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Here’s an article from CFAInsitute describing the DOL Rule Origin.

By Jim Allen, CFA

Baseball great Yogi Berra once said of a National League pennant race, “It ain’t over till it’s over.” If a group of nine industry organizations has its way, the Department of Labor’s (DOL’s) fiduciary rule, issued in April to address conflicts of interest in retirement advice, ain’t over either. In fact, there is a very good chance that it won’t be over for a while.

The organizations suing the DOL aren’t concerned so much with the best interest contract exemption requirement, or even the narrowing of investment options for personal retirement accounts. Make no mistake, the costs of such requirements and the expected loss of revenue and client assets are unwelcome outcomes for the businesses these organizations represent.

No, the industry is most concerned about the potential for trial lawyers to use the rule to launch a massive legal offensive on the financial sector aimed at advice given and investor outcomes. As one industry representative said to me after a panel discussion hosted by CFA Society Washington in April, “your members won’t like this.”

Making Enemies with Hardball Politics

It is no surprise that the DOL’s fiduciary rule has so many enemies. It will cut deeply into $18 billion in annual fees the industry now enjoys. Morningstar has estimated that upward of $3 trillion in assets under management will come into play as a consequence of the rule. When so much money, and the lifestyles that go with it, are threatened, one should expect a big fight.

But the Obama administration didn’t make things any easier for either itself or the rule’s supporters with its approach. From its decision at the launch in February 2015 to portray the problem as $17 billion of investor “losses” every year because of poor investment recommendations, to its choice of a progressive think tank to announce the final rule in April 2016, the administration brought its brand of hardball politics into what was previously a nonpartisan, or at least bipartisan, policy arena. By doing so, it also made support a partisan matter. That has not been good for anyone.

Politically speaking, the February 2015 rollout, replete with President Obama’s personal presence, was brilliant. It dared his opponents—and many inner-city allies—to publicly say they didn’t think it was a good idea for “financial advisors” to have their clients’ best interests in mind when suggesting retirement investment options. Opponents were stuck, initially, and unable to counter the argument that investment vehicles charging fees of 2% to 3% were inappropriate for many, if not most, retirement investors. But brilliant political moves do not necessarily mean good policy or good outcomes for real people.

When opponents regained their footing, they responded with the tried—and, to some disputed extent, true—rebuttal that such a proposal would deprive many low-income investors of professional investment advice. Small investors, they argued, would not have access to advice just when they might need it the most, such as after receiving a small inheritance. Of course, this line of reasoning did little to address the thorny matter of how a guaranteed-income annuity could drain a retirement account of years of earnings, or how some complex instruments sold to retirees were deemed appropriate.

The reasoning did consider, however, the very real possibility that without professional advice, some, and perhaps many, investors would have few options beyond a “safe” bank certificate of deposit, yielding less than 2% if you’re willing to put it away for five years. At those rates, the amount of time people would need to build a retirement nest egg would nearly triple.

Investors, Lawmakers Face Tough Choices to Move in Right Direction

Investors have to weigh their options and make difficult choices, sometimes concluding that a high-priced option is better than a low-yield option. As long as they are aware of the different options, and any in between, they might prefer the opportunity to weigh those trade-offs and make a decision based on what they believe will meet their needs best.

The problem is, they weren’t and aren’t aware. And they aren’t aware because of the subterfuge some parties to this lawsuit used to deliberately confuse investors. Use of the ever-so-subtle term “financial advisor” sounds awfully similar to the title, investment adviser, but they are anything but similar. I know the difference, and it still occasionally catches me off guard. The SEC should have stopped these deceptions years ago.

Like investors, politicians must also make difficult choices and accept legislation that is less than perfect to move things in the right direction. The desire for a higher standard of care might have been worth the Obama administration compromising on some provisions in this case. But President Obama and Labor Secretary Thomas Perez wanted it all, and they didn’t want to deal with trade-offs. They won, but as the pending lawsuits indicate, in the long run it may prove a Pyrrhic victory.

Maybe the Obama administration’s approach was needed to get movement on this difficult issue. With that much money at stake, it was going to take something drastic to get movement. But the hardball approach has its drawbacks, and those of us who favor a best interests standard must hope the politics used to get this rule through the system won’t come back to taint the term “fiduciary duty” for a generation to come.

Here is a good legal definition of fiduciary duty from Cornell Law website.

A fiduciary duty is a legal duty to act solely in another party’s interests. Parties owing this duty are called fiduciaries. The individuals to whom they owe a duty are called principals. Fiduciaries may not profit from their relationship with their principals unless they have the principals’ express informed consent. They also have a duty to avoid any conflicts of interest between themselves and their principals or between their principals and the fiduciaries’ other clients. A fiduciary duty is the strictest duty of care recognized by the US legal system.

Examples of fiduciary relationships include those between a lawyer and her client, a guardian and her ward, and a director and her shareholders.

Here’s an article written by CFA Insitute describing Morningstat’s analysis of the DOL Rule and the industry.

By Jim Allen, CFA

Washington, DC, is known—and regularly scorned—for its role in picking winners and losers through its legislation and regulation, a stigma that dates back centuries. So, it should come as no surprise that the Department of Labor’s (DOL’s) fiduciary duty rule, one of the most sweeping regulatory changes of recent decades, is widely expected to help some existing players while hurting others. Although the rules don’t involve direct infusions of money into the winners, it is expected, nevertheless, to produce changes in the way significant sums of investor money are invested.

Morningstar, a Chicago-based rating agency, has thoroughly assessed the new rules and determined that it will produce three primary trends.

First, it will shift customers from commission-based arrangements to fee-based structures, which is estimated to increase industry revenue by $13 billion.

