Questions Linger On DOL’s Fiduciary Rule

Potential unintended consequences aside, firms shouldn’t get lulled into the idea of it being delayed.

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Reviewed by: Fran Reed
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Edited by: Fran Reed

[The following originally appeared on FactSet.com’s Insights.]

In April 2016, the U.S. Department of Labor (DoL) Employees Benefits Security Administration finalized a rule to address conflicts of interest for investment advice on individual retirement accounts (IRAs); this has become commonly known as the “fiduciary rule,” and the first elements of compliance are set for April 2017.

While the rules have the capacity to fundamentally change the retirement investment industry, their staggered release, jurisdictional ambiguity, and a changing political scene could impact their rollout. Here, we’ll look at some of the challenges the rules face, and where the lines of opposition and support fall.

Concerns And Consequences

Any time regulatory requirements go into effect, the immediate question for those impacted is: “What will this cost me?” 

The DoL estimated the rule could save investors $4 billion a year, a figure widely disputed by brokerages and investment firms. On the other hand, the U.S. investment industry trade group Securities Industry and Financial Markets Association estimates that brokerages could spend over $4.5 billion complying with the rule in the first year, with an additional $1 billion spent annually on written disclosures, notices, and complying with the new reporting requirements.

Potential unintended consequences of the rule include new pressures on advisers to recommend lower-cost products and offer far fewer investment choices, regardless of suitability and appropriateness for the investor.

Additionally, many investors with small account balances (e.g., $50,000 or less) may end up paying higher annual fees for advice over time than the commissions they traditionally incurred only when buying or selling an asset, or they may be dropped entirely by brokerage firms as they become too expensive to service.

Opponents also claim the rule exemplifies federal government overreach into the private sector and will cause more harm than good, impacting the market with greater complexity, higher costs (which will eventually be passed on to investors), fewer investment choices, and less access overall.

Additionally, signed best interest contracts between investment advisers and investors open up advisers and firms to greater legal liability and potential “breach of contract” class action lawsuits.

Jurisdiction And Responsibility

Concerns about overreach are amplified by lingering jurisdictional questions concerning the rules.

Despite a history of regulating markets, the SEC—weakened by partisan politics and a lack of resources—did not act in a convincing manner to tackle the fiduciary ruling.

 

Rather, the SEC supervises brokerages that operate under a weaker standard that only requires their advice be “suitable,” meaning their recommendations must merely fit a client’s general needs and risk tolerance. Interpretation of this looser standard allows brokers to recommend mutual funds and other products that carry higher fees rather than lower-cost investment alternatives.

The DoL’s proposed fiduciary rules are based on the department's authority to oversee tax-preferred retirement savings accounts as supplied by The Employee Retirement Income Security Act of 1974 (ERISA), which is the primary federal law governing the world of workplace retirement plans, like 401(k) plans.

The fiduciary rule extends ERISA’s “higher standard” over workplace retirement plans to cover all retirement investments and advice, including IRAs. The new rule states that anyone receiving compensation for providing individualized “advice” or specifically directed to a plan sponsor, plan participant, or IRA for consideration in making a retirement investment decision is a fiduciary.

In addition to the optics surrounding a department tasked with overseeing labor laws dipping its toes into financial regulation, concerns around the DOL’s effectiveness as an arbitrator are also front and center. 

Political Vulnerabilities

The fiduciary rules were very publicly backed by President Barack Obama, so it’s perhaps not surprising that the Trump administration is among its detractors. As a result, addressing the DoL fiduciary rule feels like good theater for the populist anti-establishment backlash against the “swamp.”

The groundwork for taking the teeth out of the fiduciary rule is already being laid. For example, earlier this year, Representative Joe Wilson (R-SC) introduced a new bill “Protecting American Families’ Retirement Advice Act,” which would delay the effective date of the DoL Fiduciary Rule by two years.

According to the draft, the bill would give “Congress and President-elect Donald Trump adequate time to re-evaluate this harmful regulation,” arguing that, “the Department of Labor’s fiduciary rule is one of the most costly, burdensome regulations to come from the Obama administration.”

Wilson is not alone in this sentiment. Representative Virginia Foxx (R-NC), Chair of the House Education and Workforce Committee has said, “the DoL rule tops its list of the most reckless and harmful regulations.” Representative Jeb Hensarling (R-TX), Chair of the powerful House Financial Services Committee, has also been a consistent opponent to the Dodd-Frank Act and a strong proponent for less federal government oversight and regulations.

As of right now, it would take a considerable amount of legislative effort to change or delay the the fiduciary rule. Furthermore, a wholesale repeal of the rules may not be in the best interest for large firms, which could stand to make more money as the industry moves away from a commission-based model and may have already spent large sums in pursuit of compliance.

The fact that the fiduciary rule has yet to be enacted is a technicality at this point, and with larger policy issues on the agenda for Trump’s first 100 days, it’s unlikely the basics of the rule will be changed.

As a result, those impacted need to understand their compliance obligations and calibrate their strategies to make the best of the new regulatory regime.

To learn more about the fiduciary rule and how it can impact you, download our eBook.

Fran Reed is a corporate strategy analyst in Global CTS Specialists at FactSet. 

 

Fran Reed is a corporate strategy analy, global CTS specialists, for FactSet. He joined FactSet in 2015 as an experienced capital markets professional with extensive fixed-income trading, structuring and sales expertise at top-tier investment banks like Morgan Stanley, UBS, Lehman Brothers and Barclays Capital. Fran is an industry author and speaker on topics including debt capital markets, financial regulatory reform, housing reform and public policy matters.