Over the past two months, this blog has attacked guaranteed income annuities and the purported advantages of leasing a vehicle, assuredly triggering ill sentiment from annuity salespeople and auto dealerships. Given the recent string of controversial opinions and analysis, what better time to address the Department of Labor’s “fiduciary rule”? The fiduciary rule has been a subject of heated debate for years within the industry and has more recently become a politicized topic of public conversation outside of just the financial community.
What is the “fiduciary rule”?
This rule proposed by the Department of Labor way back in 2010 and later termed the “fiduciary rule” would require all financial advisors to adhere to a fiduciary standard. In short, the rule means that advisors would have to act in the best interest of their clients when providing investment recommendations for tax-advantaged accounts.
Wait, what? You mean financial advisors are not required to put my interests as the client in front of their interests already?
That is partially correct. Presently, there are two different legal standards: the fiduciary standard and the suitability standard. Some financial advisors operate under the “fiduciary standard” which mandates that they work in the best interest of their clients. Alternatively, most financial advisors, insurance agents, and stock brokers operate under the suitability standard which merely requires that they recommend suitable products.
The Director of Investor Protection for the Consumer Federation of America, Barbara Roper, describes the suitability standard:
“Brokers just have to recommend products that are suitable. But they can recommend the worst of the suitable products, the one with the highest costs or the poorest performance if it happens to be the one that offers them the highest financial compensation.”
The fiduciary rule would force financial advisors (with still a few exceptions) to operate as fiduciaries and work in their clients’ best interest.
So why do people work with financial advisors or brokers who are not required to work in the client’s best interest?
Because the public often does not know the difference. It is usually that simple. Terms like ‘financial advisor’, ‘financial planner’, and ‘wealth manager’ do not require a minimum standard. The fiduciary rule is promoted as a way to make things more clear for the public. Under the proposed rule, if you’re working with a financial advisor and that advisor is providing investment advice on assets in a 401k or an IRA, he or she has to provide advice as a fiduciary that is in your best interest.
What does the rule mean for RPG and advisors like RPG?
For RPG and other advisors who are already held to a fiduciary standard, the proposed rule would mean little or no changes from the way we currently operate. RPG’s only material change, if the rule took effect, would be to add a line in our advisory agreement that says we meet the definition of a fiduciary under the DOL rules.
What does the rule mean for brokers/advisors at firms like Merrill Lynch, Edward Jones, and JP Morgan?
The new rule presents a sea change for brokers and advisors who sell commissioned products inside IRAs. In many cases, these individuals have to fundamentally change the way they do business: how they charge clients, what type of products they recommend, and the disclosures they present to clients when making a recommendation.
These firms and brokers have obviously fought hard to combat the fiduciary rule as it threatens to dramatically disrupt a long-standing business model. Studies suggest that the fiduciary rule will cost the brokerage industry $11 billion in reduced revenue over the next four years.
Making financial advisors work in their clients’ best interest sounds good. What is the objection to the fiduciary rule?
There are a few common objections:
- The rule inhibits choice. There is a very reasonable argument that if people in a free society want to eat food that is bad for them and might make them die younger, they should have the opportunity to do so. The financial equivalent is that if people want to enrichen their brokers and receive conflicted advice, they should be permitted to do so.
- Some people will pay more for financial advice under the fiduciary rule. Trump advisor, Anthony Scaramucci, spells out this argument here. The idea is that investors who do not trade frequently will pay more in the new world of fee accounts rather than commissions. The other side of this argument is that those investors who are simply using a broker to occasionally trade stocks can go to discount brokers like Charles Schwab or Fidelity and trade for less than $5 per trade.
- Small investors may not be able to get advice under the new rule. The argument here is that since advisors will no longer be permitted to use commission models for small investors and those investors won’t be able to afford fee-based models, these smaller investors will not be able to get financial advice. Said differently, if brokers cannot hide egregious fees in product commissions that are not transparent to the client (for products that were not in the client’s best interest), they will not be able to work with these clients in the future. Our view on this is that small investors will still have avenues in which to get advice – they just may have to pay the same fee in a more transparent way.
