Fiduciary follies?

A new Department of Labor rule expands who is defined as a fiduciary, and wealth managers now must define themselves accordingly.

From the pages of In Business magazine.

Listening to some professional wealth managers, you’d swear the Department of Labor has thrown a grenade into their foxhole, but not every wealth manager agrees that the DOL’s new rules governing their industry is an act of war.

While some financial firms backed off after first agreeing to an interview, we spoke to two local financial advisers who have no problem with the fact that the new rule expands the investment advice fiduciary definition under the Employee Retirement Income Security Act of 1974 (ERISA). It will automatically elevate to the level of fiduciary all financial professionals who work with retirement plans or provide retirement planning advice, and legally and ethically require them to meet the standards of that status.

“It’s actually what your mother and father told you about the golden rule,” explains independent financial adviser Nathan Brinkman, president of Triumph Wealth Management in Madison. “It’s basically what I would consider common sense — to treat others as you would want to be treated yourself.”

The new rule likely will impact those who work on commission, such as brokers and insurance agents, the most. In addition, expect rollovers from 401(k) plans to individual retirement accounts to receive more scrutiny from regulators, but the retirement plans covered under the rule include various types of defined contribution plans such as 401(k)s, 403(b) plans, employee stock ownership plans, simplified employee pension (SEP) plans, and savings incentive match plans such as IRAs. There are certain types of irrevocable trusts, such as credit-shelter trusts, that some firms are adding to this list because there are fiduciary implications, but they are not identified in the rule.

Jon Goldstein, a private wealth adviser with Goldstein & Associates, an Ameriprise private wealth advisory practice, says the definition of fiduciary is still being clarified, as are the criteria used to evaluate whether the standard has been complied with. One of the goals is to level compensation in a firm so that it’s clear and understandable, and so clients can determine what firm to choose. Since advisers and firms have different focuses, compliance will mean different things to different firms.

“Every firm is different, and every client’s needs are different,” Goldstein explains. “The products are different, and then their needs probably change over time. So, again, it’s pointing the clients to the appropriate situation.”

Advisers hope that an 18-month extension on the rule will give people a chance to work through what the rule actually means, and previous guidance appears to give wealth managers some breathing room. Even with the delay, parts of the rule were enacted. 

“The Department of Labor said — I think it was sometime early in January — that they are not necessarily going to look at claims for fiduciary standards as long as you can document that you are working toward improving your process to become a fiduciary,” Goldstein notes. “So to some extent — I’m not sure that’s the exact reason for the 18-month delay — but I’m hoping that’s where people go because some people were hoping, and that’s firms and clients and advisers, for some very concrete standards, and while the term fiduciary is out there, there is a lot of interpretation of exactly what it means.”

The rule also does not allow advisers to conceal any potential conflict of interest, and states that all fees and commissions must be clearly disclosed in dollar form to clients. “Yes, but just to clarify that, usually what they’re doing involves a percentage of the dollar amount,” Brinkman says. “As an example, let’s use bonuses. In the past, companies may incentivize advisers to sell a certain product, and so what they are trying to do is make sure that all compensation is disclosed.

“Number two, in the past every organization or institution defined fees separately, so some of them were transparent and some of them were not overly transparent. So the premise of this is just being transparent with fees, which I am a big fan of.”

What are the different kinds of fees typically charged? According to Brinkman, there are platform fees, administrative fees, and trading fees, and with some of these there could be good reasons why they’re not overly transparent. For example, if you engage a product that has no initial trading fees, it’s easy to not disclose those, but then when you make a change in the future that triggers a trading fee, Brinkman believes that should be disclosed.

What the rule is trying to do, he reiterates, is create transparency in fees. Alternately, he believes it will more than likely level fees. “With full disclosure, and everybody forced to disclose fees the same way, eventually what it’s going to do is level fees,” he says. “The great majority of our industry does it the right way, in a transparent way, and has been disclosing fees, but there are always a couple of bad apples in every industry that traditionally have not been as transparent. As a guy in the industry, I’m a big fan of the belief that everybody should play by the same rules.”

