May 06, 2016
Fiduciary Rule: Why the industry remains uneasy
By: Tim Owen
The fiduciary rule has been the topic of the financial services industry for quite some time, but now that it has been approved, industry concerns continue to increase.
For those that are unfamiliar with the rule, here's the quick scoop:
The rule, according to investment news, "requires that brokers act in clients' best interests" when providing retirement planning advice.
Although many financial advisors currently provide client best interest investment advice, some believe that the current suitability standard may not be enough. There is speculation, and there have been some cases, where advisors select investment options for clients based on the plan that provides the highest commission reimbursement. This rule was put in place to ensure that financial guidance was given based on what's best for investors. Support of increased standards for retirement financial advice seems like a no-brainer, right?
The DOI worked to ensure that the final rule addressed several important industry concerns. But there are new concerns about the unintended consequences of the rule, so let's play devil's advocate. After all, a rule this impactful to the industry cannot come without other impacts on businesses such as technology, operations, compliance, etc.
Take a look at some of the concerns that have surfaced from evaluations of the bill.
Along with this rule came no formal form of enforcement, leaving the consumers in charge of taking action if they believe that their advisor didn't act in their best interest. This will require investors to form a strong case to prove that a broker wasn't acting in their best interest. The courts will then determine what "best interest" means on a case-by-case basis. Even if an advisor already uses ethical practices, the liability risk increases when the evaluation of how they conducted business is based on a consumer, jury, judge, and/or lawyer's ruling.
So it is not surprising that there are a growing number of apprehensive advisors.
In order to avoid legal risk, it is rumored that broker dealers will begin serving small retirement accounts on a flat fee basis or with level compensation for all financial products. This will eliminate commissions or at least differential commissions for advisors unless they qualify for a best interest contract exemption? a BICE proves that the advice given was in the best interest to the client. According to SIFMA, this could "limit investor choice, limit investor access to education regarding retirement accounts, and increase costs for saving."
The unintentional costs
The costs that may come with the fiduciary rule in particular could lead to more expensive investment advice. Increased compliance costs and potentially lower revenue may impact agencies and broker/dealers to the extent that providing retirement solutions is harder. Investment news recently reported that these higher costs may mean loss of revenue and will force mergers and consolidation amongst smaller firms as pointed out by managing principal of Commonwealth Financial Network, John Rooney.
Investment News directly states, "In addition to increased expenses, the DOL fiduciary rule could also impact the revenue side of the ledger by significantly curbing sales of high-commission variable annuities and alternative investments, including nontraded real estate investment trusts, the executives noted."
The cost implications could mean major changes for small financial services firms and in some cases, closing doors.
Some believe that with new requirements and legal implications from this rule, advisors may "run for the hills". Which as we previously said, fewer advisors means less availability of investment advice. Financial services firms will then have to make up for lost revenue and increased compliance cost elsewhere?leaving unintended cost increases to consumers.
Will consumers end up paying even more in increased fees?
Members of the Securities Industry and Financial Markets Association (SIFMA) have voiced opposition and provided analyst reports from Morningstar revealing that that the new restrictions and requirements from the DOL rule "would cost savers an additional $13 billion in a year," due to limited advice and restricted choice.
NAIFA also states its concern for cost increases to consumers?will low and middle income investors welcome additional costs or go at it on their own?
A consumer cost-benefit analysis of the rule is certainly needed.
With new rules, come new requirements for compliance, which means improved compliance technology, new business structures, and increased costs to do so. As far as the fiduciary rule in particular, brokers will see additional reporting and disclosure requirements. Again, more time, enhanced technology, more money.
LifeHealthPRO reported that, "Implementation will be more challenging for firms unaccustomed to complex regulation and/or for smaller firms lacking the resources to make the necessary technological investments," Moody's March 31 report states. "We therefore would expect these companies to exit affected business segments or potentially sell out to large players."
Opponents of the legislation believe the bill could potentially lower access to investment advice, increase financial services costs, increase liability risk, and cause smaller firms to exit the market, all of which can negatively impact consumers. And although keeping consumer best interest in mind is essential, unintended consequences should make us all think about the pros and cons of regulation versus market competition to best serve the consumer.
U.S. Representative Peter Roskam sums up the oppositions position best, "We share in the administration's goal of raising the bar for the financial services industry by requiring advisors to serve in their clients' best interest." However, "My fear is, that by mandating this best interest contract, it actually creates the barrier for getting advice as opposed to lowering a barrier to get good advice."
His words show that those in opposition aren't against ethical investment advice, rather the implications to small businesses, advisors, and consumers that follow.
"The better approach is to put the burden on the industry: 'You've got to create products that are in the clients' best interests," says Roskam in Investment News.
Now that the rule is final the industry must now work to adapt and comply. As always, Vertafore monitors these types of disruptive changes and creates solutions to help our customers cost effectively and efficiently adapt and comply.
Industry veteran Tim Owen brings nearly 20 years of expertise in creating and deploying usable and scalable technology solutions for the insurance and securities industries. As Vice President of Product Management, Tim focuses his attention on delivering high-level strategies for product development, product requirements, product launches, and regulatory compliance for Vertafore's Producer Lifecycle Management offerings.