Getting rid of the Department of Labor’s Fiduciary Rule is one of the best instincts coming out of President-elect Donald Trump’s transition team.
First: what is the DOL’s Fiduciary Rule? Well, you’re welcome to read the Federal Register synopsis here, but for those of us who like a shorter approach, it’s an expansion of the “investment advice fiduciary” definition under the Employee Retirement Income Security Act of 1974 (ERISA). It essentially precludes investment advisers from receiving compensation that varies from recommended investment choices — so, if you’re a broker-dealer running a commission-based operation, you can’t just recommend your client invest in products that will generate the highest compensation for yourself. Instead, the Rule requires you to act in the client’s “best interests,” a step up from the previous standard of only having to offer “suitable” products.
Sounds great, right? Everyone should act in each others’ best interests, and especially the people who are managing future retirees’ money! There’s only one big, hairy problem: expanding the fiduciary definition makes it near-impossible for commission-based broker-dealers to offer their services to ordinary investors, including both near-retirees and young people like me.
The rub is that the DOL’s rule requires advisors to use the best-interest contract exemption (BICE) to sell products like variable annuities on a commission basis. In practice, this means an individual broker will have to contend with extensive compliance costs simply to continue assisting their clients, incurring time and financial outlays that could cripple their business model. And to talk one-on-one with an investor — even just to provide general education about available options — the advisor would be obligated to charge an advisory fee. And then there’s the prospect of litigation over a bad piece of advice, which undoubtedly puts an extra burden on investor-advisor interactions. The uncertainty this new environment creates has been a bit too much for certain industry players, with high-profile companies like Merrill Lynch doing away with their new commission IRA offerings entirely.
Still, that’s all a bit wonky. Why is the Fiduciary Rule’s suppressing effect so bad for Americans? Think about it this way: on one hand, there’s a new government regulation that is either going to destroy the commission-based model entirely, or, even in a best-case scenario, force commission-based broker-dealers to charge more for their services while providing less investing education. On the other hand, there are two other well-known models that can replace a commission account. The first I’ve already touched on: full-on fees for investment advice that are typically designed for larger investors for whom a fee structure makes economic sense (for example, the average annual fee charged by advisors in 2016 was 1.30% for $100,000 in assets under management, compared to 0.75% for $10,000,000).
The second option is a robo-advisor, a la Wealthfront, Betterment, or similar algorithm-based services. While robo-advisors aren’t terrible, they work best as autopilots for small investors who aren’t ready to jump to hourly fees. As a result, they’re built for stability, not necessarily for generating the best returns that an investor may need for a successful retirement, or anything else for that matter. I’ll use my own experience for reference: as a millennial just out of college, investment wisdom suggests that I should have a healthy appetite for risk, especially since I’m starting from scratch and don’t need to execute rear-guard actions to protect a substantial portfolio. I can probably even get away with making a few off-the-reservation decisions in the hopes of identifying some businesses that crush the market early on. Yet as a Wealthfront user, I can crank the risk dial to a pretty high level and still see older exchange-traded funds that track the S&P, but don’t offer anything particularly eye-opening. Of course, that’s not to say that Wealthfront doesn’t offer a solid selection. It’s just that moving from a commission-based system to a robo-advisor makes it a lot harder to get the personal services you’d prefer — and, in many cases, really need.
So, in sum, the Fiduciary Rule makes sweeping generalizations that diminish advice to investors, complicates a major business model that many future retirees depend on, and/or forces people to either fork over more money for a similar service or leave their finances to less responsive automations. Trump transition team member Anthony Scaramucci nailed it on the head when he said one of the Rule’s biggest issues is that it will “ultimately hurt the end user.” With the President-elect representing America’s best hope for practical, functional solutions free of stifling regulations, his team would do us all a great service by dumping the Rule and starting fresh on Day One.
For those interested in some factoids, a one-pager from the Securities Industry and Financial Markets Association (SIFMA) produced during the Fiduciary Rule fights last year can be found here. Obligatory disclosure: I have previously worked on issues surrounding the Fiduciary Rule, although I am currently not professionally involved in any efforts against the DOL’s retirement advice standards. I have been a Wealthfront user since July of this year.
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UPDATE, 11/21/16: Now that the Fiduciary Rule is facing its demise, one of the more simple proposals for how to actually do away with the Rule is to have the Trump administration refuse to defend it in federal court. My first instinct is that the government should act to reduce litigation costs, but since the Rule already faces ongoing lawsuits, this could be a less top-down way of addressing the DOL’s mistakes. This approach is summarized here.