The Fiduciary Rule: What’s next in Trump’s America? (Department of Labor Edition)

Sunday, February 26th, 2017 at 4:31 pm, by Alexander Dvorscak

On February 23, 2015, President Obama announced his intention to have the Department of Labor shake up the way investment advice in the US was given. In a major departure from the way investment products had traditionally been sold, every broker and financial advisor who dealt with retirement accounts would now be held to a fiduciary standard. The President claimed that hard working Americans, who had diligently saved for retirement, were losing a combined $17 billion every year to fees and higher costs imposed by brokers who put their own financial interests ahead of their clients. The rule was drafted and issued as the “Conflict of Interest Rule Retirement Investment Advice, 81 Fed. Reg. 20946” on April 8, 2016.

Although set to take full effect on April 10, 2017, the rule’s future is now in limbo after a memorandum by President Trump, issued on February 3, 2017, moved to delay the implementation of the new rule and called into question its continued existence. Interestingly enough, the reasons given for the delayed implantation are very similar to those given for its original implementation: namely, to protect the ability of Americans to save for retirement and receive meaningful advice about how to do so. Is this simply presidential double speak or an alternative fact? As it turns out, the issue is more complicated than it seems, and both sides may reasonably claim to be (at least partially) correct.

Preexisting Standard

Prior to the proposed rule, brokers and other investment advisors were not able to freely provide investment advice. Instead, the SEC regulated brokers under a “suitability rule.” As fleshed out by Wall Street regulator FINRA, a broker was required to “have a reasonable basis to believe” that an investment product was suitable for a particular customer before selling it to them. This inquiry included basing investment advice on common sense elements such as age, tax status, and risk tolerance, among other factors. However, the rule did not require that the broker or advisor provide their customer with the best option. They were free to offer products that carry sales commissions or higher fees and sell them to customers even if there existed a product with lower commissions or fees.

This was in contrast to the fiduciary standard that the SEC previously required of investment advisors and under the proposed rule would apply to both brokers and advisors. The fiduciary rule requires advisors to always act in the ‘best interests’ of their clients. The SEC in its materials for newly registered investment advisors instructs them that they “owe [their] clients a duty of undivided loyalty and utmost good faith.” Advisors under the fiduciary standard cannot engage in any activity that would constitute a conflict of interest and must take reasonable care to disclose all material facts related to an investment decision to their clients. Additionally, they must maintain compliance programs and file certain reports on a regular basis to the SEC.

Controversy

The proposed rule would supersede the regulation of brokers and advisors by the SEC with regulations issued under the Department of Labor. It would bring all individuals, whether broker or advisor, under the same fiduciary standard of care. There has been controversy over whether or not it would cause brokers to stop serving lower- to middle-income savers and whether or not it would cause higher fees for some savers by eliminating commission-based accounts.

The biggest worry is that instead of providing better service to customers, brokers will exit the market. Thaya Brook Knight of the Cato Institute worries that, “[f]or investors with accounts of a certain size, [for brokers] to comply with the rule, and still use a commission-based fee structure, it just may be so onerous that they may just say, ‘I don’t want to deal with this.’” Anecdotally, the Wall Street Journal has interviewed Judith Friedlander, an 80-year-old retiree, who is being pushed to convert her commission based account to a “fee-only” account that charges based on a percentage of assets invested and could cost her far more for the same service. This is happening across the industry with Bank of America Merrill Lynch, saying it will no longer offer IRAs that charge commissions and JP Morgan Chase following suit, by only offering a fee-based IRA for brokerage clients.

Others have argued that it is the financial firms’ response to the rule, and not the rule itself, that is the problem. Barbara Roper, Director of Investor Protection at the Consumer Federation of America, claims that the rule would allow commission accounts as long as brokers make their clients aware of the potential conflict of interest. Additionally, the Department of Labor has argued in recent litigation that groups such as the Chamber of Commerce have mischaracterized the scope of the rule. They claim it only applies under three conditions: if (1) the recommendation concerns a plan’s investment property; (2) results in the adviser getting paid; and (3) is directed to a specific person. Thus, the rule would not bar advisors from providing group investment discussions or “free-meal seminars,” as the group had argued, among other things.

Presidential Memorandum

The Presidential memorandum on the Fiduciary Duty Rule instructs the Department of Labor to restudy the proposal to determine if access to advice would be restricted and costs would increase under a fiduciary standard. This is likely in response to industry groups, such as the Securities Industry and Financial Markets Association that has prepared studies showing that the rule could add $6 billion in compliance costs, all of which would be passed on to consumers. Given the tone of the administration, this rule is likely to never go into effect. However, even if the industry group’s number is correct, if the Department of Labor’s $17 billion in cost savings is also correct, on net the rule could provide a great benefit. Certainly more research is necessary, but at least one retiree will be happy with keeping her commission account and is likely to save money as a result.