It’s been just over a month since the U.S. Department of Labor (DOL) announced its final Fiduciary Rule, which requires advisers to provide advice on retirement savings at a “fiduciary” level of care. The rule has been controversial in the financial services sector, because – believe it or not – it’s not an across-the-board requirement for advisers to place their clients’ interests first!
This topic was an eye-opener for some of the attendees at my Financial Scrapbooking seminar on April 29 (thanks to all who attended, by the way!), so I thought I’d address it a little more in-depth in this week’s blog. The DOL’s new rule involves two key standards: fiduciary and suitability. Understanding what these standards mean and when they apply may make a huge difference in the amount of money you get to keep in your portfolio!
The Fiduciary Standard
The DOL has described a “fiduciary” as advisers who are required to put their clients’ best interest before their own profits. Fiduciaries include registered investment advisers, advisers to mutual funds (like the Dimensional Funds AMDG Financial uses), and others who hold themselves out to be fiduciaries (like trustees and certain retirement plan consultants).
Fiduciaries must act impartially and provide advice that is in their clients’ best interest, and in doing so, must act with the care, skill, prudence, and diligence that a prudent person would exercise based on the current circumstances. A fiduciary must avoid misleading statements about fees and must avoid conflicts of interest.
Fiduciaries typically receive compensation by payment of a fee, rather than a commission. Fiduciaries to retirement plans, plan participants, and IRAs are also prohibited from receiving payments that create conflicts of interest unless they comply with the terms of certain exemptions issued by the DOL.
Probably most important, clients can expect that a fiduciary will act with transparency and avoid prohibited conflicts of interest. For example, given two comparable investment choices for a client, a fiduciary should typically recommend an option with lower management fees.
Fiduciaries are personally liable for breaches of their fiduciary duties. For example, if a breach of fiduciary duty causes a loss, the fiduciary must make the plan or IRA whole by restoring any losses caused by the breach and restoring to the plan or IRA any profits made through the use of plan or IRA assets. Civil actions to obtain appropriate relief for a breach of fiduciary duty may be brought by a participant, beneficiary, fiduciary, or the U.S. Secretary of Labor, and the fiduciary may be subject to excise tax penalties.
The Suitability Standard
Historically, representatives of a broker-dealer are required, under the securities laws, to judge the “suitability” of a product for a prospective investor, based on that person’s financial goals, income, and age. Unless the adviser and client have a separate agreement, the suitability does not legally require: a recommendation of the most cost-effective product, a disclosure regarding conflicts associated with the investment, or disclosure of the compensation received when making that recommendation. Under the new DOL rule, it may mean that common forms of broker compensation, such as commissions and revenue sharing, will be restricted.
A Single Standard of Advice
Since many financial advisers are dually registered as both brokers and investment advisors, some investors may have trouble determining under which standard they’re receiving investment advice. In creating the fiduciary rule, the DOL’s primary goal was to create a single standard for retirement financial advice based on a fiduciary model (note that this applies only to retirement advice!).
A number of clients already receive fiduciary advice, and for those clients, the change in rules will not have much impact. (That’s the case for clients of AMDG Financial, because we are a fee-only firm, committed to placing our clients’ interests first in all aspects of our practice.)
As a result of the new DOL rule, it’s possible that professional financial advice for retirement assets (whatever the source) is subject to a level fiduciary standard. (Note: the DOL has included some exceptions, such as when advisers provide general investment education, or execute a buy or sell order without making a recommendation, or in certain cases involving “robo-advice.”) However, as with any investment advice, clients should conduct their own research, ask questions, and learn more about the reputation and philosophy of an advisor before making a decision to invest.
If you have questions about the fiduciary and suitability standards, please feel free to contact us. In the meantime, never hesitate to ask an adviser how he or she gets paid, and whether the adviser will act as a fiduciary on your behalf – it’s all part of being a good steward of your own money.