A new rule was enacted Wednesday April 6, 2016 that increased the responsibility of brokers who manage and advise clients on retirement investment plans (WSJ). Retirement plan brokers will now assume fiduciary duty in managing and advising clients. The enacted version omitted additional regulations that many in the financial services industry considered excessive and onerous.
With over $14 trillion invested in American 401(k)s and Individual Retirement Accounts (IRAs) this funds are an important component of the American economy. The new rule was modified to incorporate feedback from many of the stakeholders most affected by the regulatory change. John Theil of Merrill Lynch was quoted as stating that the previous version was “unworkable” and “highly burdensome and expensive (WSJ, experts).”
At this year’s American Economic Association and ASSA, increasing fiduciary standards was a key topic and consideration in improving the quality of transactions, services, and reporting in the industry. Previous regulations required investors to provide truthful information, fiduciary duty requires investors to provide clients with information about the best options for their retirement plan even if at the expense of the investor’s benefits. Fiduciary duty increases responsibility from suitability to the best interest of the client.
The rule applies to brokers and registered investment advisors (RIAs) with no impact on taxable accounts (WSJ). The rule establishes new procedures before accepting commissions they recommend that give them an incentive. Under previous standards brokers could recommend more expensive options without informing clients of all options as long as the option was suitable. Any advice about moving retirement funds from a 401(k) to an IRA must be documented (WSJ).
A potential negative impact to clients is that many brokers are planning to transition the accounts of clients valued under $50,000 to automated services because the fees will no longer be enough to be profitable for a broker (WSJ, experts). In addition, they must make more detailed disclosures about costs, fees, and conflicts of interest to clients when requested.Best interest is not necessarily lowest cost. The Labor Department rejected the option to establish a low price recommendation and establish best interest as the option most beneficial to the client (WSJ). At issue is the cost of fees to the consumer and the financial interest of the bank’s advisers. Particularly indexed annuities.
Increasing fiduciary duty can have significant impact on the probability of industry wide planning that engages in excessive risk or negligence. Widespread financial failure is often the result of unregulated bubbles in the economy. From derivatives, shadowing banking, and captives; excessive capitalization in high risk investments leaves firms and the industry vulnerable to default or excessive loss on expected returns.
The Labor Department estimates that the rule could save investors $4 Billion dollars annually (WSJ). Fees make a significant impact on long term investments like retirement because of multipliers like interest and returns. Previous suitability level fee arrangements will be upheld under the rule. Banks must establish a best-interest contract that makes them liable to fiduciary duty. Clients can take legal action. Firms can make arbitration a contractual option, class action lawsuits are a current option, in addition to litigation.
Banks have until January 1, 2018 to align full compliance (WSJ). It is reported that the rule is backed by the support of President Obama, who has worked diligently to increase regulations, standards, the quality of reporting, and security since the 2009 financial crisis and subsequent government financial relief offered to many banks and other major United States, non-bank financial institutions. The decision to provide the billions of dollars of financial stimulus was one of the most criticized decisions in the President’s two terms.