Unveiled on April 23, 2024, the Biden administration’s Retirement Security Rule has again pitted fee-only financial advisors against insurance professionals who receive commissions. There have been a wide range of responses from professionals and considerations for individuals seeking financial advice.
— What is the new investment advice fiduciary rule?
— What is a fiduciary?
— Why does a fiduciary standard matter?
— How big of a problem is this?
— How were clients protected before this new rule?
— How did the DOL arrive at their decision?
— When does the new rule go into effect?
— Why is the rule contentious?
— Reaction from the investment community.
— Reaction from the insurance community.
— Where do courts stand on the rule?
— What is different in this version?
— Will I be better off under this rule?
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What Is the New Investment Advice Fiduciary Rule?
The Retirement Security Rule (“the DOL Rule”) will require all advisors who are working with retirement savings options, including 401(k) retirement plans, qualified plan rollovers and annuities, to follow a fiduciary standard, regarded as the strictest in the industry.
The current fiduciary definition for retirement advice has not been meaningfully updated since 1975. Since then, there has been a major corporate shift away from traditional pensions (defined benefit plans) in favor of 401(k)s (defined contribution plans). In defined contribution plans, each individual participant is responsible for their retirement security.
What Is a Fiduciary?
A fiduciary is an advisor who is required to put the best interest of their client ahead of their own.
Not all financial advisors are required to follow this standard. Depending on the products being used and even the firm where an advisor works, they may be required to follow a different suitability standard.
— Fiduciary advisors are regulated according to the Investment Advisors Act of 1940. They must assess information to be accurate and correct, and do a thorough analysis for the client. Most importantly, they must avoid any conflict of interest, unless it is fully disclosed to the client. These advisors are usually paid a fee directly by the client.
— Non-fiduciary advisors work for a broker-dealer (BD) that is regulated by the Financial Industry Regulatory Authority (FINRA). They must believe that the recommendations that they are making to their clients are suitable for them. These advisors will receive a commission for their work paid by the product provider through the BD.
The DOL Rule is designed to protect retirement investors from recommendations that are not appropriate for the client, which can arise when an advisor has a conflict of interest. Acting Labor Secretary, Julie Su, has said of the new rule, “Retirement investors can now trust that their investment advice provider is working in their best interest and helping to make unbiased decisions.”
Why Does a Fiduciary Standard Matter?
There is a significant amount of money at stake. Given that a 401(k) may represent a person’s entire life savings, it is important that they are receiving the best possible advice in their investment choices, rollover options and ultimately, retirement distributions.
This rule change was unveiled by the DOL in conjunction with President Joe Biden’s initiative on junk fees and related pricing practices. While the DOL asserts that financial advisors should be paid fairly for their professional work, the Biden administration also ascertains that commissions in the retirement advice arena are too high and unsuitable for some clients.
How Big of a Problem Is This?
When a person leaves their employer, they have a choice to “roll over” the money from the corporate plan to a range of individually owned options. However, the test for an advisor in determining which standard they must follow included whether or not the advice was provided on a regular basis. Given that a rollover is considered a one-time event, this important action became a key loophole in prior regulations.
The DOL reported that Americans rolled over about $779 billion from 401(k) and IRA plans in 2022. In opining that commissions create lower returns or higher costs, the Council of Economic Advisers found that clients may be able to recoup up to a collective $5 billion per year by receiving advice under a fiduciary standard.
How Were Clients Protected Before This New Rule?
Even if a financial advisor is not required to meet the fiduciary standard, they are still heavily regulated under a different governing body.
Additionally, there is an exception to the DOL rule called the Impartial Conduct Standards (ICS). An advisor must adhere to the ICS in order to benefit from two Prohibited Transaction Exemptions (PTE) created in 1977 and 2020.
— PTE 84-24: This exemption allows producers to receive a commission whenever they implement life insurance or annuities within a retirement plan or IRA. However, they cannot receive more than reasonable compensation and cannot make any materially misleading statements. Notably, reasonable compensation has not been fully defined.
— PTE 2020-02: Created by the Trump administration, the exemption designated the financial institution offering the insurance and annuity contract to also be considered a fiduciary whenever an investment professional gives fiduciary advice to a retirement plan client. This exemption eliminated financial institutions from creating incentives for a financial advisor to place business that may not be in the client’s best interest. These incentives include production awards and bonuses, travel, contests, sales quotas, and even performance reviews.
How Did the DOL Arrive at Its Decision?
The DOL offered the planned proposal in late October. A 60-day comment period on the rule immediately followed and 19,459 comments were received.
Industry groups were angered at the timing and speed of the comment period. Not only are some of the most major holidays during November and December, but December is also typically the busiest time of the year for professionals to meet year-end tax deadlines.
The DOL also held a two-day public hearing in December. The public hearing was unprecedentedly held during the comment period.
Once the comment period ended on Jan. 2, 2024, the final proposal went to the White House Office of Management and Budget. Throughout the spring, the OMB met with key industry officials, including those representing AARP, the U.S. Chamber of Commerce, Finseca, the Insured Retirement Institute, the CFP Board, the National Association of Insurance Commissioners and the Financial Services Institute.
But because of the perceived lack of questions posed to the advisory industry and lack of debate, some opponents of the new rule intend to seek relief in the court system.
When Does the New Rule Go Into Effect?
The new rule will go into effect on Sept. 23, but the industry will have a 365-day transition period in order to put into place the procedures and paperwork necessary to properly integrate it into their daily activities.
Why Is the Rule Contentious?
