DOL Fiduciary Rule will encourage more dialogue and closer alignment with investors

The relationship that broker-dealers and registered investment advisors have with pension investors is set to be turned on its head on 10 April 2017 when the Department of Labor introduces the DOL Fiduciary Rule. 

In short, what this means is that brokers and advisors will have to demonstrate that they are acting in their clients’ best interests at all times. This may sound surprising to some but as CNBC highlighted in a recent article, the White House Council of Economic Advisers estimates that conflicts of interest by investment advisors leads to USD17 billion in lost income every year for most savers. 

The Department of Labor has basically imposed a new standard of ownership. What was once a suitability standard is set to become a fiduciary standard. “What that means is that brokers now have to evaluate what is in the best interest of retirement accounts. It creates a lot of discussion within firms because there are several streams of income that brokers receive,” commented Daniel Viola, Head of the Regulatory and Compliance Group, Sadis & Goldberg, LLP, a New York law firm. 

Viola was speaking at the end of November at the Nasdaq Advisor Symposium, an event designed to address some of the most pressing topics to US-based financial advisors, including clarifying some of the main points of the new DOL regulation. 

Moderating the panel discussion was Ron Geffner (pictured), Corporate & Financial Services Partner, Sadis & Goldberg. He noted that with the Trump presidency there are some doubts as to whether the rule will be enacted after he takes office. 

“Some suggest the rule may be repealed. Even if the rule is introduced and later repealed, regulated entities, which would have spent countless dollars complying, may find it is difficult to undue all that work and reverse the steps taken. The reality is, regulated parties can’t wait until the day of the rule’s introduction to pass. We’ve seen certain broker terms announce that they are transitioning their brokers and 401K (IRA) accounts from a commission-based model to a flat fee model; Merrill Lynch and others are doing this.

“In my mind, the DOL Fiduciary Rule is shifting the burden to the broker and away from the investor,” said Geffner. 

Broker-dealers and RIAs have three ways to comply with the rule. The first option is known as the ‘best interest contract (or BIC)’, which could be difficult for financial firms to comply with. “The second option is not to charge any transaction-based compensation but to charge a flat fee or a favorable fee based on assets under management, which is always a little easier to comply with.  And the third option is to exit the business altogether because it’s not worth it,” said Steve Blume, Director – Fiduciary Strategies, RBC Correspondent and Advisor Services. 

Geffner expects that people will largely engage in level fees and that the BIC will be difficult to comport with.  

Those retirees whose IRAs are fee-based should not expect to see much disruption when the rule is enacted. However, for those who have been paying commissions to their advisor, if the decision is taken to formulate a BIC they can, says Geffner, expect to receive a lot of paperwork. 

“Our concern is the disclosures required to comply with the best interest contract and whether you can accurately and completely disclose away all conflicts of interest,” said Geffner, adding that the fee models will not likely change that much, “they’re just going to be expressed differently”.

The best interest contract does not exist as a template in physical form so it is not as if brokers and RIAs have anything codified to adhere to. It is a concept and as such, knowing exactly what disclosures to include to adequately demonstrate that the client’s best interests are being upheld is a tricky proposition.

Tom Dorsey, founder of Dorsey, Wright & Associates, a Nasdaq Company, and a speaker at the event, said that most of the Nasdaq Dorsey Wright clients he’s spoken to feel that they are in good shape with regard to the upcoming regulation. “Advisors using the DWA Research Platform are already using an objective and transparent way to build their portfolios. Everything they do – every trade they make – is based around what the [point & figure chart] numbers are telling them. There is no room for emotional decision-making that can be viewed as a conflict of interest when they are using a system that is structured and relies on a solid methodology like Relative Strength.”

That more and more Americans’ retirement assets are held in self-directed brokerage accounts, the US Government decided they may be less capable of guarding themselves from conflicts of interest; hence the creation of the DOL Fiduciary Rule.

There are, however, inherent conflicts of interest when dealing with a broker. If a broker is paid a commission and you purchase shares in a fund that climb from USD100 to USD120 six months later, the broker may say ‘Let’s take those gains and take a position in another issuer’. 

“The conflict arises in that the broker benefits from each transaction that occurs. So the question is, is the transaction in the broker’s best interests or the client’s best interests?” asks Geffner.  

Asked what financial firms can do to prepare ahead of the 10th April deadline, Geffner said that first and foremost it depends how essential 401K business is to their overall business. Is it an important source of revenue, or is the anticipation that it will become an important source of revenue? Is it an important service that is provided in tandem with other services? 

“If I were to summarise the steps to take they would be: Step 1, determine how much your business will be affected. Step 2, if it will be affected, how integral of a component is it to your business? Step 3, if you intend to transition it how will you do this? And if you intend to keep it, what modifications will you need to make to your disclosures and your fee model: both in respect to compensation to the IFA, and fees to the investor?” explained Geffner. 

Gregg Zeoli, Founder and CEO, Empire Asset Management Company and one of the panelists, expanded on the above by suggesting that firms should take a “good inventory of the kinds of relationships that you have, a good understanding of your client segments and who all of your IRA clients are”. He said the reality was that from a preparation perspective, there’s never been a better time to actually do many of these things “that I think from a practitioner’s perspective you should do. Also, think about setting a good timeframe for what your service model delivery is going to be.”

The panelists stressed that what should not be underestimated is that this will be a fiduciary standard, the inference being this will be much higher and difficult to meet than anything registered investment advisors currently face. “Put some time into your craft and understand it because it’s a lot to get around,” advised panelist Thomas Mullooly, Owner and Founder, Mullooly Asset Management. 

Viola added: “I think this is probably the most disruptive rule that we’ve seen in a long time. You really have to evaluate your income streams that you generate [from client accounts].”

In principal, the rule should be welcomed. After all, the purpose is to protect 401K plans and make sure that retirees have the biggest pension pot available to them without fear that their advisor has been skimming the cream. 

But Geffner was in no doubt that this is just another example of regulatory purgatory for asset managers. 

“I call it post regulatory syndrome. Managers have had to go into their foxholes to duck for cover from all the artillery being shot by lawmakers. We’re creating such a maze of rules and regulations that we’re regulating away opportunity,” opined Geffner. He added: “It’s imperative that a regulated person or entity work with lawyers who have a regulatory background and on-hand experience. If you fail to comply you run the risk of regulatory action, which may result in civil and/or criminal penalties as well litigation brought to you by clients.”

Whether the rule gets repealed or not, for now it is another layer of protection for investors to take succor from and brokers and RIAs to get their heads around, operationally speaking. 

Zeoli was upbeat in his concluding remark, stating: “I think if you're an advisor, it’s going to be a very exciting time. There will be fantastic opportunities over the next three years.”

Mullooly said the bottom line is that there will be more disclosure and more discussions with clients. “Whatever side you're on, I don’t think that’s going to hurt.  I think that can only help the relationship that you have with your clients.”

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