The Department of Labor today released its final rule requiring advisors overseeing retirement accounts to act under a fiduciary standard to put their clients’ interests ahead of their own.
While the broad strokes of the rule have been known for some time, the Department of Labor tweaked the final version to “minimize” the compliance burden on firms and throw open the window to allow for a broader range of investments, including non-traded REITs and variable annuities, as long as advisors guarantee they are putting their clients’ interests ahead of their own.
The final rule also eliminates the requirement that firms give clients a projected cost analysis of their investments over time as well as an annual disclosure of fees.
The rule marks the first meaningful update to regulations of retirement advice since 1975, when the Employee Retirement Income Security Act was enacted to protect investors in private pension plans. According to numbers released last year by the Obama administration, imposing a fiduciary standard on advisors to retirement accounts would save investors some $40 billion over the next 10 years.
UPDATED: Read the full rule
Originally introduced last April, the new regulations were championed by consumer protection groups and registered investment advisors already working under the standard, and were strongly opposed by Wall Street’s traditional brokerage firms.
Those firms argued that curtailing certain business models (like sales-based commissions and revenue-sharing arrangements) for brokers of retirement accounts would shift the cost of advice to the consumer, making it unaffordable for smaller investors and putting a costly compliance burden on brokerage firms.
Thomas Perez, secretary of the Department of Labor, said the final version of the rule addressed many of those concerns.
“The DOL held over 100 meetings, hosted four days of public hearings and reviewed nearly 400,000 comments,” he said during a conference call with reporters Tuesday night. “With every meeting we took, every comment letter we read, every witness we spoke to at the hearing, we got smarter. We listened, we learned and we adjusted. And you’ll find that reflected in the final rule.”
Among the biggest changes in the final rule is throwing open the window for advisors to sell any financial investment, including listed options, non-traded REITs and variable annuities, under the so-called “best interest contract exemption.” The contract exemption allows advisors to collect commissions and compensation from revenue-sharing arrangements as long as the advisor agrees to put the client’s interests first, charge only “reasonable” compensation and avoid “misleading” statements about fees and conflicts.
Previous versions of the rule suggested some assets, including alternative investments and some private placements, would not be eligible for the exemption.
At the same time, the new version of the rule eliminated the requirement that advisors under the contract exemption provide clients with 1-, 5- and 10-year projections of the impact of fees on their investment, saying it was too difficult and costly for firms to provide.
The new rule also eliminates the proposed requirement that advisors acting under the exemption provide clients with an annual transaction disclosure detailing fees and costs.
The requirement that firms put conflict disclosures on a website is, in the new version, “streamlined” but still “designed to enable third parties to help customers evaluate different firms’ practices.” Clients can request more detailed disclosures on costs and fees if they choose, so they “can get the information they need at less cost to the firms,” according to the DOL.
The final version of the rule also streamlines how an advisor enters into the best interest contract exemption with clients.
For example, to address concerns that advisors would have to have potential clients sign the contract before they were even hired, the final rule allows for these contracts to be completed when a client fills out other paperwork to open an account. The contract can be as simple as a sheet of paper or a paragraph attached to one of the other documents the account holder is signing, Perez said.
Perez said some read the proposed version of the rules to mean that advisors who sold proprietary products were put in the penalty box.
“Folks said that it would be like having to recommend a Chevy when you worked at the Ford dealership,” he said.
The rule clarifies that the department has no bias against proprietary products, and it provides advisors who sell those products with a roadmap for complying with the best interest contract exemption.
The DOL also clarified that a whole range of investment education activities would not trigger a fiduciary duty, including statements made in general marketing materials, as long as a “reasonable person” would not view the statements as an investment recommendation.
The rule also does not impose a fiduciary mandate on statements made in “general circulation newsletters, television, radio or public media talk show commentary or remarks at conferences.”
Rather than having to comply within eight months, the implementation of the rule will be phased in to give firms more time to comply. Firms will have one year to apply the broader definition of fiduciary; at that time, they can make use of the best interest contract exemption, but there will be limited conditions for compliance. The full requirements will go into effect Jan. 1, 2018.
The requirements for getting existing clients to sign contracts are also more lenient; firms simply have to send a notice telling clients that the firm has taken on new obligations, unless the customer says they don’t want these rights. A simple email or letter will suffice, Perez said.
Perez reiterated the argument that conflicts in retirement advice shave off roughly 1 percentage point of an investor’s return each year.
An estimated $1.7 trillion of IRA assets are invested in products where conflicts of interest reside, according to the Department of Labor.
“The majority of folks giving advice should support this,” Perez said, adding that most advisors want to put clients first, but operate in an environment where misguided economic incentives prevent that from happening. With the rule in place, “advisors will compete based on the quality of the advice they give.”
“Many companies advertise that they put their clients’ interests ahead of their own,” he said. “Today’s rule ensures that putting clients first is no longer a marketing slogan. It’s the law.”