What Is the Fiduciary Rule?

Judge Barbara M.G. LynnYesterday, the headlines were full of the news that Texas federal trial Judge Barbara M.G. Lynn had ruled in favor of the Labor Department, and against financial industry challengers as well as the Trump administration, on the DoL’s proposed “fiduciary rule.” Her decision marks the third time challenges to the rule have been shot down in the courts. Wondering what all the fuss is about?

Many people don’t realize that some advisors and brokers can offer investment advice that isn’t in their best interest. In other words, some kinds of advisors and brokers can recommend an investment that pays them (the advisor) a high commission or a high fee, even if there is a comparable investment option that would cost the client less.

The Obama Administration’s Council of Economic Advisers estimated that investors (you and I) are spending $17 billion a year on these kinds of fees and commissions. A rule proposed by the Department of Labor (DoL) in 2010, known as the “fiduciary rule,” would require money managers and advisors who sell financial products to investors for their retirement accounts to act as “fiduciaries.” This means that financial advisors and brokers would have to put their clients’ interests first when providing investment recommendations for their tax-advantaged retirement accounts.

The idea is that the fiduciary rule will stop advisors from putting their own interests first, and clients will benefit because they will be paying lower fees.

Here’s how this works: Say, for instance, your investment advisor or broker recommends an investment fund to you, Fund A, which is a U.S. stock fund. The annual fee you pay to invest in the fund (to the fund management company, not your advisor or broker) is 0.95 percent per year (on the amount you invested) and your advisor or broker receives a 5 percent commission on the amount you invested.

Now say there is another investment fund that also invests in U.S. stocks, Fund B. It only charges you an annual fee of 0.15 percent (as opposed to 0.95 percent) and there is no commission tied to this fund. Some advisors and brokers might recommend Fund A because they receive a commission on that fund, even though it wouldn’t be the best choice for you. This happens often and it’s completely legal.

It’s a lot like when a realtor only shows you apartments she makes a commission on, and doesn’t show you no-fee apartments that would suit you just as well.

The fiduciary rule is intended to address these conflicts of interest. Advisors and brokers would no longer be able to put their own interests before yours when giving you investment advice for your tax-advantaged retirement accounts. It’s important to note that the rule would not apply to any after-tax investments you may make, even if that money is earmarked for retirement. In a regular brokerage account a broker or advisor would still legally be allowed to recommend investment products that may charge higher fees to you, but provide them a commission, rather than a similar product that had lower fees for you and no commission for them.

The regulation behind the fiduciary rule already went into effect in April 2016, but initial compliance by the industry isn’t required until April 10, 2017, and full compliance isn’t required until April 2018. President Trump recently issued an executive order to require a new review of the law, which would effectively prevent it from being implemented. He feels that the fiduciary rule will hurt those saving for retirement. His reasoning is based on the way many financial advisors and brokers are currently compensated. Typically, these advisors charge their clients an annual fee based on a percentage of the assets (typically 1 to 2 percent) they are managing for the client. They often also take a commission on some of the products they recommend, as described above with fund A.

President Trump and some commission-based advisors argue that high commissions enable financial firms to service clients with fewer assets. In other words, they need to be able to sell high-fee/commission products because this revenue covers the cost of servicing clients who have fewer assets and are contributing less revenue to the firm.

In a nutshell, enforcing the fiduciary rule could put commission-based advisors or brokers out of business. Why? Because the fiduciary rule would make pushing products with high commissions and high fees, when there’s a comparable option without a commission and a lower fee, a no-no.

Those opposed to the fiduciary rule argue that receiving these commissions and fees is what keeps the lights on for advisors and brokers. They say that this way, at least people with fewer assets can still have access to advisors. But do people even want access to advisors and brokers who are not putting their clients’ own interests first? Is bad advice better than no advice?

Personally, I’ll take no advice, thanks.

Whenever you work with someone who is selling or recommending financial products to you — and that means everything from stocks and bonds to annuities and insurance — it’s wise to ensure they are working with your best interest in mind, not theirs. Always ask if they are a fiduciary.

 

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