Who really knows exactly what the DOL rule will look like when April 10, 2017 comes around? From what I can see, the smart money is on betting that the rule will survive, maybe with some adjustments. As I’ve said before, the bet is that since the law is already on the books, it will take a lot to change it – and with the April 10 deadline looming, there probably isn’t the time nor the ability to fix/change/delay in the 80 days (55 if you only include weekdays) after the presidential inauguration. Most BDs, custodians and advisors are preparing and have invested huge sums of money getting ready. As the law gets closer to implementation, I thought it would be helpful to list some of the rule’s biggest myths (or hidden risks) that are sure to trip up a few advisors.
Myth #1: All fee business is the same.
When I watched the initial press conference announcing the DOL rule, one thing stuck out: the term “conflict of interest.” Everyone in the press conference referred to the rule not as the fiduciary rule, not as the DOL rule, but as the “conflict of interest rule.” The DOL stressed often that they want to eliminate any conflicts of interest in providing retirement advice to consumers. Of course, they consider any compensation – even fee compensation (directly or indirectly) paid to an advisor – a potential conflict, so advisors need to understand how they are paid. For your fee-based accounts, ask yourself:
- Is there a financial incentive for me to pick one fund/product/service over another on behalf of a retirement client or are “level fees” being charged and level compensation being earned?
- If I am using a third-party program, who is listed as the advisor in the agreement? Am I the advisor, or am I considered a solicitor? You will need to read into the duties and responsibilities of each party and compare them to what the rule considers to be “investment advice,” rather than merely relying on titles. You can disclaim fiduciary status all you want in any agreement or contract – but if you are providing fiduciary investment advice under the rule, you are fiduciary, regardless of whether you call yourself a solicitor or not. The advisor is paid by the client; the solicitor is technically paid by the advisor. Many third-party programs use the solicitor model, although the solicitor is actually providing investment advice pursuant to the new rules, thus would require more documentation and a BIC contract to continue.
Myth #2: I need to change my product choices and go all passive because product fees are now in question.
After the release of the rule, the headlines screamed “Wall Street got a break!” because advisors were allowed to use any products they wanted in qualified accounts (as long as they used Best Interest Contract Exemptions). But lately, a lot of discussion has been about product fees. The conversations start with the fiduciary rule, move to the cost of different product fees, and end with a fear of getting sued for not offering the least expensive products. (What happened to that “break?”)
The fiduciary rule is about advice and compensation, not about product. What I think is missing in these conversations is what an advisor should be offering: ADVICE. The conversation with prospects can contain your value proposition, maybe financial or income planning, the service(s) you will provide and the type of fees you will charge (for example, 1% of invested assets). This advice will trigger fiduciary acknowledgement (BIC lite), but not a BIC full contract.
The Investment Management Agreement is the document that lays out your investment philosophy, products, implementation and reasonable fees – and, for IRA accounts, that would be subject to review by FINRA or the SEC, not the DOL. In fact, why would an advisor discuss products before the plan anyway? Does the doctor discuss medication before the diagnosis?
Myth #3: All advisors will get sued.
When an advisor is being compensated by anyone other than the client (a conflict of interest), a contractual BIC is needed. The contract itself adds a whole new wrinkle in the enforcement and potential relief to the client’s complaint. The plaintiffs’ bar is now in the mix and we are arguing contract law (instead of suitability), so a judge (or jury) gets to decide, instead of arbitration. While I can’t guarantee advisors won’t get sued down the road and I’m sure there are many clever lawyers out there and a lot are going to try to sue anyway, if there is no contract (BIC Lite instead of contractual BIC), is there standing to bring a suit? Who knows?
Reliance on the BIC Lite should focus your attention on ensuring that you can really support any proposed transition as being in your client’s best interests (and not your own). If you can do that, you reduce your litigation risk by having a good and documented story to tell their clients to keep the client from filing suit in the first place.
Myth #4: Converting everyone to fees will fix the problem.
The idea of converting to fee accounts makes sense for a lot of reasons, not just the DOL, but those accounts aren’t right for everyone. While rare, the SEC may look at advisors making the monitoring for reverse churning. Sorry to break it to those advisors looking to convert their entire book by 4/10/2017, but you still have to add value to the relationship.
Think about your offering:
- What is the value you bring to your clients? Go beyond investments.
- Can you tier your offering for small-investment-only accounts and larger planning accounts?
- Can you justify your increase in the clients’ fees? Can you document it?
Myth #5: BICs (Lite or full contractual) don’t matter; they will be buried in the paperwork that clients sign.
One of the key drivers of the rule going forward hasn’t started yet; I believe it will be the consumer who will really drive the rule in the next few months. We have already started seeing the beginning salvos in a consumer war against prohibited transactions. You only have to watch a recent episode of John Oliver’s Last Week Tonight, watch the media pick up on some major wire houses announcing that they won’t support brokerage assets in qualified accounts, or see Sen. Elizabeth Warren support Betterment’s open letter to Donald Trump to see the beginning stages of a consumer awakening about being a fiduciary. Advisors may think BICs will be “covered up” in the paperwork, but the client is going to be asking some very difficult questions – and how will it look if you try to hide it in a stack of paperwork, instead of being transparent?
What to do
I’ve said it before: speculation is not a strategy. The smart money is continuing to prepare for the rule. Sure it may change, but what happens if it doesn’t? Continue to prepare and watch out for the hidden risks and myths of the rule; you don’t want to be surprised.