Now that the Department of Labor's somewhat controversial Fiduciary Rule is in effect (as of June 9, 2017), we thought it prudent to provide an update on where things stand, what the new rule means to you and to us, and what may change down the road. This is no doubt a controversial topic; what follows is solely our opinion based on our own experience and may or may not reflect reality. 

Where things stand

As of June 9th, all investment professionals providing service to retirement plans (401(k)s, 403(b)s, et cetera) and retirement accounts (IRAs, Roth IRAs, SEP IRAs) are required to act solely in the best interest of the participants or account owners. This is a major shift from the old "suitability standard," which required advisors to only recommend products which were "suitable" for a particular client's needs, even if that recommendation paid the advisor greater compensation at the expense of the client. Attorneys, accountants, and many other professional service providers have been required to act solely in the best interests of their clients for years; it's finally time the financial services industry caught up. 

What it means

Although conceptually the law is a welcome change, we're still not entirely sure what it means in practice. Advisors are required to act in a fiduciary capacity, but how does an advisor actually prove he or she has only recommended the investment which is most appropriate? For that matter, how does one define "most appropriate?" How much and what documentation is required for each recommendation? The law doesn't answer any of these questions, meaning it's up to each individual firm to set its own standards.

There is also a great deal of discussion on the matter of compensation. The Fiduciary Rule essentially does away with (or at least attempts to do away with) commission-based sales practices. No problem there; the commission model has been broken and inappropriate for most investors for a long time. Instead, the Department of Labor proposes "level" compensation, with an emphasis on fees as a percentage of account value. We support this entirely. However, the DoL also imposes "fair" compensation with no explanation as to how the term is defined. We believe our compensation is fair, as do our clients (that's how the free market works... buyers and sellers negotiating a price), but what's to say the regulators agree with our interpretation?

What's to come

A major concern cited by the large financial services firms regarding the Fiduciary Rule has been the potential unintended effect on smaller investors. At first I thought this was a bogus excuse, but the more I've thought about it the more I think I agree. Requirements for additional paperwork means additional time. As the expression goes, "time is money," and many advisors may decide that smaller accounts and smaller relationships are not worth the hassle. While this will likely protect some investors from unscrupulous advisors who were charging exorbitant fees for little service, it may also harm some investors who were paying reasonable fees for a high level of service from a competent professional. 

To this point: in anticipation of the Fiduciary Rule, several large wirehouse firms have already changed their compensation structure. Advisors don't get paid for their time servicing accounts below a certain value threshold. Some firms have created second-tier programs to service these accounts through 1-800 call centers that only provide basic account maintenance functions and do not offer actual financial advice. 

What if investors don't want to call a 1-800 number? Low-cost online providers like Vanguard and Charles Schwab, as well as "robo-advisors" like Betterment and WealthFront are going to be the largest beneficiaries of the new law (and have been the ones championing it all along... surprise surprise), but again these providers tend to offer only basic services with very little personalized human attention. 

With all of that in mind, I think we can expect to see a consolidation within the industry. Investment firms with human advisors will set higher account minimums and only serve wealthy clients, while non-human online offerings will be available to smaller, less wealthy investors. 

Closing thoughts

We have been acting in a fiduciary capacity as long as we have been in business. It is a requirement of both the CFP Board and CFA Institute that we serve only our clients' best interests, and we lose our eligibility to be a part of these prestigious programs if we violate that promise. We support wholeheartedly the shift to a fiduciary standard across the industry and would challenge anyone who suggested acting in a fiduciary capacity (conceptually) is a bad thing. That said, I'm not sure the law in its current form is the right approach. Is the Department of Labor the right organization to implement or supervise it? Should it only encompass retirement accounts? Do the responsible parties truly understand their obligations and the requirements for compliance? My suspicion is that this version of the Fiduciary Rule will not be long-lived and our lawmakers will take it back to the drawing board by the end of this decade, hopefully to replace it with something that works better for everybody. 

Submitted by Benjamin Sadtler - 2017 CFA Program Level II Candidate