In early February, President Trump issued an executive memorandum on the fiduciary rule directing the Department of Labor (DOL) to review the rule and determine whether it may adversely affect the ability of Americans to gain access to retirement information and financial advice.
The DOL is to consider, among other things, whether the anticipated applicability of the rule:
- Has harmed or is likely to harm investors due to a reduction of Americans’ access to certain retirement savings offerings, retirement product structures, retirement savings information, or related financial advice;
- Has resulted in dislocations or disruptions within the retirement services industry that may adversely affect investors or retirees; and
- Is likely to cause an increase in litigation, and an increase in the prices that investors and retirees must pay to gain access to retirement services.
On March 1, the Department of Labor proposed postponing the effective date of the fiduciary rule to give the new administration an opportunity to review its potential impact on retirement investors. Currently, according to the Federal Register, if postponed the rule will become effective June 9, 2017.
Some have characterized the implementation delay, as well as general opposition to the rule, as an effort to avoid establishing a fiduciary standard. I don’t believe this to be the case.
The fiduciary rule is intended to protect retirement investors by ensuring that financial advisors act as fiduciaries, putting their clients’ interests first. It’s a goal that many in the industry support. However, the stipulations included in the final fiduciary rule could have consequences that harm investors rather than protect them—and that’s an issue the industry would like to resolve.
For instance, as written, some think the fiduciary rule has the potential to:
Increase the cost of advice
Large broker-dealers and advisory firms that want to work with retirement plans have spent millions of dollars to comply with the fiduciary rule. They have adjusted processes and workflows, modified platforms, and developed educational materials for financial professionals working in the retirement space. On earnings calls, they’ve let investors know the cost of compliance is likely to run a few million dollars each year.
Bank of America, Merrill Lynch and JP Morgan, may impose restrictions on advisors. Reports indicate the firms will not offer “Best Interest Contract Exemptions” to clients who receive retirement advice. Instead, retirement clients will be required to pay a fee that is based on total assets. The Financial Times pointed out in December 2016,
“Legal risk may have played a role in the decision; neither bank wants to hazard a court case over perceived best interest contract breaches. But simple financial interest may have mattered more. Fee-based assets tend to offer higher, more predictable revenues. At broker Charles Schwab, competitive pressures have driven down average commissions by a third in 10 years.”
Limit some plan participants’ access to advice
When commission-based business models were eliminated in the United Kingdom after a “Retail Distribution Review,” an advice gap opened. A 2015 survey by the U.K.’s Financial Conduct Authority found:
The number of investment products sold without advice increased from 40% in 2011/2012 to around 66 percent in 2014/2015.
The number of financial advisors fell significantly over the same period.
In 2014/2015, 45 percent of advice firms very rarely advised customers on retirement income options, if they had less than £30,000 to invest.
The shift to an advice model (similar to a fee-based model) rather than a sales commission worked for investors who were able and willing to pay. It didn’t work so well for those who couldn’t afford the fees or didn’t have significant wealth.
Make IRA rollovers less available to plan participants
Historically, many plan participants have chosen to rollover the assets in their employers’ 401k plans to Traditional or Roth IRAs. In general, rollovers have provided retirees with access to more diverse investment and withdrawal options, and offered an opportunity to consolidate retirement assets in a single account.
The complexities of the fiduciary rule and heightened scrutiny are predicted to significantly reduce rollovers. Cerulli Associates suggested one-half of the assets that might have been rolled into IRAs will remain in 401(k) plans.
Limiting IRA rollovers could lead to an unexpected consequence – more cashouts. IRA providers tend to offer a streamlined and straightforward process, as well as assistance with paperwork. In contrast, plan roll-ins are often time-consuming and complex. A recent survey asked plan participants why they cashed out rather than rolling assets to a new employer’s plan. “…22 percent said they weren’t sure how to do so; 17 percent said roll-ins seemed too hard to do; 17 percent said they didn’t have time to complete the process.”
No matter what happens with the fiduciary rule, it’s critical that the retirement plan industry standardize roll-ins to improve portability.
Limit small businesses’ access to retirement services
The U.S. Chamber of Commerce recently expressed its concern that the final version of the fiduciary rule did not resolve critical issues, “…such as whether the final rule discriminates against small businesses, limits the availability of investment education, substantially increases litigation risk to the detriment of savers and the retirement system, and gives insufficient time to implement the final rule.”
The fate of the fiduciary rule is far from certain. While it has an admirable goal–improving the advice that retirement investors receive from financial professionals–it is best that any unexpected consequences that could negatively affect retirement investors be thoroughly examined and adjustments made, if necessary, before the rule is implemented.
Terry Dunne is Senior Vice President and Managing Director of Rollover Solutions Group at Millennium Trust Company, LLC. Mr. Dunne has over 35 years of extensive consulting experience in the financial services industry. Millennium Trust Company, LLC acts as a directed custodian, and does not provide tax, legal, or investment advice.