Implications of the Fiduciary Rule
After months of anticipation and years of debate, the Department of Labor (DOL) “Conflict of Interest Rule” has finally been released. During the proposal process, the DOL fielded over 400,000 comments, some of which were in opposition to the rule while others were seeking clarification to specific areas within the rule. The one thing there is little debate about is the intent of the rule. There may be arguments around the government’s role in this process, or the nuances of what constitutes investment advice, but how do you argue that a rule requiring the industry to act in the best interest of their clients is a bad thing?
It will likely take weeks, if not months, to fully dissect and understand the scope of the new fiduciary rule and how the landscape will change as it is phased into implementation. Here are a few of my initial interpretations and what I think the potential implications are.
Potential Impact on Financial Advisors
The registered investment advisors (RIAs) that have already been acting in a fiduciary capacity just saw their marketplace get considerably more crowded. With the vast majority of advisors now being considered fiduciaries, RIAs will be forced to adjust their value proposition to distinguish themselves amongst their competitors. My opinion is that the most impactful point of differentiation will be to not only improve outcomes for participants but to quantify those outcomes for the plan sponsors and retirement plan committees.
Some broker-dealer registered reps may need to utilize the ‘education carve-out’ to limit or avoid fiduciary status. However, the carve-out is going to be narrower than it previously was (per DOL Interpretive Bulletin 96-1) and the education provided under this approach will be limited and may be considered unsatisfactory to many plans. Registered reps who wish to stay in the retirement plan industry using the education carve-out may ultimately need to rely on a very strong fiduciary partner to do so (a view shared by notable fiduciary expert Fred Reish in a recent blog post as an evolving “common solution” for 401k-focused registered reps in the wake of the new fiduciary rule).
Potential Impact on Advisory Fees
In recent years, fees have been compressing as a result of the DOL’s fee disclosure initiatives and the increasingly competitive nature of the marketplace—something that is expected to accelerate under the new fiduciary definition rule. It’s also highly likely we’ll see increased litigation over the matter.
However, we don’t believe that there will be a bright-line test on fee reasonableness. It’s not necessarily about the fee but rather what is being done to earn the fee. For that reason we believe that an advisor’s business model will need to include greater fee transparency, a prudent documentation and monitoring process, and the ability to quantify participant level outcomes. Advisors that can accomplish this will be in a better position to justify their fees and differentiate their services in a fiduciary environment where everyone is essentially viewed as an equal.
Potential Impact on Compliance
Compliance complexity and oversight will greatly increase. For example, testimony to the DOL indicated in the first year the rule goes into effect financial institutions will have to produce more than 86 million written disclosures and notices. This does not come without a cost. Who will pay for this?
Potential Impact on Vendors
Many major vendors will be exempt from the fiduciary rule or attempt to structure relationships to avoid fiduciary status under the rule. This means litigation that develops may be between the plan sponsor and the advisor since the vendors may not be a fiduciary—that is unless you are working with a vendor that is willing to accept fiduciary status such as my firm, Unified Trust who not only is willing to accept fiduciary status, we sign on as discretionary trustee, and thus a named plan fiduciary, in the plan document for every plan on our platform.
The DOL Conflict of Interest Rule will no doubt have a sizable impact on the industry. The extent of that impact will unfold over the coming months and years. We do firmly believe that it will increase the need to have a fiduciary process that is not only accurate but also automated and algorithm-based. In other words, it won’t be enough to say you’re a fiduciary, rather you will need to show prudent fiduciary processes are in place and in the best interest of the investor.
- Jason Grantz, QPA, AIFA