A regulation proposed by the U.S. Department of Labor could have a major impact on the retirement advisory industry.
The proposed regulation, which would require that brokers and advisors disclose to retirement account clients whether they receive a commission for recommending certain products, has received both praise and pushback from the industry.
On the one hand, the commissions paid to advisors keep advisory costs low for clients, and all advisors already follow a “suitability standard” that requires them to recommend only products that make sense for a client’s situation.
On the other hand, consumer confusion has arisen around which type of advisors are independent, and some argue advisors should be held to a more stringent “fiduciary standard” that would require them to put clients’ interests before their own.
The DOL has argued that conflicts of interest result in about 1 percent lost per investor account per year, which adds up to $17 billion nationally per year. The department is taking public comments on the matter until Sept. 24.
Milwaukee-based Northwestern Mutual Life Insurance Co. has submitted a comment in opposition to the proposed rule that reads, in part: “Northwestern Mutual has long supported a uniform ‘best interest’ standard of care when providing investment advice across its brokerage and investment advisory businesses (including for retirement account and plan clients) so long as the standard is business model neutral, preserves client choice, ensures continued access to investor education and affordable retirement options, and provides reasonable certainty for the adviser in its implementation.
“While Northwestern Mutual supports the (Labor) Department’s objective of changing the standard of care that applies to persons giving retirement advice to clients, we believe the proposal significantly misses the mark on the criteria noted above and would lead to increased consumer cost, greater consumer confusion, and reduced consumer access to high-quality investment products.”
The DOL’s suggested rule has caused controversy in the industry, with some professionals unable to comment publicly on the matter. A senior financial services representative in Milwaukee who declined to be named said he also disagrees with the DOL’s proposal on the grounds that it would make financial advice cost prohibitive to low-income clients.
“The bottom line as I see it is the middle-income and low-income clients are going to essentially be disenfranchised,” he said. “They’re probably going to have to depend on an 800 line to get their financial advice and the Main Street advisor isn’t going to be able to really deal with them.”
Under the DOL’s fiduciary standard, retirement advisors would be required to enter into an advisory contract to give advice to clients, and would likely charge an upfront fee of about 1 to 2 percent to serve that client, the representative said. That would be a departure from many advisors’ current model under the suitability standard, through which the advisory fees are covered by commissions from the financial product providers.
“Currently, I’m paid a modest fee in the form of a commission to handle these accounts and to help people with the enrollment issues and such,” he said. “If you’ve got somebody with a $15,000 or $20,000 401(k) account, how do you justify going into an advisory contract with them?”
The fiduciary standard also puts an added burden on advisors to substantiate that the chosen product is the absolute best way for a client to invest, which increases the liability on the advisor, the representative said.
That increased liability will, in turn, escalate time spent on compliance and result in increased rates on advisors’ Errors and Omissions insurance, which could be passed on to customers, said Michael Smith, LUTCF, president at CPS Horizon Financial in Hales Corners.
“The talking points and the spin are that we are supposed to act in our clients’ best interests,” Smith said. “We all do that. Nobody disagrees that we should be acting in our clients’ best interests.”
Smith doesn’t agree with the Labor Department’s proposal as it’s currently written, because its tenets seem unworkable, he said. For example, a potential client could be required to sign several Best Interest Contracts before an advisor could even begin having a discussion with him or her, and the advisor would have to try to predict which topics would be covered in the conversation to assure all proper contracts are signed.
“How can you possibly do that before first getting to know your client, their risk tolerance, their family situation, their financial situation, all these kinds of things?” he asked.
In addition, there is some gray area around how long an advisor’s liability for investments would last, and who determines what is in a client’s best interest, Smith said.
The Labor Department’s fiduciary standard proposal could result in some operations shutting down because they currently offer just one company’s products or the increased exposure to liability is too great, he said.
“Someone’s going to get paid no matter what,” Smith said. “If it’s a fee-based planner, they’re charging money for the client to meet with them. It’s not a conflict of interest. It’s a different way to get paid. Either method, the client, it’s their choice.”
The Labor Department’s proposal is a potential game-changer for the industry, said attorney Michael Francis, CIMA, president and chief investment officer at Brookfield-based Francis Investment Counsel LLC.
“It’s the intersection of the retail investor with the retirement plan rules and laws that have created the confusion that is currently in the industry,” Francis said. “Right now there are two words that are radically abused in the industry: one is ‘independent’ and the other is ‘fiduciary’. These words legally have meaning, but in a sales context are used to describe so many different things, the consumer has no idea what they mean.”
Francis Investment Counsel is a registered investment advisor, and does not receive commissions. The proposed rule would take away some of the firm’s differentiation in the marketplace, but it would also put other retirement advisors on an even playing field, so Francis said he supports the rule.
“It is not surprising to us the wailing and gnashing of teeth that you’re hearing from the industry about the additional costs that they’ll incur and etc., because this threatens their way of life, at least in regard to retirement assets,” Francis said. “It will change the way financial services – banks, brokerage firms, insurance companies – they’ll change the way they interact with retirement plan assets in a meaningful way. It will force them to shine a bright light on how they are compensated to their customer.”
The national organization representing certified financial advisors, CFA Institute, has testified in support of the DOL’s proposal, said Bill McGinnis, CFA, past president and board member at the CFA Society of Milwaukee.
“It will make it a greater challenge to sell products that aren’t in the best interests of clients,” McGinnis said. “Our organization is 100 percent in support of the concept of what the DOL is trying to achieve.”
In the meantime, the CFA Institute even formed its own Statement of Investor Rights, which lays out 10 things every investor should expect of a financial advisor, which amounts to something similar to the fiduciary duty.
“(As a) Chartered Financial Analyst charter holder, you annually have to attest to the fact that you will put your clients’ interests first,” McGinnis said. “If you talk to the average person, they think that their stock broker, their insurance salesman, their banker, their mortgage broker, their real estate agent all have fiduciary duty. And none of them do, or very few of them do.”