Fiduciary role

Fiduciary role

History of the Fiduciary Rule

For many years, the regulation of the quality of financial advice offered to retirees has been under the provisions of The Employee Retirement Income Security Act of 1974 commonly known as ERISA. Since 1974, no revisions have been made on ERISA to reflect the changes in the retirement saving trends such as the surge in the Individual Retirement Accounts (IRAs). Additionally, since the enactment of the ERISA, the financial sector has experienced a rapid growth in the defined contribution plans.  According to Pasztor, “40 years have elapsed since the Department of Labor’s defined what comprise a fiduciary act when it comes to the provision of advice that involves retirement plans (9).  In 2010, several recommendations were proposed but were quickly abandoned following a fierce opposition from the different stakeholders in the financial industry (Skinner).

On February 23, 2015, President Obama authorized the Department of Labor to update the rules guiding the advice that the financial service providers give to retirees. According to President Obama, the new rules aimed at ensuring that the financial advisors put their client’s best interest above their own (Skinner).  On April 2016, the Department of Labor proposed new rules as per Presidents Obama’s directive.  The new recommendations were approved by the Office of Management and Budget and endorsed by President Obama (Pasztor 2). The Department of Labor issued its final set of rules on April 6, 2016. However, this was not until it held public consultation that lasted for four days. Under the Department of labor’s new definition of fiduciary demands, all financial advisors need to act in the best interest of their clients. For this reason, there is no way a financial advisor can conceal any potential conflict of interest.  Additionally, the advisors are mandated to disclose all the commissions and fee their charge for their services to the client in terms of dollars.  The rule issued by the Department of Labor is set to be implemented starting on April 10, 2017 (Pasztor). If implemented, the new rule will ethically and legally bind all the professionals who offer financial advice to retirees since they can be held personally liable if their actions contradict with their client’s best interest (Skinner).

The ruling will not only affect the financial advisors but will also have tremendous consequences on the insurance agents and brokers as well. The new rule binds all professionals in the financial sectors including those making solicitation or recommendations. As such, one does not have to be offering on-going advice to the clients to be bound by the new fiduciary rule created by the Department of Labor. Prior to the enactment of the new regulations, the definition of a fiduciary only comprised of professionals charging a fee for their services in terms of a proportion of account holdings or hourly payments (Parztor 3). The new ruling places a higher level of accountability on the financial salesmen such as insurance agents, brokers, and planners who deal with retirement accounts and plans than the suitability standard.  According to Pasztor, unlike in the suitability standard, under the new fiduciary rules, financial advisers have to ensure that the recommendations they offer to their clients meet the latter’s well-defined objective and needs (Consumer Federation of America). Under the new regulations, professionals in the financial sector have a legal mandate to prioritize their client’s interest and not just offering recommendations on suitable investments. Besides, the rules say that all professionals who receive commissions from their clients will have to provide to the later a disclosure agreement known as Best Interest Contract Exemption in case they foresee a situation that may bring about a conflict of interest. The document must also contain all the commissions that are set to be paid to the financial advisors by the client (Pasztor).

Some of the retirements plans that are covered in the new Fiduciary rule include the defined-contributions plans, individual retirement accounts, and defined-benefit plans.   Under the defined-contributions plans, the new rules cover the employee stock ownership plans, 401(k) plans, 403 (b) plans, Simplified Employee Pension (SEP) plans, and saving incentive match plans. Under the defined-benefit plans, the arrangements that promise a certain amount of money to be paid to the participants as stated in the plan document also falls under the new fiduciary regulations.

However, there are certain interactions between a customer and the financial advisors that do not require the utilization of the new fiduciary rule.  For instance, according to Pasztor, sales pitches can be made if the assets involved are worth $100 million and more. However, parties engaging such pitches “have to enter this exception with the understanding that they are acting at arm’s length and neither party expects that the recommendations will necessarily be based on the buyer’s best interest” (Pasztor 11).  Besides, sometimes customers make calls to financial professionals requesting information regarding certain investment plans or products.  In such a case, the information the professionals gives to the customer does not amount to a financial advice.  Additionally, in certain circumstances, financial advisors may offer education to clients based on the latter's age or income. This does not fall under the provisions of the fiduciary rule.  Also, taxable transactional accounts are not viewed as retirement plans regardless of whether or not the money in these accounts serves as retirement savings (Skinner).

