With one eye on Washington and the other on their client list, the nation’s financial industry is already ramping up for the “fiduciary rule,” which dramatically overhauls the regulatory regime for retirement-investment advice.
Intended to protect investors from predatory financial advisers, industry insiders warn the rule will leave many people to fend for themselves in an automated, impersonal world of stripped-down investment choices.
The rule updates the Department of Labor’s 1974 Employee Retirement Income Security Act. It says any professional who is paid to handle retirement investments has a fiduciary duty, or is legally obligated, to put their clients’ “best interests” first, rather than simply finding ”suitable” investments.
This includes disclosing any possible conflicts of interest and clearly stating fees and charges, which means far greater scrutiny of commission-based accounts and more liability for advisers. It also means more time spent on paperwork for retirement accounts. A Labor Department report says complying with the rule could cost as much as $31.5 billion over 10 years, making it the most expensive federal rule of 2016, according to the American Action Forum (AAF).
The rule is slated to take effect April 10. But a Feb. 3 memo from President Donald Trump ordered the Labor Department to further review the rule’s economic impact. There’s also a bill in the works to delay the rule for two years.
But many investment firms are preparing for the rule anyway. Anticipating they won’t generate enough revenue to offset the added costs, they have already begun to adjust staff and services to cut back on the number of fiduciary relationships with clients.
The AAF calculates these changes so far have affected 92,000 investment advisers, through job elimination or reassignment, for example.
Smaller retirement investors, however, will bear the biggest brunt. The smaller the account, the less money advisers and firms make on fees and commissions. These clients will likely find themselves at the mercy of call centers, or online services where algorithms rather than people figure out their investment portfolios.
One consultant estimates the use of these so-called “robo-advisers” will grow 68 percent by 2020.
The downside, advisers point out, is that algorithms don’t care about life events that might change a person’s retirement needs, such as a child going to college or a spouse with extraordinary health expenses.
Not worth the risk
In addition to drastically reducing the choices available to investors, the rule is likely to result in a dramatic increase in litigation.
The rule allows class action lawsuits rather than arbitration to settle brokerage-client complaints. One equity analyst estimates the litigation would cost the industry between $70 million and $150 million a year — on top of compliance costs.
“Like that’s what the courts want?” remarked one longtime financial planner. ”The courts want Gladys and Pearl showing up in court complaining that they bought Occidental Petroleum at $28,000 and now it’s at $23,000 and they should get their $5,000? It’s ludicrous. Somehow I should have been a soothsayer?”
Kathleen McBride, co-founder of the Committee for the Fiduciary Standard, argues that compliance and litigation costs will drop once financial service firms have processes in place for providing fiduciary advice.
“This leads to better outcomes for retirement investors, through plans and in IRAs,” McBride told Watchdog.org.
And outcomes are at the heart of the rule, announced last year by President Obama, Sen. Elizabeth Warren (D-Mass.) and then-Labor Secretary Tom Perez. Supporters say exorbitant fees and commissions charged by the industry’s bad actors combined with conflicted investment advice cost investors $17 billion per year in potential earnings.
“Financial services [insurance companies, broker dealers, banks, mutual fund companies] structured their businesses not to serve retirement plans or retirement investors but to systematically rip them off,” said McBride. “Conflicts of interest are rampant, not the exception.”
McBride’s group, along with a broad coalition of nearly 100 labor unions, public interest, civil rights and consumer groups have joined a campaign called Save Our Retirement, which appears to be handled by a non-profit group called Better Markets. (A media representative declined a Watchdog.org request for comment.)
In the meantime, many coalition members, including McBride, AFL-CIO, Public Investors Arbitration Bar Association (PIABA) and the Consumer Federation of America and Betterment recently met with representatives from the DOL and Office of Management and Budget to push for the April 10 implementation.
“There was a good dialogue at the meeting,” McBride said, adding that while there was no indication about whether a delay is coming, several recent court decisions have supported the fiduciary rule, with judges writing “that a delay would not be in the public interest.”
‘Huge changes in our business’
Delay or not, the finance industry is well on its way to accommodating the requirements.
Metlife, AIG and Merrill Lynch have abandoned some retirement services altogether, according to AAF, which compiled a list from published reports. State Farm, Morgan Stanley and Edward Jones are drawing down their brokerage business, while LPL, Raymond James and Commonwealth are switching from commission to fee-based products.
Others, like Wells Fargo, are adding salary-only account handlers, call centers and online retirement services. And some, like UBS, are staying status quo. “If we have to turn it on, and say, ‘OK, we’re fiduciaries now,’ we will,” a person familiar with UBS told Watchdog.org.
In the meantime, at least one broker predicts retirement accounts are just the beginning.
“I think in the end, you’re probably going to see the Securities and Exchange Commission take a lead role in putting some sort of semblance of this in place for non-IRA accounts over the next couple of years.” he said. “When that happens, there’s going to be some huge changes in our business. Big changes.”
Kathy Hoekstra is a national regulatory reporter for Watchdog.org. Contact her at [email protected] and @khoekstra.