One thing is clear to Goldstein — the rule does prohibit advisers from concealing any potential conflict of interest, and it states that all fees and commissions must be clearly disclosed in dollar form to clients so the consumer can make an informed choice. Does that mean all the fees that are part of an overall charge? “Not necessarily,” Goldstein says. “There are a couple of different things that you’re looking at here. There are multiple ways advisers can work and multiple ways that clients can engage their services. The goal here is to make very clear what the compensation is that’s being received.”

In terms of setting a fiduciary standard for wealth managers, Goldstein calls it “phenomenal” and wishes such a rule had been in place for the past 50 years. “They have always said you’re supposed to disclose it, but not everybody always did — partially because it historically has not been enforced,” he explains. “Advisers just said, ‘No, we’re not necessarily always going to bring it up.’ The assumption is that advisers get paid for their work and maybe they just didn’t want to do that.”

In the context of the broker-dealer relationship, Goldstein believes a problem with brokerage firms, which have varied and targeted clientele, is that having a uniform standard doesn’t necessarily result in the best product or service because there is not a uniform distribution of need. However, there is one client benefit, intended or not, that is a direct result of the new rule, and that is some advisers could break away from brokerage firms and move to an RIA (registered investment adviser), or vice versa, to get in compliance.

“From that standpoint, the concern is that if you have advisers who are potentially at the wrong firm, their client is not a good match anymore, and we’re starting to see a lot of advisers changing firms so they can hone in and focus on the clientele and the process and the systems that fit their clients,” he says. “That is a really nice result, whereas previously a lot of advisers would stay at the same firm just because that’s where they have always been.”

Also under the new rule, financial professionals are legally obligated to put their clients’ best interests first rather than simply finding “suitable” investments, and many believe this aspect of the rule therefore could eliminate commission structures that have governed wealth management. So while a fiduciary standard has been established, Goldstein notes there still are “best interests contracts,” both of which are designed to put a wealth manager in the client’s shoes. In other words, what would you do with your knowledge and everything you know to align yourself with the interest of your client?

“There are going to still be, as far as I can tell, some exceptions for commissioned products and services,” Goldstein adds. “Which firms maintain that and for what types of accounts — that’s yet to be determined. The presumption is that those are probably going to go away. I don’t know how and I don’t necessarily know what replaces them, but there are some clients for whom maybe that still is the most reasonable and most beneficial course of action.

“Some clients innately understand that and they are more accepting of that than a fee for service, so you’re meeting the client’s expectations, as well as the intent of this fiduciary standard. As long as clients are still asking for that, how does it get regulated away? That being said, I’m not necessarily a fan of that structure, but I can see where it could still be around for awhile.”

According to Brinkman, the rule originally was to help in the 401(k) deferred compensation industry, but moving down to the IRA space, there will be one unintended consequence. Traditionally, the financial adviser that did business by way of commissions would service clients that did not have large account balances, and they felt they could earn what they wanted to earn. If you eliminate commissions, much of the general public is going to become underserved because advisers won’t be able to afford to service low-balance accounts. “Commissions are not necessarily bad and really all they’re asking us to do is make sure that advisers disclose commissions,” Brinkman adds.

A consumer with a low account balance will have to find the kind of adviser that trusts that kind of match.

In terms of how this is going to affect the general public, Brinkman says that when you introduce a new regulation that is going to a drive additional paperwork and drive additional compliance, those costs eventually will filter down to the clients in one of two ways. “One way is that they are going to have to pay higher fees, so even though the intention of the rule is to lower fees, there is a probability that this could actually increase fees that most people would pay because it puts a lot more liability on an adviser, which again I’m a fan of.

