On June 9, a new rule was officially promulgated by the U.S. Department of Labor. The so-called "Fiduciary Rule" places a greater responsibility upon investment professionals who give advice on retirement assets to place their clients' interest ahead of their own. The action was not without controversy, and was delayed for two months by the incoming Trump Administration. But in a somewhat surprising move, Labor Secretary Alexander Acosta allowed the rule to become effective.
Investors may not appreciate that the level of legal obligation pursuing the best interest of clients has heretofore depended upon the business model of the person providing the advice.
Christopher HopkinsThe Investment Advisers Act of 1940 imposed a fiduciary duty upon professionals acting as "advisers," prohibiting deceptive conduct and requiring that advisers must always act in the best interest of their clients. This precludes an adviser, among other things, from selling products with high fees and commissions that would benefit the adviser to the detriment of the client.
Fiduciary advisers are registered with the state or the Securities and Exchange Commission (SEC), and are called "Registered Investment Advisers" (RIA). RIAs typically charge asset-based fees and do not accept sales commissions or other incentives. In this way, the interest of the client is clearly aligned with that of the adviser.
The other predominant framework is the traditional stockbroker or agent model, in which compensation generally derives from sales commissions or trailing residual payments.
Under this variant, the salesperson is held to a less stringent standard, required only to attest to the "suitability" of a particular recommendation. This arrangement clearly creates opportunities for conflicts of interest if one suitable investment pays a higher commission than an alternative with similar objectives.
One notable example has been the widespread sale of inappropriate high-cost variable annuities inside retirement accounts, which often disadvantages investors but is profitable to the salesperson and his firm.
In a perfect world, transparency and full disclosure would leave the decision in the hands of the client. But the labor department has found (as has the SEC) that investors are unclear about the difference between a fiduciary duty and a simple suitability standard. To make matters worse, many commissioned brokers have adopted a variant of the title "adviser" or "advisor," implying a level of responsibility that does not obtain. Study after study confirms that many in the investing public are confused and therefore pay too much, suffering an erosion in their long-term returns.
Enter the Labor Department. The agency imposed a fiduciary duty upon traditional pension managers in 1974. But today, the majority of retirement assets reside in 401(k) and IRA accounts, which have not been subject to best-interest requirements. DOL estimates that conflicted advice will cost investors nearly $15 billion in lower returns over the next 10 years. The new rule attempts to address this erosion of retirement assets by leveling the playing field.
The rule is far from perfect. Actually, the Dodd Frank financial regulation directed the SEC to address the issue, but the agency has been sadly AWOL on the subject, other than a 2011 comment paper supporting a fiduciary standard. Hence, the DOL decided to jump in.
But change may be coming, as the SEC opened a comment period on June 1 soliciting input on fiduciary duty, and the new chairman is accelerating the discussion. The SEC and not the DOL is the proper venue for industry-wide standards of investor protection, and an SEC version of a fiduciary rule is likely to be more workable and enforceable.
Progress is often slow, but the public will benefit from an industry framework that requires putting investors first.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co., in Chattanooga.