This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Mark Eshman, chairman and chief investment officer of Sun Valley, Idaho-based ClearRock Capital.
Earlier last week, a last-ditch effort to save the Department of Labor’s proposed “fiduciary rule” failed.
A three-judge panel from the Fifth Circuit Court of Appeals—the same three judges who vacated the Obama-era rule in March—struck down motions from AARP and the states of Oregon and California, which were seeking standing as defendants in the case.
The DOL has 90 days to ask the U.S. Supreme Court to review this ruling, but this seems unlikely. For the near future, the much-anticipated DOL rule is dead.
Clients’ Best Interest
The DOL rule would have required broker-dealers managing retirement accounts to act in their clients’ best interests, holding them to the same fiduciary standard that has always governed all SEC-registered investment advisors, like ClearRock.
Having worked for broker-dealers before starting an RIA, we understand the need for such a rule. The fiduciary standard is fundamental to how we plan, invest and service our clients. By now, we are all familiar with unsavory sales practices perpetuated by many of the traditional banks and brokerages. Wells Fargo recently paid a $1 billion fine to settle such bad behavior, among other questionable practices.
The DOL has calculated that the absence of a fiduciary rule reduced investors’ retirement savings by 1% per year, an estimated $17 billion annually (source: DOL News Release # 16-751-NAT, 4/6/2016).
Rule 405’s Lesser Standard
Broker-dealers are held to a lesser standard for broker/client relationships, known as Rule 405, the so-called suitability standard. It simply requires brokers to “know their client,” in recommending a suitable investment, not necessarily one that is in the best interests of the client.
Consequently, Rule 405 does not prevent brokerage firms from recommending products with higher fees. The fiduciary rule, however, holds RIAs to a much higher level of legal responsibility, one that must always be in the client’s best interests.
When we started ClearRock in 2007, we chose ETFs as the primary investment vehicle for our model portfolios due to their low-cost, tax efficiency and high level of transparency. While this aligns nicely with our fiduciary obligation to our clients, ETFs are simply a smarter way to access market beta.
ETF Tool Kit
In addition, as the ETF universe deepened dramatically in the last 10 years, so have additional opportunities to diversify our asset allocation using sectors, geographies and factors. We can offer our clients portfolios that once were only available to large institutional investors.
Importantly, in the past 10 years, the average expense ratio in our portfolios has decreased from around 0.45% to an average of 0.20%.
Many firms, including J.P. Morgan, LPL and Commonwealth Financial, are already touting to their sales forces that the DOL fiduciary rule is dead, and that they will release the restrictions imposed on fiduciary-compliant sales practices for retirement accounts. UBS and Merrill Lynch have not publicly commented yet.
In other words, for unwitting retirement investors who choose to work with a bank or brokerage instead of an RIA, it will be back to business as usual.
Perhaps the best hope to protect investors will be the more rapid adoption of ETFs by traditional brokerages and banks. The sheer size of the market, their ample liquidity, low cost and tax efficiency should compel most advisors, irrespective of the rules, to do the right thing and use more ETFs in helping clients reach their financial goals.
Mark Eshman is co-founder and CIO of ClearRock, an SEC-registered investment advisor with offices in San Francisco and Sun Valley, Idaho. Contact [email protected]. For a full list of disclosures, please click here.