“But for the adviser, in order to stay current with everything, there is a cost of doing business with clients and that’s got to get passed out in someway, and so I don’t have that crystal ball to predict. My guess is that eventually the public, the consumer, is going to have to pay more for the services of a financial adviser.”



Delayed definition

The 18-month delay is effective from the date of the final rule on Aug. 14, 2017. President Trump has been mum on the new rule, but gumming things up is the fact that the new presidential administration has not hired back a lot of the Labor department administrators. Even if the administration wanted to implement the new rule, nobody is there to do it, so enforcement is in limbo.

Meanwhile, the DOL is not seeking additional public comments, just rewinding the tape a bit. This got started because the IRAs and deferred compensation plans like 401(k) accounts are regulated by ERISA and a lot of those laws date back to the 1960s and 70s. Since investment products gained in sophistication and were integrated into retirement planning, both on an individual and group basis, some of those laws probably need updating, Brinkman says.

“So this was started many years ago, and became a new topic of conversation, particularly in 2015 when it was reignited via U.S. Senator Elizabeth Warren (D-Massachusetts) and the Obama administration,” Goldstein adds. “Their view was that you had financial advisers that have a lot of influence in people making retirement decisions, and more Americans are dependent on their 401(k) plans than they are with pensions, so we should have somebody look at this to create a standard that mandates the financial industry think in the best interests of the client and really disclose the conflicts of interest.

“The main purpose, obviously, has to do with compensation, and that’s where this started, but where we are today is this initial launch. That launch has not gone through due to delays and so the question now is: How much of this are we really going to implement? They did the first phase in April and then the next phase was supposed to go in June, but that’s been delayed.

“A lot of it is going to be about disclosure to the general public or our clients in terms of what the conflicts are, and then compensation. That’s what they are trying to get to.”

Earlier in the year, there was a big push to be compliant with the new rule, whether it was with the certification or education of transitioning firms, and now with the delay people in the industry are taking one last look at it before putting new systems and processes in place.

For some of the systems and processes, “we don’t even have the technology and forms,” Goldstein notes. Some firms have an expense structure for compliance and that’s where the larger broker-dealers might have an advantage because they have more resources. On the other hand, smaller firms might have the advantage of being more nimble in responding to the new rule.

Data associated with regulations is changing in terms of what the SEC wants in the form of data and how they are going to regulate it, and the government has allowed some delays on that. “A lot of firms are changing and rolling out products, a specific product to comply with this so that if the advisers don’t have systems and processes in place, they can just offer the firm’s services and products,” Goldstein notes. “To some extent, they said, ‘Okay, you can’t use your own products and services, and so a particular firm could not use a fund-of-funds approach with their own products. Some firms said, ‘Yup, we’re not going to do that,’ and they have eliminated their proprietary funds for those types of services. Other funds said, “No, we’re going to use just ours,’ and they have gone in the polar opposite direction. So again, the interpretation of how they are going to comply with this with new product is not even remotely uniform.”

In addition, while some firms were proactive, others don’t have new systems set up yet, Goldstein notes. “Some were reactive — let’s wait and see what the rules are before we set up systems. If you’re an adviser at a broker-dealer that was a little reactive to it, it might have been easier to maintain current systems, but you have to change faster. There are pros and cons to both approaches that different firms took, but hopefully that matched their clientele. That’s the biggest thing — making sure your systems match your clientele.”

Advisers that did not prepare are seeing reductions to their compensation such as 12B-1 fees on mutual funds. “That might be a quarter percent of compensation, but if you’re giving up a quarter percent of a large book of business, that’s not an insubstantial amount of revenue that would otherwise come back to the adviser at some point,” Goldstein notes. “Those are changing and for the most part, I see advisors eating that compensation. I don’t necessarily know that it’s an easy thing to change in terms of the business structure for advisers, but we’re seeing lower compensation structures across the board for advisers.”