Reaction to the Fiduciary

The new fiduciary ruling has been received with mixed reactions by the various stakeholders in the financial sector.  The majority of the stakeholders in the financial sector agree that the ERISA rules that were enacted 40 years ago were almost becoming obsolete. Since their enactment, several changes have occurred in the industry hence a new set of rules were needed to offer the necessary regulations. The supporters of the new Fiduciary rules applauded the arguing that they will increase the level of transparency in the industry in addition to preventing the financial advisors from abusing their positions by charging excessive commissions. A 2015 White House Council of Economic Advisers report found that biased financial advice results in the loss of $ 17 billion annually from retirement accounts (Pasztor 5).  On this note, according to the Editorial Board of the ST. Louis Post-Dispatch, the White House Council of Economic Adviser, had speculated that a 45-year-old person with a retirement savings of $100,000 could lose $37,000 as a result of conflicts of interest by the time he/she attains the age of 65 years (Pasztor 5). These are some of the reasons the new rulings were applauded, particularly by consumers and activists.

While the majority of the citizens have applauded the new fiduciary rule, the legislation has faced intense criticism, particularly from planners and brokers. This group of persons favors the suitability standard established by the ERISA Act. This is because unlike the suitability standard, the fiduciary regulations will result in them losing money in terms of added compliance cost and lost commissions.  According to Skinner, the new fiduciary rues will cost the financial service industry approximately $2.4 billion annually if it achieves its goal of eradicating conflict of interest. Consequently, the major stakeholders in the retirement assets management have undertaken several actions aimed at ensuring the new DOL rules are never implemented starting in April 2017.

Several stakeholders have filed lawsuits against the new regulations hoping that the court will declare them unconstitutional. Currently, three lawsuits have already been filed against the fiduciary regulations. However, out of the three lawsuits, the one that many individuals are following keenly is the one that the U.S Chamber of Commerce, Financial Markets Association, the Securities Industry and the Financial Service Roundabout filed in June 2016 in the United States District Court for the Northern District of Texas (Skinner).  The arguments presented by these organizations are that President Obama overstepped his mandates by authorizing, endorsing, and fast-tracking the implementation of the new DOL regulations.  On the other hand, some the groups opposing the implementation of the New DOL regulations went to the court in order to delay their implementation hoping that the coming government would override the rules (Skinner).

Apart from the above agencies that filed lawsuits against the new fiduciary rules, there are some lawmakers who believe that the Department of Labor overstepped its mandate when it targeted the IRAS. According to Pasztor, “during the adoption of the ERISA act in 1974 by the Congress, the department of labor was given the mandate to establish higher standards for retirement accounts that should work alongside those that exist under the federal securities laws” (9).  However, according to the lawmakers opposed to the new regulations only the Congress has the power to approve rules aiming at regulating the consumer’s right to seek certain services. 

 According to Skinner, some Republicans lawmakers had already passed congressional resolutions with the aim of killing the Department of Labor regulations. However, President Obama had pledged to halt those congressional resolutions using his veto powers. The opponents had to back down since they could not garner enough votes to help them override the president’s veto powers (Skinner).  Additionally, there are some critics who argue that the new rule will make no difference since the consumers are still at the mercy of financial advisors. This is because the adherence to the new rule requires a lot of paperwork.   Consequently, the rogue financial advisors may trick their clients into signing a contract authorizing them to receive a certain commission (Skinner).  

The Effects of the New Fiduciary Rule

According to the Federal Reserve statistics, the total financial retirement assets were about $ 62.3 trillion by the end of September 30, 2015 (Pasztor 4). If the amount of money in the checking and savings accounts which amounted to $ 10.5 trillion is deducted from the $ 63.3 trillion, the remainder which is $52.8 trillion is left as the total financial assets (3). This is the amount that was set to be regulated by the Department of Labor fiduciary rule in addition to the $7.3 trillion held in the IRAs. The main reason that inspired the DOL to come up with the new regulation was the high amount of fees charged on the retirement assets. Pasztor reports that “an annual fees of just 10 points on retirement assets of $23.5 trillion would be $23.5 billion” (4). The relatively high amount of money brokers deduct from the retirees in terms of fees and commission is what triggered the Department of Labor to enact the new fiduciary rules.

The new rules have both negative and positive consequences.  Firstly, the new rules will result in an increase in compliance cost, particularly in the broker-dealer sub-sector. Additionally, the increase in compliance cost will affect registered investment advisors (RIA) and fee-only advisors as well (Skinner).  Besides, the new rules will change the way in which the financial advisers get paid.  The Departments of Labor’s new rule does not outlaw revenue or commissions sharing. It only requires financial advisers to have their customers sign a best interest contract exemption.  By signing the contract, the advisor pledges to act in the customer’s best interest in exchange for a reasonable compensation.  In the presence of such a contract, investors who think that their advisors did not act in their best interest can sue them in the court.   According to Skinner, experts expect retirees to start filling lawsuits starting in January 2018 when the DOL ruling will become fully implemented.  This means that the financial advisors who will remain in the industry will have to set aside a certain amount of money to be used as litigation fees in case they are sued by their clients. Consequently, the legal fraternity will embark on a journey of nurturing hundreds of lawyers in preparation to the ligations resulting from clients suing their financial advisers.  As such, lawyers are some of the indirect beneficiaries of the new fiduciary regulations (Skinner). 

