The Department of Labor’s fiduciary rule — aka the Conflict of Interest Rule or colloquially the new DOL rule — requires anyone providing investment advice to ERISA plans, plan sponsors, fiduciaries, plan participants, beneficiaries and IRAs and IRA owners to either avoid recommendations that create conflicts of interest or comply with the protective terms of a prohibited transaction exemption (for instance, The Best Interest Contract Exemption or BICE).
As financial advisors work to understand how the new rule affects them, additional questions arise, specifically about why the rule applies only to retirement accounts and not taxable accounts, and whether an expanded fiduciary definition that applies to non-retirement accounts can be expected in the future. Below are expert insights we’ve gathered to help financial services professionals gain a clearer understanding of the whys behind the new DOL rule.
Setting The Stage For a Fiduciary Standard
Before finalization of the fiduciary rule, employer-sponsored retirement plans were subject to the protections of The Employee Retirement Income Security Act of 1974 (ERISA). ERISA established minimum standards for pension plans in private industry and provided extensive rules on the federal income tax effects of any transactions associated with employee benefits programs. Responsibility for enforcing ERISA protections was divided among the Department of Labor, Department of the Treasury, and the Pension Benefit Guaranty Corporation.
Over the decades there has been a shift away from employer-sponsored pension and defined benefit plans to participant-directed plans such as 401(k) plans and Individual Retirement Accounts (IRAs). Today, there is more money in IRAs than there are in all other types of ERISA plans combined, making IRAs the primary retirement savings account for most Americans.
Double Standards for Different Accounts
The reason why the new fiduciary standard applies only to retirement accounts and not to taxable accounts is that the Department of Labor was not granted legal authority by Congress through the provisions of ERISA. Instead, the Securities and Exchange Commission (SEC) and certain state laws have legal and regulatory control over other types of taxable investments and savings accounts. However, there are certain aspects of IRAs and 401(k)s that the IRS has regulatory control over instead of the DOL.
The new DOL rule focuses on just a few things, it expands out the fiduciary standard to more situations relating to ERISA plans and IRAs, it redefines what it means to provide investment advice, and it created some new forms of prohibited transaction exemptions to make the changes more workable for the financial services industry. Ultimately, the goal of the new DOL rule is to protect investors who receive advice about retirement accounts like 401(k)s and IRAs.
Should Investors be Concerned?
The DOL’s new fiduciary rule aims to give more protection to investors, but investors should still exercise caution especially when considering an investment in non-qualified accounts. Advisors should be sensitive to their clients’ questions or concerns and help them understand differences between the suitability and fiduciary standards. Because taxable accounts are not subject to the fiduciary standard (yet), they are under the jurisdiction of the Securities and Exchange Commission (SEC), not the DOL. Unless and until the SEC unifies regulations for fiduciaries across the board, investors must be aware that advice given about taxable investments is not subject to the same regulation and requirements. Generally speaking, if a recommendation is in the best interest of an investor, it should meet the legal standard of the investor’s IRA, not force them to go outside of their retirement account.
How Do Other Professionals Feel?
Financial advisors have opinions on both sides of the matter, some extolling the DOL’s new rule while others are extremely critical. Concerns exist regarding problems that could develop from the “hat-switching” that would need to be done when making recommendations involving a client’s IRA (subject to the fiduciary standard) versus recommendations to a client’s taxable-accounts (subject to the suitability standard). Other advisors voice concerns over labeling individuals as “fiduciaries,” before establishing a true fiduciary culture.
Will the Extended Fiduciary Definition Be Applied to Non-Retirement Accounts in the Future?
Michael Wong, CFA®, CPA® predicts the fiduciary rule will have a ripple effect and influence the way taxable assets are serviced instead of just retirement assets. Other advisors recognize that contradictory standards exist permitting firms to be fiduciaries in certain cases and non-fiduciaries in other cases, but “expect the SEC will address this at some point within the next decade or two.”
The future is yet to be seen since the first phase of compliance doesn’t begin until April 2017. Former Defense Attorney Jason Roberts remain skeptical about an extended fiduciary definition being applied to other, non-retirement accounts in the future. His reasoning is that the Best Interest Contract Exemption (BICE) opens a wide door to class action lawsuits in state court for brokerage IRAs and litigation in federal court for employer plans that fall under the protection of ERISA.
Should Advisors Be Prepared for Any Future Changes?
While it’s impossible to know what the future holds, advisors would be wise to prepare for an enhanced fiduciary standard by increasing expertise on product knowledge, tax and retirement income strategies, and general topics like Social Security and Medicare. Julie Ragatz, Assistant Professor of Ethics at The American College of Financial Services and head of the Cary M. Maguire Center for Ethics in Financial Services recommends that organizations structure their compensation in a way that aligns advisor interests with client interests by making compensation product-neutral.
Christine Gaze, president of Purpose Investment Group, predicts a significant increase in demand for credentials. Advisors serious about keeping pace with and capitalizing on the constantly evolving regulatory changes in the world of financial services should pursue an advanced designation like the Certified Financial Planner® (CFP®) or Retirement Income Certified Professional® (RICP®). Designations like these create demonstrable value to clients and solidify an advisor’s position as an expert about retirement income and comprehensive financial planning.
Learn more about the increased fiduciary standard set forth by the DOL rule and prepare for the upcoming compliance deadline with expert insights. Get the fact sheet, 5 Things You Didn’t Know About the DOL Conflict of Interest Rule But Should.