- The fiduciary rule will increase compliance costs which will force some brokers out of business and will otherwise be passed on to consumers. Fair enough. If you work with a commissioned advisor who now needs to operate under the fiduciary standard, that advisor faces a big cost to comply with the rule (estimated at $2.4 – 5.7 billion over 10 years) which may be passed on to you. Advantage to fiduciary advisors who face little to no increased costs to comply.
- Advisors will be compelled to use the cheapest investments even if these investments are not the best option for clients to avoid the increased threat of lawsuits under the fiduciary rule. This objection has some merits although it really just means advisors will have to better document the reason they use specific investments.
How does the new administration impact implementation of the fiduciary rule?
The rule was supposed to begin phasing in on April 10, 2017. On February 3rd, a memo from President Trump to the Department of Labor (DOL) asked the agency to reevaluate the rule to assess the “economic and legal” impact. This memo attempted to delay the rule’s implementation by 180 days but it was legally unclear that the memo would be effective in delaying the compliance requirements. On March 2nd, the DOL issued its own memorandum, proposing to delay the applicability of the rule by 60 days until June 9, 2017.
It now looks like implementation of the rule will be delayed until June as a result of the DOL memo. During the delay, it appears that the DOL will determine that the fiduciary rule increases the cost of advice which means that (to satisfy the original memorandum from the President) they will likely need to modify or kill the rule. If that plays out, we will go back to the environment of the fiduciary standard competing with the suitability standard and the public left to decipher what sort of guidance they’re getting.
With all this said, what is your view of the fiduciary rule?
The fiduciary rule was never going to solve the problem of advisors giving bad advice. Because the barriers to entry to become a financial advisor are so minimal (as we describe in the true story of a dog who was named one of “America’s Top Financial Advisors”), the rule was not going to change the fact that there were minimally trained advisors giving harmful advice. The rule also was never going to stop unscrupulous and unprincipled advisors from taking advantage of clients. In many cases, as Allan Roth explains here, “those advisers touting their fiduciary duty and claiming they always put their clients first are usually the ones abusing their clients the most. And the reason they do is because they are in complete denial of these conflicts of interests.”
At the end of the day, we just hope that the publicity of the proposed rule opens more eyes to the difference between fiduciary advisors who operate in their clients’ best interest and non-fiduciary advisors who do not. A lot of prospective clients come to us because they are looking specifically for fee-only fiduciaries but many prospective clients still are not aware of the difference. It is arguably better for us and better for consumers if people simply understand that there is a difference.
How should consumers respond?
We explained in a 2015 article about conflicts of interest that “the deep pockets of insurance industry and Wall Street lobbyist groups make it easy to envision a continuation of consumer confusion and the two standard status quo. It pays not to wait for regulation and instead be your own regulator.” This appears to be prophetic. Furthermore, we explained:
The point to all of this is not necessarily to say that a fiduciary standard is the perfect model for everyone. The important concept is that consumers need to simply understand the conflicts of interest that can cloud the advice received. If your advisor is receiving compensation from recommended investments, insurance, or annuities, you need to determine if that might lead to misleading advice. If your advisor is not disclosing conflicts of interest, you should be concerned with what else he or she is not disclosing. If your advisor refuses to sign the Fiduciary Oath to put your interests ahead of his or her own, you should understand why.
Fiduciary rule or not, the burden still falls on consumers to understand if the advice they’re getting is conflicted and how any conflicts might impact the advice. If the increased publicity and exposure of the fiduciary rule brings the different standards to light and makes it clear that most advisors do not work in their clients’ best interest, then perhaps that is a win for consumers and fiduciary advisors regardless of whether or not the rule is implemented.
What do you think about the fiduciary rule? What questions do you have that were not addressed above? Leave your comments, questions, or ideas below.