What You Need To Know About The New Department of Labor Fiduciary Rule

Last month, the Department of Labor's new "Fiduciary Rule" governing financial advisors was scheduled to take effect. Although officially delayed 60 days, the basic tenet of this new rule remains; to apply a uniform policy for advisors that defines how and when to act in a client's best interest. Language in the rule is meant to provide a distinction between transaction-oriented salespeople (by far the vast majority of financial advisors) and professional advice from real advisors. Said another way, it equates broker-type salespeople with a suitability standard vs. a more rigorous fiduciary standard for legitimate financial advisors.

Suitability

Brokerage firms and their reps who sell products and earn commissions adhere to their own self-regulatory organization Financial Industry Regulatory Authority's (FINRA) guidelines. It's true, Wall Street gets to police itself!

Instead of having to place broker interests below that of the client, the suitability standard only requires that the broker has to "reasonably believe that any recommendations made are suitable for clients, in terms of the client's financial needs, objectives and unique circumstances".

Recognize that a broker's loyalty isn't mandated to the client. What's surprising to investors is that the broker's duty lies with their employer; the large, mainstream firms we mistakenly believe are pinnacles of trustworthiness such as Merrill Lynch, Edward Jones, and Wells Fargo.

It's no surprise every client I've ever taken on that came from any of these firms has a portfolio littered with expensive, illiquid, chronically underperforming, and tax inefficient investments that which brokers were somehow convinced were a good option for their clients. Brokerage firms are all about profitability, and what's good for the firm and broker is almost never good for the investor.

I've written about this before, HERE, HERE, and HERE.

Fiduciary

Professional advisors only charge fees (no insurance, investment, annuity, or 12b-1 commissions), hence the compensation structure referred to as Fee-Only. Advisors who charge fees are regulated by the Securities and Exchange Commission (SEC) or state equivalent. Within a true fiduciary capacity, advisors MUST place an investor's interests above their own. Additionally, if a potential conflict of interest arises, the advisor must discuss the conflict with the client.

For example, if a client asks me if they should invest extra income in their IRA (that I happen to manage) or in their 401(k) plan, I would explain why it's better for them to utilize their 401(k). If I had simply responded with sure, let's get that $$$ into your IRA, then I would have profited from the additional fee I could charge. However, the client's opportunity cost would have been missing out on the ability of 401(k) contributions to lower their taxable income. An equivalent IRA contribution doesn't always accomplish that.

My opinion on being a fiduciary versus those who aren't (from my website):

Yes, that's super crazy! Seriously though, that's what investors are unknowingly signing up for when they ignore the facts and incentives surrounding an advisor's compensation structure. But hey, at least the advisor works for a "big company" and "has a nice office". Despite my best attempts at logic and reality, I lost two prospects earlier this year for those reasons. But I digress...

What's Supposed To Happen Under The New Rule

Commission-earning salespeople who happen to be masquerading as financial advisors now have to not only recommend investment products in their client's best interest (versus their own), but disclose fees and potential conflicts.

Sounds good so far... But, as always, the devil is in the details.

The fiduciary standard only applies to "retirement" plans, such as IRAs. Any "non-qualified" annuity or taxable brokerage account isn't subject to the new rule. In addition, the advisor can still sell overpriced insurance products, usually the proprietary kind with the biggest commissions, without any fiduciary compliance restrictions.

The biggest issue is that the DoL rule doesn't actually outlaw advisor practices such as selling proprietary products, recommending a more expensive investment to earn a special bonus from their employer, or receiving a commission. As long as the broker discloses these conflicts alongside a fee comparison, then under what's called the "Best Interests Contract Exemption" (BICE), everything I just mentioned becomes permissible again.

Whew! Back to screwing over clients.

What's Probably Going To Happen Under The New Rule

Fundamentally, not much will change. Compliance costs will go up, and this cost will be passed down from brokerage firms to their reps in the form of lower revenue payouts. This puts pressure on reps to sell even more garbage under the BICE (to maintain THEIR standard of living), further perpetuating the exact opposite behavior the new rule was supposed to curtail!

In all reality, brokers who are used to selling whatever crap they want aren't giving up their revenue so easily! The way I see brokers accomplishing business as usual is to simply shove a mountain of paperwork in front of new clients saying sign all this to get started with me. Buried somewhere 63 pages into the paperwork stack, that no client is going to actually read, is the vague BICE disclosure the brokerage firm so carefully tucked far into an overwhelming heap of legal mumbo jumbo.

How convenient...

What Can You Do

First, ask your financial advisor if the new DoL rule impacts your relationship. The answer will be no, first because you're grandfathered into whatever type of existing arrangement is already in place. And second, because many brokers who like to call themselves financial advisors may already have you in a "fee-based" account. Within a fee-based account, the advisor is supposed to be acting in your best interest.

The better question to ask is are you a fee-only advisor? If they're not but you want to stick with them (OMG really), at least make them provide you with a full breakdown all of potential sources of compensation and which of those sources applies in your scenario. This helps you sniff out any potential conflicts as well as any excessive fees.

The problem with any fee-based relationship is that the broker legally gets to tell you they act in your best interest when working within any account subject to a fee. What they love to leave out from the story is that they can still sell you insurance, annuities, and earn commissions on other investments OUTSIDE of the fee-based account. Good luck trying to determine when the broker is acting as a salesperson versus when they're behaving like a real advisor!

Despite all my ranting, there are a few good fee-based advisors that generally shy away from selling products, charge reasonable fees, and do their best to limit commission incentives. The real challenge is without asking the fee-only & compensation breakdown questions above, you're in the dark as to what incentives might be driving their behavior. Clearly, the dark is a dangerous place.

How My Company Operates

Aspen Leaf Partners is a fee-only Registered Investment Advisory (RIA) practice. We never switch hats between transactions and advice. It's crystal clear that everything we do is in our client's best interest, 100% of the time. We won't ever sell you a product, and we don't accept commissions of any kind.

The new DoL rule doesn't impact the way we do business. We've been fiduciaries since day one, and certainly we would never need a law forcing us to do the right thing like the rest of the industry does.

Think of is this way- your doctor would never recommend an outdated, expensive, low success rate prescription he just happens to have behind the front desk counter, right? How ridiculous! Unfortunately, this is the way the financial industry works; here's a crappy product that's great for us and will most likely deliver a mediocre (at best) outcome for you.

If you're not sure about your financial advisor or their brokerage firm, ask me! I can review their regulatory disclosures and explain how they operate. In addition, the fees you pay are usually detailed somewhere on your statement, and we can help you find them.

It's really hard to know what you don't know, so don't be afraid to ask us. And remember, we're not salespeople with an agenda. We're real financial advisors excited to hook you up with what's best for you!

#fiduciary