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If you thought election speculation ended on November 8, you clearly haven’t been paying attention to the conversations online and off about the pending DOL regulations that are set to apply on April 10.
Initially, Trump’s victory had many in the industry speculating that the DOL fiduciary rule that has filled the industry with angst would be on the chopping block. But just a week later, that hope dissipated into a wishful pipe dream. The current thinking seems to be that since Trump has many battles to fight once he takes office, it’s unlikely he’ll be willing to take on an issue that spotlights any turning on the heel of his anti-establishment platform. And like it or not, the DOL rule is considered by many as a win for “the little guy.”
Of course, those of us in the industry know well that the rule itself is a double-edged sword. While it is designed to protect retirement savings for a population that is in the midst of a full-blown retirement crisis, it also takes a major blow at the very people who have the skills to help solve that crisis: investment advisors. The DOL rule affects—if not downright threatens—the profitability of the brokerage business as we know it. So what’s an independent advisor to do?
At the recent Nasdaq Advisor Symposium in New York, Dan Viola, the head of the regulatory defense and compliance group at New York City-based Sadis & Goldberg and former examiner for the SEC, suggested that one thing not to do is rely on the Best Interest Contract Exemption (BIC) to sidestep the regulations. “The BIC exemption includes a laundry list of requirements that are difficult to follow,” said Viola. “Not only must the firm assign a conflicts officer (who, by the way, can be personally sued for compliance failures), but it must also create and post on its website a detailed conflicts policy that explains how any collected commissions are explicitly serving the account—not the broker. That’s a pretty tall order, no matter how large or small a firm may be.”
Instead, Viola’s advice is to assume the rule as it stands will go into effect on April 10, 2017, and to plan accordingly. Even if the new administration does take action against the rule, it’s more likely it will be rolled back in some way—not killed completely—and even that will take time. Possibly lot of time. That means it’s vital that firms implement a fee-only structure for retirement accounts by the April deadline to avoid any DOL scrutiny down the road. For firms that operate with a large percentage of brokerage fees, that shift is likely to create a significant revenue challenge, but risk may outweigh any revenue that’s at stake in the decision. To be clear, that risk is substantial.
The risk of heightened scrutiny by FINRA and the SEC is no doubt why so many banks are choosing to opt out of commission structures that are associated with retirement accounts.
Merrill Lynch was among the first when it announced an end to mutual funds in retirement accounts that charge commissions. JPMorgan Chase, Wells Fargo, and Capital One Investing followed suit soon after. And while others, including Morgan Stanley and Raymond James, have announced plans to continue to allow commissions for IRAs, the larger trend seems to be toward opening the door to fee-based retirement accounts in what may signal a slow-but-steady approach to moving toward a full shift to level fees further down the road. Note that all of these companies are expected to lose millions as a result of their shift away from commissions on retirement accounts and mutual funds, but the risk of compliance-related penalties is simply too great to move forward any other way.
For smaller firms that simply can’t exist under a fee-based structure, another option is to shift existing retirement accounts to a self-directed structure. Though that, too, has its challenges. “Assume the advisor is working with a client who has a non-retirement investment account, and the advisor recommends buying Apple stock to build up that account,” says Viola. “Is that advice relevant to the self-directed account as well? Could it be perceived that way by the client?” Without a way to differentiate how such advice should be given, received, and even perceived, a regulator could potentially question the structure, and the advisor could face penalties, despite the best intentions. For some, that may be a risk worth taking.
Whichever path advisors choose, the DOL deadline is four months away. And with commission-oriented structures likely to be pretty tough to justify to the regulators, beginning the transition to level fees as soon as possible may be the smartest—and safest—approach as we head into 2017. Assume the change is happening. The last thing you want is to have the SEC knocking on your door looking for answers.
Editor’s Note: Read more about the DOL and what advisors need to know from the Nasdaq Advisor Symposium panel - click here .
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