On the other hand, clients are the biggest beneficiaries of the new DOL ruling.  According to Skinner, the new rules put the “clients in the driver’s seat.”  The regulations are intended to raise the client’s consciousness. The enormous media attention the new regulations have received as well as the campaigns mounted by fiduciary advisers serve to trigger clients to start asking pertinent questions regarding conflict of interest and compensation (Consumer Federation of America). Research shows that 46% of Americans think that financial advisers are mandated to put their customer’s interests first when they offer advice to retirees (Skinner). However, this is not what happens on the ground since financial advisers extort their clients by charging exorbitant fees and commissions.

 The amount the clients pay in terms of commissions to their financial service advisors will decline once the new rules are fully implemented. On this note, financial advisors will be forced to spend a substantial amount of time with their clients trying to decipher how the latter want their money to be invested.  Under the new fiduciary rule, financial advisors will be forced to look closely at the needs of every client and determine whether they can be achieved under the existing arrangements or some changes are necessary (Consumer Federation of America). According to Skinner, the biggest gain for customers is that they will be in a better position to exit “the more egregious advice business” that put their money into expensive investments that do make good profits in the long run.  However, regardless of the path the clients and the advisors decide to take there will be a lot of monitoring and documentation involved (Consumer Federation of America).

Apart from the clients, some RIAs are celebrating the passage of the new fiduciary regulations. According to Skinner, Registered Investments Advisors are already being held by the best interest standard. As such, they will only have small operational changes to make to handle IRAs and retirement plans. The only thing they will need is additional documentation to demonstrate to their clients how the customers' best interest will be achieved.  On the negative side, many financial service providers will be forced to drop undersized retirement’s accounts. According to Skinner, the country's thousands of brokerage, insurance, and advisory firms that offer financial advice within the $ 25 trillion retirement service industry will be forced to make adjustments in their procedures and operations in order to comply with the new regulations.   Skinner says that the new regulations may prompt many customers to enroll for fee-based accounts. However, these accounts do not bring any meaningful profits to firms, particularly when low balances are involved.  As such, according to Skinner, some clients will be forced to find a new financial adviser for their retirement assets.  Individuals with smaller retirement accounts may start hearing their advisers tactfully suggesting that they move their account to companies offering digital financial services.   However, Skinner reports that the retirements accounts that some advisors view as too small for them to profitably offer conflict-free advice will be taken over by the country's growing number of digital advice providers such as Personal  Capital, Betterment, and Wealthfront. 

The new fiduciary rule will have a devastating effect on Registered Investments Advisors (RIA) firms and small independent brokerage enterprises. Such firms may lack enough resource to upgrade their technologies and meet the compliance expertise that will enable them to meet all the set requirements (Pasztor 12). As such, some of these enterprises will be forced to close doors while others will be absorbed by larger ones.  The effects of the new rules is already being felt as two companies; American International Group and the Brokerage Operations of MetLife Inc. have been sold off as their owners were intimated by the anticipated increase in compliance cost (Skinner). Besides, one month after the DOL announced the new regulations Charles Schwab Company reported that it would be moving away from mutual funds citing higher implementation expenses of the new DOL rules (Skinner). According to experts, more firms will opt to adjust their products in order to incorporate less expensive options. Cathy Weatherford, the CEO of the Insured Retirement Institute claims that the new rule is likely to limit the investors choice (Skinner).  Consequently, insurers will be forced to create new retirement products that operate under the fee-only basis as well as those that do not fall under the stricter BICE standards (Skinner).

Additionally, the new rules will result in a decrease in the annuity vendors’ profits.  The new regulations require the annuity vendors to reveal their commissions to their clients. Before the enactment of the new regulations, financial experts have been complaining about the high commissions that the annuity vendors charge and which reduces the amount of money their clients receives. On the other hand, according to Skinner, the final Department of Labor’s rule comes as a “pleasant surprise for the $ 10-billin-year-a-year industry of nontraded real estate investments trusts.”  Nontraded real estate investments trusts are a high-commission product since 7% of their sales is paid to brokers as commission.  As a result of the high-commission involved in the sale of Nontraded REITs, brokers prefer selling them to retirees in order to create a regular flow of income.  The new rule does not prohibit brokers from putting the retirees into nontraded real estate investment trust. However, under the new regulations, brokers will have to adhere to the requirements set by BICE such as the reasonable parameter and fee disclosure provisions. If this happens, the nontraded REITs will be a tougher sell for brokers (Skinner).