Second, robo-advisers will likely pick up a large percentage of the $600 billion in low-net-worth IRA balances currently held by full-service wealth managers.

Third, it could lead to a significant increase in the use of passive investment products.
In aggregate, Morningstar predicted that $3 trillion in retail client assets are at stake, relating to $2.4 billion in fee revenue. That is more than double the $1.1 billion in compliance costs the industry estimates will be needed.

The Winners and Losers

On the basis of these trends, the rating firm concluded the rule will favor those engaged in discount brokerage as well as those selling exchange-traded products and index funds. By contrast, life insurers and alternative asset managers are seen as the likely losers. Their high commissions and vertical integration are the areas Morningstar believes will create the problems for insurers.

“[W]e believe that companies that rely heavily on annuity sales and investment services will feel the greatest impact,” Morningstar reported in its Financial Services Observer prior to release of the DOL’s rules. The rules “will make it very difficult for many investment agents and professionals to continue offering investment services and retirement products to clients.”

Morningstar highlighted two reasons why it will be difficult. First, the new rules will look at insurance agents advising about the sale of annuities as fiduciaries, and thus needing not only to enter best interest contracts with their clients, but also to justify high-cost investment instruments to skeptical regulators. Even worse, they will have to justify those instruments to skeptical trial attorneys.

Rise of Robo-Advisers and Passive Investing

The new rules are expected to have mixed effects on full-service wealth managers, although the overall effects will tend toward the negative. For example, Morningstar said the sector will encounter negative effects from the shift toward fee-based accounts, which, while producing higher revenues per account, will cause as much as $600 billion of low-net-worth IRA assets to find new investment channels. Among the beneficiaries will be firms offering advice through robo-advisory systems.

The shift toward robo-advisers is seen pushing such firms toward the critical threshold of $16 billion to $40 billion in collective assets under management, which is believed as the level they need to attain profitability. The use of robo-advisers, meanwhile, is seen directing investors toward passive investment products. Discount brokers, too, are seen furthering the trend toward passive investing because of the DOL rules.

It has been apparent since the introduction of the DOL’s rules in April 2015 that it would cause some firms to lose. The Morningstar report helps describe who the losers are as well as indicate who will be among the winners.

Here is an article written by CFA Institute describing panel discussion at NY Analyst Society meeting.

By Linda Rittenhouse, JD

When moderator Bob Dannhauser, CFA, head of private wealth management at CFA Institute, asked each panelist last Monday how likely it is that the Department of Labor (DOL) conflict of interest rules will take effect on the April 2017 target date, all answered “100%.” Only time will tell whether this forecast is accurate, especially given that two days after the New York Society of Security Analysts’ (NYSSA) event nine organizations filed a lawsuit to stop implementation of the rules.

If the panelists’ predictions hold true, participants in NYSSA’s Conflict of Interest Rule (Fiduciary Rule) Unwrapped event are a step ahead in navigating the compliance tributaries posed by the DOL’s 1,000 pages of final rules. The expert panelists — Greg Nowak (Pepper Hamilton), Tom Marsh (Deloitte), Rob Sichel (K&L Gates), and Kevin Walsh (Fidelity) — covered a range of topics aimed at highlighting the many business and legal considerations practitioners and firms must address to comply with the rules.

Not All Is Clear in the Rules

Not all aspects of the rules are straightforward or intuitive. For example, although ERISA (Employee Retirement Income Security Act of 1974) did not change, as Sichel noted, a redefinition of the scope of who is a fiduciary has “profound implications for the industry,” and particularly for the discretionary fiduciary. What constitutes a “recommendation” is pivotal, with even suggestions about whether to take or refrain from taking a certain course of action arguably tagging the provider with fiduciary status under the rules.

But the final rules streamline the regulations for “level fee fiduciaries,” making compliance easier for them. Another such nuance involves private funds, which are not subject to ERISA if no more than 25% of assets are from retirement accounts. However, engaging in certain promotional activities with respect to the funds may bump up against the fiduciary definition and trigger the need for compliance with those regulations.

Fees Exposed and Reduced

So, what are the business models that pose insurmountable problems? Nowak noted that the classic example is the retail broker/dealer selling variable annuities with hidden fees or revenue sharing agreements. And although disclosure could cure oversights in the past, that is no longer the case under these conflict of interest regulations. Walsh suggested a multistep framework for evaluating each business model for compliance by asking the following questions:

How are you paid?
What are your new products and how are you compensated for them?
What are possible issues when looking through the lens of existing business and new business models?
Marsh noted that although there is not one response, firms will be looking at client segmentation (for example, high net worth versus lower net worth), with an aim toward reducing risks and limiting platforms.

In regard to what clients should expect, Marsh believes the good news is that the new rules will reduce fees and provide greater transparency around those fees. Sichel thinks more than just fees will be affected; he believes the implicit message from the DOL is that retirement assets are better left in the workplace and that implementation of the rules is intended to curtail rollovers.

Active asset managers, contrary to what many doomsayers say, Marsh contends, will not have “a stake in the heart” because of the rules. Instead, the rules will serve as a rallying cry to get fees to the level they should be in a competitive environment.

Nowak agrees, predicting that managers that provide “pure advice” for a fee will be in high demand. He added that the new rules will force the industry to educate consumers and consequently allow managers to “take control back from distribution.”

All of this, of course, depends on the full implementation of the rules. What effect the ensuing court battle will have on the substance of the rules and effective date will unfold in the coming weeks and probably months. The DOL’s message until then is for investment managers to get their ducks in a row and move toward compliance. April 2017’s effective date will be here soon