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Financial Planning

Confused About the Fiduciary Rule?

Investor advocates are jubilant while many financial services professionals are apprehensive, as regulations designed to ensure investors have access to objective retirement savings advice, are implemented.

The financial services industry is in the middle of some regulatory tumult. With the much publicized and debated Fiduciary Standard implemented in the financial services industry on June 9, 2017, the name of the game for retirement planning has changed. But, even more than that, the new rule is reflective of an evolving industry, one that has gradually shifted focus from the brokerages and wire houses of yesteryear to the proliferation of registered investment advisers and even online wealth managers today. Overall emphasis has largely shifted from selling products (which are now seemingly limitless) to selling professional advisory services.

Many financial industry groups allied in a bid to either halt or at least delay the implementation of the Department of Labor’s (DOL) Fiduciary Rule – and, for a time, they got their wish. The rule’s initial April 10 compliance date was delayed until June 9. On the other hand, most investors are less apprehensive about the fiduciary rule. In fact, many welcome the higher standard for the professionals managing their money or proffering related advice.

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There is some confusion among investors about what the rule means, and what the historical and legal context surrounding it reveal about the financial services industry. In this article (the first of two parts) I will lay out the main points in the debate. The second part will provide some historical context, and conclude with the most significant takeaways from this potentially consequential rule.

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On the surface, the consequences of adopting an industrywide fiduciary standard for retirement accounts would appear relatively benign for investors at best and inconvenient for financial providers at worst. As we delve deeper, though, it becomes apparent that there is far more at stake than the idiosyncratic regulations surrounding retirement accounts. Time will tell whether we have a reaffirmation of the status quo, or set the precedent for a wave of change in the relationships between financial firms and advisers.

Going Beyond What’s Merely ‘Suitable’

First of all, the DOL rule only affects retirement accounts, such as IRAs, 401(k)s and 403(b)s, pensions and employee stock ownership plans. Brokers, insurance agents and some financial advisers merely have been held to a “suitability standard” in the past. Essentially, financial advisers have adhered to a kind of scout’s honor system, where they simply had to ensure their advice or products being sold were suitable to the client and the client’s situation – they wouldn’t necessarily have to be the best, most cost-efficient options out there.

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The new rule dictates that such salespeople act as more than just intermediaries, but rather, in the best interests of the client. Unfortunately, with transactional accounts and commission-based compensation structures, conflicts of interest abound in the old-fashioned brokerage and insurance business lines, where advisers are often incentivized to offer certain proprietary products, rather than the best investment option available, to the client.

The DOL rule, if rigidly interpreted, would hold firms and financial intermediaries accountable if they fail to act in the best interests of the client, pursuing the optimal investment decisions to meet those needs. The lone exception to this rule would be where a client or prospective customer specifically asks for a certain product or investment for their retirement account, even after being fully apprised of any related costs and fees.

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In the past, regulation focused mostly on disclosure. Essentially, if conflicts of interest were sufficiently disclosed, then advisers could recommend products, as long they were within reason. The nature of commissions and sales charges, in fact, has long been based on a “reasonable standard.” Now, under the new fiduciary rule, regulating intent and simple disclosure would no longer be enough to satisfy a more rigorous standard of the advisory relationship.

Some Financial Firms’ Reactions to Proposal Were Revealing

Already, several large insurance firms have terminated their brokerage and annuity businesses in anticipation of such constraints. That simple fact, and the loud protests emanating from advocates and lobbyists of such interest groups, shows the underlying conflicts of interest in the old way of doing business. The proliferation of independent RIAs (registered investment advisers, who operate under the fiduciary standard) and fee-only advisory platforms in recent years, along with the increase in low-cost passive investment offerings, has further underlined the overall trend in the advisory sector away from product-oriented sales, in favor of a solutions-based approach requiring higher levels of expertise among financial advisers. Clearly, there is a fast-moving current, whether those tides of change are directed from above or generated from below (and it appears to be both).

It has become obvious, given the changes taking place at many firms across the industry, that consumers increasingly expect their financial advisers to follow the spirit of the rule even if the letter is less onerous and exacting. That is encouraging to see, and is indicative of the grass-roots support for the fiduciary movement.

In the second part of this two-part discussion, we’ll outline the regulatory trends and historical backdrop for the DOL rule, along with its ultimate significance and the effect on the nature of the advisory relationship.

About the Author

Marguerita M. Cheng, CFP®

CEO, Blue Ocean Global Wealth

Marguerita M. Cheng is the Chief Executive Officer at Blue Ocean Global Wealth. She is a CFP® professional, a Chartered Retirement Planning Counselor℠, Retirement Income Certified Professional and a Certified Divorce Financial Analyst. She helps educate the public, policymakers and media about the benefits of competent, ethical financial planning.

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