Additionally, according to Skinner, the new DOL rule will force financial advisers to adhere to the BICE conditions before they can begin to sell indexed annuities and variable annuities in qualified accounts. The primary effect of such a move is that a decline in the sales of these high commission annuity products will be witnessed. According to Ryan Krueger, who heads the Keefe Bruyette & Woods Inc, the sales of indexed and variable annuities in qualified plans will decline by between 25% and 50% (Skinner).

Historical backgrounds

 Since the Stock Market Crash of 1929 which was one of the factors that caused the Great Depression, major changes have taken place in the securities market regulations.  During the Great Depression, two security acts were passed; the Securities Act of 1933 and the Securities Act of 1934 (Pasztor 5). The Securities Act of 1933 aimed at regulating the primary markets. On the other hand, the Securities Act of 1934 established the Securities and Exchange Commission. However, its main objective was to regulate secondary markets. The two securities regulations laws were followed by the Investment Act of 1940.  This is the law that established the fiduciary standards that guided the operation of the registered investments advisers until 1974.  The objective of the Advisers Act was to eradicate the tipsters and salesmen who offered ill advice to investors triggering the 1929 stock market crash. However, the Act failed to set the minimum level education that an RIA must attain before he/she is allowed to offer financial advice to investors. It only required that advisors seek registration before they start offering financial advice to retirees (Pasztor 5).

The Great Recession that began in 2008 and ended in 2010 was a major global economic downturn. Its major cause was the deregulation of the financial sector and the mismanagement of people’s money. The Great Recession was also caused by the action of people borrowing more than they could afford to repay. Some of its effects included the widespread unemployment, increased debts, and many individuals losing their homes as they were confiscated by creditors after they failed to pay their loans (The Editorial Board). The Aftermath of the Great Recession saw the U.S government enact several regulations that hoped to prevent the occurrence of another financial disaster. Some of these regulations included the Dodd-Frank Wall Street Reform and Consumer Protection Act which were passed by the Congress in 2010 (Pasztor 7). The legislation aimed at stabilizing the country’s financial sector. These pieces of legislation also aimed at improving transparency and accountability in the financial system.  Lastly, the Act hoped to protect consumers from unscrupulous financial service providers.   The bill also created the Financial Protection Bureau.   The Great Recession of 2008 did not occur by accident. It was triggered be the action of Wall Street that engaged in overly risky investments practices as a result of the lax regulations set by President Obama’s predecessors. As such, the DOL fiduciary has one goal in mind which is to ensure that whatever happened during the 2008 economic meltdown does not occur again (The Editorial Board).  If the new DOL rule was in practice in 2008, the Great Recession could have been averted.  As per the new rules, financial advisers have to follow what their clients what and not the other way around (Consumer Federation of America).

In conclusion, the country has experienced several economic disasters such as the 1929 stock market crash and the Great Recession of 2009-2009. These economic crises have one thing in common; they were caused by the deregulation of the financial sector. Since 2010, when the Great Recession finally came to an end, the department of labor has been contemplating on ways of ensuring that the financial advisers are inspired by their client’s best interest when making the various investments plans. The efforts of the Department of Labor finally bore fruits when their recommendations were endorsed by President Obama in 2016, and the implementation of the new rules was set to begin in April 2017. Under the new DOL laws, financial advisors are legally and ethically mandated to put their customers' interest before theirs. If this rule was in existence in 2009, the Great Recession could have been thwarted since there is no way Wall Street could have been inspired by their self-gains to engage in overly risky investments that jeopardized the country’s economy.

Work Cited

Consumer Federation of America. “6 ways the DOL fiduciary rule improves protection for retirement savers.” 6 April 2016. http://consumerfed.org/wp-content/uploads/2016/04/6-Ways-the-DOL-Fiduciary-Rule-Protects-Retirement-Savers.pdf Accessed on April 3, 2017.

Pasztor, Jim, M. "Embracing the future: Implications of the DOL fiduciary standard for the financial services industry."  2016. http://www.cffpinfo.com/download/white-papers/Embracing-the-Future-DOL-Fiduciary-Standard.pdf

Skinner, Liz. “The DOL fiduciary rule will forever change financial advice, and the industry has to adapt.” Investment News, 9 May 2016. http://www.investmentnews.com/article/20160509/FEATURE/160509939/the-dol-fiduciary-rule-will-forever-change-financial-advice-and-the. Accessed on April 4, 2017.

The Editorial Board. “Editorial: Lessons from the Great Recession seem to have been lost on Trump.” St. Louis Post-Dispatch, 6 February 2017. http://www.stltoday.com/news/opinion/columns/the-platform/editorial-lessons-from-the-great-recession-seem-to-have-been/article_4b76c14c-20b4-5b45-b540-5a27a3827bf5.html. Accessed on April 3, 2017.