At the heart of this new federal regulation is the ongoing argument between two factions of the financial services industry. There is a presumption that all commissioned sales pose a conflict of interest. Within a fiduciary standard, all conflicts must be eliminated or fully disclosed to the client.
Reaction From the Investment Community
Many financial advisors are already operating under the fiduciary standard, with assets under management (AUM) fees as their primary compensation practice. As a result, investment stakeholders are generally happy with this ruling.
CFP professional designation holders are required to maintain a fiduciary standard at all times. Their governing body applauds the new DOL rule. It points to a recent study that the CFP Board conducted, which found that “92% of Americans expect financial professionals to provide retirement savings advice in their clients’ best interests.”
However, key industry voices still recognize that broad rules of this nature will require a significant investment of both time and money to implement the compliance processes and supervision for incorporating insurance products under a fiduciary standard.
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Reaction From the Insurance Community
Insurance groups have had a stronger reaction, noting that both the U.S. Securities and Exchange Commission and the Department of Labor already subject their members to an extensive regulatory framework.
Insurance products date back to 1750 BC with the Code of Hammurabi and have historically been sold on a commission basis. The professional practice of fee-based financial planning began in 1969. The DOL rule would essentially ban many insurance compensation practices and require an entirely new compliance structure in order to accommodate it. The majority of insurance products would have to be completely repriced to fit within regulatory fee limits. This would not improve the economics of insurance products, but rather add an entirely new layer of expenses that would ultimately pass to the consumer.
Given that most of the recommendations that are used with workplace benefits include insurance products, which pay the advisor a commission, the rule is widely summed up by Finseca’s CEO, Marc Cadin, as “an ideological campaign to ban commissions.”
The ripple effect may extend even further. Cadin notes that there is a “$12 trillion protection gap with tens of millions of Americans with little to no retirement savings. At a time when we need to encourage more Americans to pursue holistic financial plans, we must expand access and choice to advice, not limit it.”
He continues: “Millions of Americans will be less financially secure. Research from Ernst and Young has clearly shown that a holistic financial plan that includes life insurance, especially permanent policies, investments and deferred income annuities, outperforms investment-only or investment-plus-other-products approaches in every combination.”
Dale Brown, president and CEO of the Financial Services Institute, presented a study by Oxford Economics that found that the proposed rule would result in over $2.5 billion in costs and 120 million sheets of paper annually. Additionally, the industry’s startup costs are estimated to run nearly $3.9 billion, a figure over 20 times greater than even the DOL’s preferred framework.
Cadin adds, “We were clear that OMB should not let this fiduciary-only approach move forward because it will cause real harm to real Americans. It will make it harder for Americans to access financial advice. It will also make it harder to bring new professionals into the business and dramatically raise costs for existing professionals.”
Many Americans do not have enough investable assets to utilize professional services, which makes them unattractive prospective clients to the investment community. Commissioned products have often been able to create a bridge that enables more investors access to quality, affordable advice. These additional headwinds may ultimately put professional financial advice out of the reach of many Main Street investors.
Where Do Courts Stand On the Rule?
The new DOL rule is not the first effort to update the federal retirement law known as ERISA.
There have been intense debates and encompassing litigation for more than a decade, beginning with the Obama administration. Each time, DOL attempts have continually been struck down by the court system for overstepping boundaries.
Obama’s plan was thrown out by the U.S. Court of Appeals for the Fifth Circuit in 2018. In a 2-1 ruling, the court vacated the regulation, saying that the five-part test to determine who qualifies as a fiduciary went beyond the DOL’s appointed oversight by Congress. They highlighted that the language was inconsistent with both ERISA and the Internal Revenue Code, as well as the common law meaning of fiduciary.
The Trump administration also started a version late in the first term. When Biden was elected, his administration halted the Trump proposal.
What Is Different in This Version?
Industry experts foresee the Biden proposal going down the same path as Obama’s, due to its reliance on similar provisions that the courts have earlier found problematic.
Biden’s version seeks to correct the verbiage of the rule, while maintaining the same goal. Proponents believe that it overcomes the issues from the 2016 rule and will be more resilient to the legal arguments that overturned the rule six years ago.
Will I Be Better Off Under This Rule?
It is always a right step for the entire financial industry when clients feel confident that their needs and interests are being met by their professional advisors.
However, regulatory action or even inaction can supersede this intent. The $64.8 billion Ponzi scheme perpetuated by Bernie Madoff was the largest in history. Madoff was a fiduciary financial advisor who was deeply trusted by both clients and regulators alike. A fiduciary standard is not foolproof.
Additionally, a fiduciary advisor typically charges a fee based upon the assets under management. Theoretically, an advisor is paid more when the assets increase, but they are also paid less when the asset value decreases. If the stock market goes down, the advisor usually has greater client responsibilities and needs to be more responsive at a time when their income is reduced. Advisors may recommend against taking any actions that could cause the account value to decrease, such as large purchases like buying a business or a vacation home or even life, disability and long-term-care insurance for risk management needs. Thus, AUM is not without conflicts, either.
Heightened regulation will not universally deter any advisor that is not already putting their clients’ needs first. The additional compliance requirements may make recruiting and retaining quality people more challenging. Institutions and advisors alike will pass along their additional costs to the client, all of which could create new barriers to accessing professional, personalized advice.
Investors can best protect themselves by asking their advisor how they are paid and why they believe their recommendations are best for the investor’s unique needs and situation.
Competent and trusted advisors will always happily answer these questions clearly and completely.
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A New DOL Rule May Change How Advisors Handle Your Retirement Money originally appeared on usnews.com
