RIA companies. They will often not have the resources to comply with the new rule both in terms of upgrading technology and in-house subject matter expertise. The industry may see many smaller brokers swallowed up by bigger fish. Just as two examples, MetLife and American International Group (AIG) sold off their broker divisions because of anticipated costs under the new rules. If too many smaller brokers close up shop, it may mean fewer advisors for small plans.
In general, the industry expects the biggest impact with respect to IRAs — especially rollovers of 401(k) funds to IRAs which are often handled by brokers. Advice regarding these rollovers now must reflect the best interest of the client, such as whether the fees in the IRA are higher than would accumulate if the client left the funds in his employer’s 401(k) plan.
To learn more about the new Fiduciary Rule, read Investopedia’s article entitled “Top Takeaways from the DOL’s Fiduciary Rule FAQs”, which address many of the issues with regard to the new rule, including questions about investments and advisor compensation.