As the advice business digests the Labor Department's new adviser fiduciary requirements for retirement accounts, it's too early to know whether the rule's advocates or its critics will be vindicated.
Long-time proponents say the new standards will produce higher quality, less conflicted advice for American workers' retirement nest eggs, while those who criticized the change foresee less availability of advice and fewer advisers, largely as a result of more expensive and cumbersome compliance.
Based on the recent experiences of our British and Australian cousins, both sides may be right. After rule changes in those countries analogous to those just made here, advice became more transparent and less conflicted, while the number of advisers declined and the cost of compliance climbed.
“Is more perfect advice for fewer people better than the possibility of less-than-perfect advice for the mass of people? That's a key question facing all our countries, yet it's largely a societal and public policy question for which there is not a right or wrong answer,” said Geoffrey Towers, chief executive officer of Pershing Ltd., the U.K. arm of the U.S. clearing and custodial giant.
Changes in the U.K.
The British approach to addressing the advice question began in 2006 and culminated in full adoption of new standards known as the Retail Distribution Review in early 2013. The United Kingdom's securities regulator, the Financial Conduct Authority (formerly known as the Financial Services Authority), concluded that despite an existing “best-interests” standard for advisers that was much like the U.S. fiduciary standard and a requirement that all commissions and fees be disclosed, the market for financial advice was not working well for U.K. investors. As a public policy matter, the government wanted to insure investors received unconflicted advice, the cost of which would be clearly stated and paid for directly by the investor.
Britain made three important changes to the financial advisory landscape:
• Commissions were banned. Advisers can charge a one-time fixed fee for advice, a fee based on an hourly rate, a fee based on assets under management or under advisement, or a combination of the three.
• Advisers and their advice now fall into two categories: independent and restricted. Independent advisers, who constitute about 60% of the U.K. market, must document that their advice encompasses the entire market of product providers and includes the full range of retail products available. Advice is restricted when it is limited to the products of one provider or if it encompass all providers but is restricted to a specific type or types of products.
• The FCA raised the bar in terms of qualifications necessary to be licensed as a financial adviser. It requires that all advisers — whether they are independent or restricted — adhere to a code of ethics, complete at least 35 hours of continuing professional education annually and hold a “Statement of Professional Standing” certificate from an accredited institution attesting to their formal training and fulfillment of all requirements.
In a white paper published six months after the changes went into effect, Andrew Clare, associate dean and chairman of the asset management department at the Cass Business School of the City University London, predicted that the rule would widen the existing “advice gap,” or access to affordable financial advice by less affluent investors.
Mr. Clare's early prediction largely has come true. In a report issued last month, the FCA found that while commission-driven conflicts of interest have been eliminated and transparency has increased, advice “remains expensive and is not always cost-effective for consumers, particularly those seeking help in relation to smaller amounts of money or with simpler needs.”
The report cited a recent survey conducted on behalf of the Association of Professional Financial Advisers in which 69% of advisers said they had turned away potential clients over the last 12 months, with 43% of those advisers saying that their advice services would not have been economic given the circumstances of those potential clients.
Specifically, the authority found that the proportion of advisory firms that ask for a minimum portfolio of more than £100,000 (about $142,000) has more than doubled, from around 13% in 2013 to 32% in 2015. The authority also found that 45% of firms very rarely advise customers on retirement income options if those customers have less than £30,000 ($42,600) to invest.
Still, 58% of British advisers polled by Schroders Investment Management in December said that the changes have had a positive effect on the overall quality of advice and have helped to increase professionalism and awareness of adviser value.
The U.K. rules also resulted in a shrinkage in the adviser population, as U.S. critics have warned will occur here. The numbers have declined from roughly 40,000 in 2011 to about 31,000 currently.
But sheer numbers don't tell the whole story. The FCA found that most of the advisers who left the business were restricted advisers who worked at banks and building societies, the British equivalent of savings and loan associations, which generally serve less affluent segments of the population.
“Many of the independent advisers who left were older advisers who didn't want to change their way of doing business or meet the new licensing requirements,” said John Anderson, a managing director and head of practice management solutions at SEI, which provides a range of services for U.K. advisers.
A spokesperson for the FCA agreed, noting anecdotal evidence that the rule change simply may have hastened the retirement of many advisers who were planning to leave over the next several years anyway. Another reason for the departures was the need for independent advisers to meet compliance reporting requirements.
The decline in advisers may be bottoming out, however; a recent FCA survey found that around 30% of firms expect to add advisers over the next year.
