The Department of Labor recently announced its new Fiduciary Rule – aka the “conflicts of interest rule.” This new rule expands the definition of fiduciary and alters how investment advice is delivered in retirement accounts. It won’t go into effect for at least another year, but it’s not too early to start thinking about how the changes will affect the professionals who render this advice.
In short, the new rule will require all financial advisers to act in their customers’ best interests. Contrary to popular belief, until now the standard only required financial advisers to adhere to a “suitability” standard, which permitted them to recommend products that would reap the highest sales commissions so long as the products were suitable based on other factors such as age and the client’s risk tolerance. With the new fiduciary rule, financial advisers cannot receive payments that create a conflict of interest with their retail investors, unless they meet a prohibited transaction exemption. This change may prompt many financial advisory firms to start considering changing their fee structures to take on more fee based clients.
The prohibited transaction exemption is known as the Best Interest Contract Exemption (BICE). According to the DOL, “the exemption allows firms to continue to use certain compensation arrangements that might otherwise be forbidden so long as they, among other things, commit to putting their client’s best interest first, adopt anti-conflict policies and procedures (including avoiding certain incentive practices), and disclose any conflicts of interest that could affect their best judgment as a fiduciary rendering advice.” The creation of BICE is designed to implement a new contractual fiduciary duty between the client and the adviser that previously was so rare or non-existent in the industry.
The contract provisions of the exemptions will go into effect in January 2018. Financial advisers need to be aware of the requirements of these contracts and ensure that they comply with the new fiduciary responsibilities. For example, the DOL has indicated the contract should clearly identify the individual advisers as fiduciaries when they provide investment advice; commit to providing advice that is in the client’s best interest; make no misleading statements regarding investments, compensation or conflicts of interest; disclose fees, compensation and conflicts of interest associated with any investment recommendation; and commit to putting in place policies and procedures within the advisory firm designed to prevent violations of impartial conduct standards.
Of course with the new regulations will come growing pains as financial firms address how they are going to implement these new requirements. A level of uncertainty will also arise as it is yet to be seen how strictly the DOL is going to enforce the new law and what areas will become hot topics for litigation. One thing can be certain though, financial advisers are now going to be held to a stricter standard, complete with new contractual requirements that can easily expose them to liability. It’s not too early to be thinking about the changes and how firms and advisers are going to ensure that they are compliant when the time comes.