The Department of Labor issued their final decision for the much-anticipated fiduciary ruling last Wednesday. This ruling has been almost six years in the making, leading to high expectations for the outcome. Ultimately, the objective of this decision was to ensure all financial representatives adhere to the fiduciary standard for retirement accounts – that is, act in the client’s best interest.
This seems like a no brainer, but not all financial representatives are currently held to this client-focused standard. With their ruling, the DOL had the best of intentions but we’re disappointed to discover the end results do little to protect investors and plan sponsors.
Fiduciary Standard Vs. Suitability
This entire ruling was based on the distinct differences of financial advice you can receive in the the industry. Some financial service providers, such as financial advisors who work at Registered Investment Advisories (also know as fee-only advisors) must adhere to the fiduciary standard any time they offer investment advice. Alternately, financial advisors or brokers who work at broker/dealers typically collect commissions on advice they give and products they sell and operate under a different standard, called the suitability standard. This standard is just as it sounds: Brokers must give advice or sell products that are relatively appropriate for the client, which is a clear step down from the fiduciary standard of doing what’s best for clients.
The DOL has identified that in retirement accounts, unknowing investors can retire with significantly less money when dealing with financial professionals who adhere to the suitability standard due to hidden and costly fees. Thus, the DOL goal was to eliminate all of the suitability tactics in retirement accounts to protect investors. Unfortunately, the DOL failed on achieving that.
We’ll Act in Your Best Interest, Even When We Say We Won’t
The biggest problem with the DOL fact sheet released on this ruling is the “best interest contract exemption.” In fact, the direct quote from this fact sheet introducing the concept offers conflicting information: “The ‘best interest contract exemption’ will allow firms to continue to set their own compensation practices so long as they, among other things, commit to putting their client’s best interest first and disclose any conflicts that may prevent them from doing so.”
In layman’s terms, this essentially states brokers may continue to collect commissions and use revenue sharing and other seedy tactics for collecting fees allowed under the suitability standard (all of the things initially identified as bad for investors) so long as the client signs the “best interest contract exemption.” This means if you sign this exemption, you opt out of the best interest care that should be provided under the assumption that your advisor will still act in your best interest. Talk about oxymoronic.
This effectively permits those who were previously held to the lower, suitability standard hold themselves out as someone who follows the higher fiduciary standard, but not actually uphold the fiduciary standard as long as they say they do.
This only muddies the already muddy waters in the financial industry, lowers the bar of the fiduciary standard and allows wolves to wear sheep’s clothing. In the end, the investor will end up signing one more nearly undecipherable document among the many they already sign, the exemption document, and financial advice and fees don’t change.
Plan Sponsors Are Still Exposed
We scoured the DOL fact sheet to see how plan sponsors, the people with the most liability for a company’s 401k plan, gain any additional protection and found nothing. Plan sponsors, those in charge of running company sponsored retirement plans, will now have to navigate even choppier waters. As we mentioned before, all of issues that we consider to be a detriment to plan sponsors’ ability to make sound decisions and effectively oversee employees’ retirement accounts will likely still be there. Revenue sharing, 12(b)-1 fees (commissions) and proprietary products are still in play and will still require plan sponsors to navigate them with no additional protection or transparency. We see no reason for this DOL ruling to force any sort of industry-wide fee reduction.
Protect Yourself and Plan Participants
As a plan sponsor you bear the responsibility to look out for your employee’s best interest. Yes, you are a fiduciary by title. Since this ruling will provide no applicable protection, your best bet is to request multiple proposals from providers in order to compare services and fees. Clearly define all of the roles in your defined benefit plan and make sure all parties who take on any fiduciary capacity acknowledge this in writing. This should all be done in the plan’s Investment Policy Statement. Even more critical is your ability to monitor your service providers. Since the investment space is fluid, the most common fiduciary breach by plan sponsors is the failure to monitor the plan and its service providers.
The DOL on Proprietary Funds: A Metaphor
Many choices in 401k plans are proprietary funds. These funds are owned by the company servicing the 401k plan, which, if chosen, provide additional revenue to the company who offers them and possibly to the advisor who suggests them. The DOL’s Secretary, Tom Perez, has this to say about the topic, “We were told that firms that sold proprietary products felt they were put in the penalty box. Folks said it was like having to recommend a Chevy when you worked at a Ford dealership. We heard these concerns and clarified that there is no bias against proprietary products and created a special rule so these advisors can have clear guidelines.”
First of all, car salesmen are not fiduciaries. Nor does any potential buyer confuse them as such. However, if they were truly a fiduciary, they should recommend the Chevy even if they work at the Ford dealership, if that’s what’s best for the client. Additionally if you’re truly a fiduciary, you should recommend the best car regardless of who makes it. However, not all 401k service providers have the capacity or willingness to offer non-proprietary funds. Now under this ruling, advisors can recommend proprietary funds, and do it in the guise of the fiduciary standard.
A Win for the Brokers
Initially, this DOL ruling had brokers and mutual fund dealers in their sights, with an agenda to remove their unsavory tactics from the investment space. The DOL clearly identified the problem. However, when all the chips fell, brokers actually received a boost because they can now say they act as a fiduciary even when they don’t. It’s no mystery why the brokerage industry praised the ruling and why brokerage stocks skyrocketed on the day of the ruling. Wall Street lobbyists earned their keep on this one.
Okay With Conflicts of Interest
The DOL also ruled that conflicts of interest (such as commissions collected by an advisor for recommending a particular product) are okay as long as they are disclosed. This is another loss for individual investors and plan sponsors. To truly act as a fiduciary you should avoid conflicts of interest, not just disclose them. Yes, some disclosure is better than not disclosing at all, but this disclosure probably shows up as fine print, accompanied with minimal investor understanding.
What Plan Sponsors Can Expect
As a plan sponsor, your current company plan will probably carry on as it did before. You can expect to receive some documents in the mail along with a request to sign and return them. These documents will the steps taken by your service provider to become compliant with the new DOL ruling. They are just formalities and, even if the papers say it’s done in your best interest, it’s probably not. Remember that when Labor Secretary Perez states, “Many companies advertise that they put clients’ interest above their own. Today’s rule ensures that putting clients’ interest first is no longer a marketing slogan, it’s the law.” This is only true until you opt out through the “best interest contract exemption,” which is also part of the law. You and your service providers have until April of next year to be compliant. In the meantime, don’t forget to read the fine print.
Curious on how this DOL ruling affects your company’s 401k plan? Contact us here and we’d be glad to answer your questions.
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