What Happened Down Under
In Australia, the enactment of the 2012 Future of Financial Advice laws — a reaction to cases of wealth management firm malfeasance during the 2008 financial crisis — seems to have had little effect on the number of advisers or the ability of investors to receive advice.
As in the U.K., the new laws banned commissions and mandated a best-interest duty and disclosure of all fees. It also required clients to affirm their advisory agreement every two years.
Amendments in 2014 permitted certain incentive payments in connection with providing general advice, as long as that advice is not conflicted and the payments were not upfront or continuing in nature.
An ethics standard and adviser educational requirements are scheduled to be taken up later this year.
Daniel Brammall, president of the Independent Financial Advisers Association of Australia, said that during the debate leading up to the changes there were fears that the financial industry would lose 35,000 jobs as a result of the legislation.
“But there hasn't been a blip,” largely because aside from the elimination of overt commissions (which now sometime take the form of various payments from product vendors), “not that much has actually changed,” said Mr. Brammall, whose group represents the small number of Australian advisory businesses — an estimated 50 — that are truly independent in the sense of American fee-only registered investment advisory firms.
Neil Salkow, the head of one such firm, the Brisbane-based Roskow Independent Advisory, said that about 80% of Australian advisers work for a bank or a bank subsidiary, while the remainder are independently owned, but may be selling products from a platform owned by a bank or an investment company.
“Everybody is disclosing more, but clients are still not sure that the advice they're receiving is unconflicted,” Mr. Salkow said.
Unlike the changes in the U.K. and Australia, the advisory rule changes in the U.S. affect only retirement accounts, which in all three countries increasingly are dominated by defined-contribution plans. The primary public policy motive of the DOL in pushing for changes was concern that the owners of the approximately $4.7 trillion of assets in 401(k)s and similar plans, as well as the $7.6 trillion in IRAs, get the best possible advice to help those assets provide sufficient retirement income.
On that score, the lessons from Australia and the U.K. are less clear.
The high level of compulsory retirement savings through Australia's government-sponsored and privately managed superannuation retirement program — which requires employers to contribute 9.5% of an employee's wages into a “super” fund, a level rising gradually to 12% in 2025 — diminishes policy concerns about adequate retirement savings.
“Even if an employee is not advised as to which product they should choose or if he fails to choose at all, deposits go into what is called a 'MySuper' product that is like a target-date fund and is required under the law to hold appropriate diversified assets,” said Meghan Milloy, director of financial services policy at the American Action Forum.
But given the lack of clarity over the impartiality of advice, it's unclear whether Australians grappling with decumulation issues are any better off after the 2012 changes.
The U.K.'s reforms also did not specifically address advice surrounding defined-contribution retirement plans. But the FCA is encouraging employers and others to provide advice on the subject, promising that it will do everything possible to avoid ensnaring them in financial advice regulations if they are not primarily in the financial advice business and if they are not being compensated for their advice. The government itself offers advice through a free service, Pension Wise, that provides impartial guidance over the phone or in person.
Bottom Line for the U.S.
Based on the experiences of Australia and the U.K., the DOL rules could well result in some of the outcomes opponents had feared. The “advice gap” probably could widen as fewer people of modest means would be able to afford or would be willing to pay for advice explicitly, although research in the U.K. has found that investors don't mind paying for advice they feel has value as long as the cost is deducted from their assets, rather than being an expense they must pay for by check.
The expense of creating and maintaining new compliance procedures no doubt will add to costs, although that could lead to out-sourcing, mergers and greater industry consolidation that probably would produce offsetting efficiencies.
And the number of advisers may well decline as smaller customers exit due to higher minimums and older advisers decide to retire rather than change their practices. John Anderson of SEI also notes that new rules probably would end the U.S. advice industry's traditional de facto training system in which many brokers who survive through a sink-or-swim period of generating commissions gradually mature and transition to advisory relationships.
Whether the changes would be better or worse for retail investors is an open question.
“The brokerage industry talks about a loss of access to advice, but they don't provide advice to the average investor; they provide a sales pitch disguised as advice,” said Micah Hauptman, financial services counsel to the Consumer Federation of America.
But regulators too often focus on the transparency of advice rather than on the clarity of advice, said Pershing's Mr. Towers.
“The difference is like explaining how a car works by going into the details of an internal combustion engine rather than explaining that the gas pedal is on the right and brake pedal is on the left,” he said. “If there is clarity about fees and everything else, people tend to see the value and benefit of advice and will pay for it.”
Evan Cooper, a former deputy editor of InvestmentNews, is a freelance writer.