As for consumers, some of the rule’s critics contend that increased compliance costs will be passed onto them and there will be more paperwork to fill out. Goldstein doesn’t necessarily agree that cost-shifting will occur in all cases, but he acknowledges it will be an issue where advisers are a lot more selective in choosing clients because they will have to run their practice more like a business as opposed to letting the needs of the client run the practice. “They are going to have to be very efficient in what they do and how they service clients,” he states.

When that happens, will clients have fewer choices in terms of professional advisers, or will they have to be more engaged to figure out which broker is right for them? “That’s the bigger issue — evaluating whether you’re in the right spot,” Goldstein says. “That’s probably always been the question for the client. There are advisers who are really good at working with clients who are just getting started. There are advisors who are really good at accumulating assets. There are advisers who are really good at recovering retirement income distribution, and there are different advisers in different firms who specialize in certain sized accounts, and the question comes into play: Are you in the right spot?

“The harder part is when you’ve developed a good, long-term relationship with an adviser, and you outgrow them. Or what if the adviser’s firm changes relative to your needs? Where do you go and how do you change at that point in time?”

That’s more challenging, but Goldstein notes the adviser is doing the same thing with broker-dealers or RIAs. “A lot of the problems we end up with are, even though the adviser is really trying to do their best, they are not necessarily focused on their clients needs at that particular time,” he explains. “It’s the same with the broker-dealer, but then there’s a need for educating the client on what the niche is for the firm and the broker to make sure it’s a good fit, and I don’t think firms do the best job of that because they really want to try and cover the whole spectrum. Not every firm is good across the entire spectrum.”

In Brinkman’s view, the impact on consumers could be more limited. For one, advisers of the future are really going to leverage technology and be much more efficient in serving clients. Two, he says the industry already is starting to see a change in product mix in the variable annuity market as it’s related to qualified plans, which includes IRAs. A third impact, also visible, is the industry is starting to see a real impetus for low-cost investments. Like everything else, low-cost investments have a place, but they are not one-size-fits all, and Brinkman believes they are being used that way.

Another impact is clients might have to start doing this more on their own, and if the cost structure squeezes out their adviser, they will have to figure out how they get compensated. Brinkman forecasts that it could result in less service than clients have come to expect, and eventually clients might have to pay more out-of-pocket.

Another likely outcome is that as firms manufacture expensive financial products, and with advisers required to show the expense of one investment over another investment, clients are going to become involved in that decision. “If you’re a manufacturer and you’re not in the ballpark, you’re going to lose market share and you are going to lose business,” Brinkman explains. “This is definitely a vertical integration impact all the way from the investment manufacturer all the way down, but that’s a neat thing because you’re going to see creativity in the end products and an investment selection, as well.”

Rules rule

The Department of Labor isn’t the only federal agency that has contemplated fiduciary rules. The Securities and Exchange Commission is considering its own set of fiduciary rules, potentially adding more complexity, and has asked for public comments. Goldstein and Brinkman believe it could add more clarity and reinforce what the Department of Labor has done.

“One of the big issues I’d like to see addressed in the comments is the similarity between RIA rules and SEC rules on some of the brokers that have not held themselves up to the standard,” Goldstein says. “On occasion, you find people who were barred from FINRA [the Financial Industry Regulatory Authority) and the SEC, but can still function in an advisory capacity as an RIA,” Goldstein says. “Again, they are trying to establish a standard but it’s not uniform yet and that’s frustrating.

“This is a huge thing,” Goldstein adds. “I’ve been a big proponent of it for a very long time because people should have systems to document that they have educated their clients on what they can do if they’re not a good fit. You should tell the clients and hopefully you’ve got enough integrity to say, ‘Look, this adviser might be a better fit,’ even if it’s within the same firm, or recognize that your clients’ needs are different than what you’re providing.”

Brinkman says there is some overlap between Labor and the SEC. “They want to make sure that they are aligned with the DOL,” he states, “not necessarily add more complexity to what Labor is doing.”

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