Since the Labor Department reproposed its draft rule to expand the definition of fiduciary – and its oversight of Americans' retirement accounts – earlier this year, one key misconception has kept some segments of our industry from fully engaging on this issue. Since RIAs are already held to a fiduciary standard, many of them have assumed that the DOL's proposal would have little or no impact on their businesses and their clients.
It's time to clear up that misconception.
For RIAs – just as for advisers affiliated with broker-dealers – the DOL's proposal will carry serious and long-lasting repercussions if it is implemented in its current form. Many RIAs who have assumed that the proposed rule would not affect them could actually find themselves in a worse spot than broker-dealer-affiliated advisers, since they may be caught unprepared when the rule goes into effect.
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This confusion stems from one simple discrepancy: the Labor Department's fiduciary standard is not the same as the standard enforced by the Securities and Exchange Commission. Since RIAs currently follow the SEC standard, the DOL's proposal would force them to comply with two separate fiduciary regimes.
WHAT'S THE DIFFERENCE?
Broadly speaking, the SEC standard requires advisers to disclose conflicts of interest up front to clients through Form ADV, minimize the impact of conflicts and manage them properly. Within this context, it is up to individual clients and advisers to decide whether they can work together given any existing conflicts.
The DOL standard, in contrast, is much more restrictive, in large part prohibiting advisers from engaging in transactions that, in the department's view, present a conflict of interest. Under the current proposal, some of these transactions would be permissible through a best interest contract exemption – or BICE – that would require clients to enter into a highly complex contractual agreement with the adviser.
In practical terms, the DOL's proposal would subject any RIA who advises on IRAs or other retirement accounts to complicated disclosure obligations, voluminous new books-and-records requirements and enormous liability exposure under 50 state contract law interpretations.
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While RIAs who do significant business in the 401(k) market have experience in complying with DOL requirements, the vast majority of RIAs – who may advise only on IRAs for individuals – could find themselves scrambling to comply with extensive and burdensome new reporting and exam obligations they never saw coming. These requirements could mean implementing entirely new compliance infrastructure and processes, at significant cost.
The DOL proposal also includes provisions that could ensnare RIAs depending on their specific recommendations to clients.
ROLLOVER RISK
Recommending that a client roll his or her 401(k) balance over into an IRA, for example, would represent a conflict of interest in cases where the adviser's management fee exceeds the fees in the existing 401(k). Conflicts also could arise if an RIA were to recommend rolling a 401(k) balance from a client's previous employer's plan into a new employer's plan and received a fee for asset allocation advice. Such conflicts would require RIAs to comply with the terms of the BICE, including developing and implementing appropriate client contracts, monitoring fees on an ongoing basis and providing in-depth disclosures to clients at the point of sale, on an ongoing annual basis and on the RIA's website.
RIAs who receive compensation through revenue-sharing or marketing allowances from product partners, who offer a variety of asset management options with different compensation structures (e.g., third-party asset managers or rep as portfolio manager) and others would also find themselves forced to comply with the BICE's strict requirements, among other new obligations under the proposed rule.
For many RIAs who assumed that the BICE would apply only to commission-based transactions – and that their level pricing structure therefore would put them well clear of its oversight – suddenly having to comply with this new regulatory structure could be a significant shock to their businesses.
(More: Labor Department's fiduciary rule too complicated to put into practice: FSI)
Although the supplemental comment period on the latest version of the DOL's fiduciary rule has closed, it is not too late for financial advisers, firms and clients to engage their representatives in Congress to urge them to push for changes in this potentially devastating rule. In order for our industry to make its case as clearly and as powerfully as possible, all advisers – whether they are affiliated with a broker-dealer or function as an RIA only – must understand the stakes.
BIG CONSEQUENCES
While it is understandable that a rule this broad and complex would have implications that are difficult to parse out, RIAs should have no misconceptions on this point: The DOL's fiduciary proposal, if implemented in its current form, will have profound negative consequences for every corner of our industry and for investors.
RIAs who stay on the sidelines under the assumption that their level fee structures and adherence to the SEC's fiduciary standard will insulate them from its impact could well find themselves facing the same crushing new regulatory burdens – and potential liability – that threaten their broker-dealer affiliated counterparts.
Dale Brown is president and chief executive of the Financial Services Institute Inc.
