Why You Should Pay Attention to the Fiduciary Rule
Craig Donofrio — Break It Down
If you’ve been trusting that your financial adviser adheres to a strict set of rules—like being required to invest in your best interest no matter what—we have some bad news for you. Not all advisers have to invest only for your benefit ... yet.
You’ve likely seen something about the fiduciary rule in the news lately. The rule is meant to protect people saving for retirement from getting bad advice and was officially proposed by the Department of Labor back in 2016 (and born way back in 2010). It isn’t in effect yet, but news about the rule is making the rounds now because the Trump administration has delayed the rule—which was supposed to be implemented on April 10 this year—by 60 days to further evaluate whether to tweak it, gut it, or ditch it.
All signs point to this bit of legislation getting gutted. A White House official told Time the administration wants “to cease the implementation of this and completely review the fiduciary rule.”
In the meantime, if you have an investment retirement account, you should pay attention. Because right now, your adviser might not have your best interest in mind.
Is your adviser really working for you?
In a nutshell, the DOL created the fiduciary rule to ensure advisers put their clients’ needs ahead of their own business or financial dealings. It might be a shock that your adviser isn’t already required to have your best interest in mind. Unfortunately, that seemingly low bar is not applied to all types of advisers. Namely, broker-dealers.
Brokers operate under something a little more flexible called the “suitability standard.” This means the broker is required only to look for what kind of investment is suitable for your lifestyle, not necessarily the best possible option for your specific situation.
Since many broker-dealers operate under a commission-based fee, that could affect their recommendations to clients.
“There’s a worry the adviser is just going to recommend a trade only to earn commission,” says. says Arthur Laby, co-director of the Rutgers Center for Corporate Law and Governance and former assistant general counsel for the U.S. Securities and Exchange Commission.
Problem is, your broker might find an investment that qualifies as “suitable” but isn’t necessarily the best option out there. As of now, it’s permissible for the broker to recommend that suitable option without pursuing the one that would actually serve you best. In fact, there’s nothing preventing advisers from just recommending whatever serves them best. Let’s say there are two options the broker is looking at, both of which are “suitable” for what you need. Option A is less expensive and pays a smaller commission. Option B is more expensive and pays a higher commission. The broker may be inclined to offer up Option B simply because he’ll get a bigger payout. And he doesn’t even need to tell you Option A ever existed. Which is pretty much why the department introduced the fiduciary rule.
“Under the fiduciary rule, brokers would be subject to that [higher] standard too,” says Laby.
That seems pretty desirable. Laby explains: “Six or eight mutual funds might all be suitable for a client, but all other things being equal, several of those funds make a payment back to the broker in exchange for recommending the fund. In that case, all funds are suitable, and the broker could recommend any one of them as suitable investments. [An adviser acting under the fiduciary standard] would have to disclose the fact of the payment and the resulting conflict of interest.”
Broker-dealers vs. investment advisers
There are two different kinds of financial advisers, brokers and investment advisers, and they don’t operate under the same rules, which can lead to some understandable confusion.
The short of it is investment advisers, or fiduciaries, follow the “fiduciary standard,” which ensures they look out for their client’s best interests. Basically, the investment standards detailed in the new fiduciary rule are currently in effect for fiduciaries and have been for decades.
As it stands, brokers don’t need to follow the fiduciary standard, so legally nothing is keeping a broker-dealer from advising a product that doesn’t really benefit the client. And it’s not a small problem—A 2016 report by the White House Council of Economic Advisers said conflicts of interest are costing investors an average of $17 billion a year.
So, who’s managing my money?
It’s not always clear whether your adviser is a broker or a fiduciary. For example, you might call an investment company and they’ll put you through to a “financial adviser,” which is a technically correct title but doesn’t have the same connotations as a fiduciary. Laby says you’ll want to ask your adviser directly. “Ask, ‘Do you have to operate under a fiduciary standard or not? Are you acting as a broker?’” says Laby. “At a minimum, you want investors to get that basic information.”
How would the rule affect me?
If it passes as it stands, you’re probably going to get a bunch more paperwork involving disclosures on all possible conflicts of interest between your retirement fund and your broker.
“[Under the rule], all these financial advisers have to do is act in their investor’s best interest. It doesn’t ban commission-based accounts—in fact, it’s very clear you can offer commission-based accounts while still acting in their best interest,” says Laby.
Even so, some firms are eliminating commission-based fees entirely because of the rule. In October, Merrill Lynch and Commonwealth Financial Network said they would do away with new fee-based commissions on retirement accounts. And even with the rule’s uncertain fate, those firms are sticking to that plan.
“The industry is split,” Laby says. “Some have abolished commission-based accounts while others have said ‘We’re still going to allow it.’”
A rule in your favor?
Those who oppose the new rule say it will stifle business and reduce retirement account offerings. At the investor level, though, it’s hard to imagine a downside to knowing for sure that your adviser is working in your best interest.
A retirement adviser “should always be acting in the investor’s best interest and not in the adviser’s,” says Laby, who thinks the rule is a good thing. “I think the rule as adopted is fairly balanced—I’m not suggesting things shouldn’t be changed [in the future but] the department spent much time and great care to get the rule right.”
Remember, the fiduciary rule only affects your retirement accounts. And the rule isn’t in effect yet—if the Trump administration keeps it at all, it won’t be instituted until June 9. Businesses won’t need to comply until January 2018 or later, given Trump’s delay.