Portfolio Perspective

Investors come first in new government ruling

Andrew Osterland, special to CNBC.com

The long-running debate over the responsibilities that financial advisors have to their clients took a big step forward on Wednesday.

The Department of Labor issued a final rule imposing new fiduciary obligations on advisors to 401(k) plans and individual retirement accounts. More than $10 trillion in assets are held in such retirement accounts, according to industry data. Initially proposed in 2010, the final rule requires that all advisors to such accounts act in the best interests of their clients.

(For a chart illustrating how the DOL develolped the final ruling from the initial proposal, click here.)

Jacob Wackerhausen | Getty Images

"Many firms say they put their clients' interests first," said Secretary of Labor Thomas Perez in a press conference Tuesday. "Now it's not just a marketing slogan, it's the law."

He added: "This is a huge win for the middle class."

Perez said the final rule incorporates changes that make the mechanics of drafting the new best-interests contracts easier, reduces the disclosure requirements on advisors and extends the timeline for full compliance with the new rule. "I believe the industry will be able to comply with these new streamlined rules," Perez said.

Despite intense opposition and heavy lobbying against the proposal by the brokerage and asset management industries, the new rule is the first major change to Employee Retirement Income Security Act law in four decades and will take full effect at the beginning of 2018.

"This involved one of the most well-funded efforts to defeat a proposed rule in the last decade — but it made it," said Ed Gjertsen, vice president of Mack Investment Securities and chairman of the Financial Planning Association. "Most people don't understand the fiduciary debate, but they do understand the idea of someone acting in their best interests.

New investment rule could save investors billions

"This rule is a huge benefit to the public," he added.

There has been opposition, however.

"Affordable, objective financial advice is a critical component to hardworking Americans' ability to save for a dignified retirement," said Dale Brown, CEO of the Financial Services Institute in a prepared statement.

"The Department of Labor's two earlier proposals were complex and unworkable," he added. "As we have said since day one, there is no compelling evidence this rule is necessary to achieve a uniform fiduciary standard, and DOL's own analysis fails to make the case. We will spend the coming days thoroughly analyzing this rule to determine if it protects Main Street investors by preserving their access to affordable, objective financial advice delivered by their chosen financial advisor."

The rule, however, remains a mystery to most individual investors. Surveys regularly indicate that few investors understand the concept of fiduciary obligation, and most believe their advisors are already required to act in their best interests.

Investors need to keep in mind that this new rule covers only tax-advantaged retirement accounts and does not apply to most other investments. However, industry observers believe it could lead to more sweeping changes in the years ahead across the financial services industry. To that point, it could make it difficult for some smaller advisory firms to do business and perhaps encourage a further consolidation into larger companies better able to handle the detailed rules of compliance.

This is a process, not a light-switch kind of event. Buyers still need to beware and demand cost and fee transparency from their advisors.
Knut Rostad
president of the Institute for the Fiduciary Standard

"If I were outside this industry, I would assume that my financial advisor was required to act in my best interest," said Skip Schweiss, a managing director of advisor advocacy and industry affairs for TD Ameritrade Institutional. He added that "the DOL rule enhances the standard of care applying to financial advisors. There may be unintended consequences, but fundamentally, this will be a good thing for investors."

The unintended consequences of the rule, say opponents, will hurt the small investors the rule is intended to protect. The brokerage industry argues that the increased compliance costs that will come with the new rule could price small investors out of the market for financial advice. Some might be forced into more expensive, fee-based accounts while others would lose access to advice entirely.

Sheryl Garrett, founder of the Garrett Planning Network of fee-based financial planners, thinks such fears are overblown. "There will be a period of adjustment, but it won't be as dreadful as many fear," said Garrett, whose network includes 280 advisors. "The brokerage industry wasn't exactly embracing the middle class, anyway.

"It could take until the next generation of financial advisors to really see the transition to a fiduciary culture," she added.

Who, exactly, are these 'financial advisors'?

The brokerage industry will be most affected by the DOL rule. Many brokers are currently regulated under a weaker "suitability" standard of conduct, in which investment recommendations have to be suitable for investors but not necessarily optimal or in their best interests. That lesser standard will still apply to brokers advising taxable investment accounts.

The rule, however, will also affect registered investment advisors, insurance agents and anyone else providing advice on individual retirement accounts. "It casts a wide net," said Gjertsen of the FPA and Mack Investment Securities, whose "hybrid" firm offers both commission and fee-based investment advice to clients. "It's not just broker-dealers that will be affected."

Fee-based advisors already operating as fiduciaries under the 1940 Investment Act will have to adjust to the ERISA rules governing retirement accounts. The issue of rollovers of 401(k) plans into IRAs or taxable accounts is a key element of the DOL's initiative, and it affects all advisors.

Roughly $500 billion in assets every year are rolled over from 401(k) plans into other accounts when employees leave a job. Those numbers will increase as more baby boomers enter retirement. The DOL wants to ensure those rollovers are in the best interest of their owners.

There are four basic options for investors: Leave the assets in the plan; move them to a new employer's plan; roll them tax-free into an IRA; or cash out the funds with a taxable distribution. What the best interests of an individual are depends on their circumstances, their need for income and their tolerance for risk.

Big banks return to managing money, here's why...

The 401(k) plan may represent the lowest-cost investment account but may not necessarily be the best choice for investors.

"Costs matter, but the appropriateness of advice and accomplishing financial objectives matters more," said Garrett of the Garrett Planning Network. "The key on rollovers is having an open, informed discussion about the client's objectives and alternatives."

Perhaps the biggest benefit of the DOL rule will be clearer information for investors on the costs of their retirement accounts and of the financial advice they receive.

"People understand price transparency, and this rule will provide more transparency on costs to consumers," said Knut Rostad, president of the Institute for the Fiduciary Standard. That includes product commissions and account management fees, as well as 12b-1 fees and other revenue-sharing payments that advisors receive from mutual fund firms and insurance companies.

The DOL rule doesn't prohibit commissions or revenue sharing, but it requires that all advisors sign the best-interests contract, disclosing all payments and conflicts of interest they have. If investors feel their interests have not been protected, they can now sue their advisors for breach of contract.

The substantial changes that the DOL rule entails won't happen overnight. Firms are adapting their platforms and putting resources in place to handle the new compliance.

Independent broker-dealer LPL Holdings, for example, recently announced changes to reduce costs and simplify fee structures for its retirement plan offerings to investors.

Other firms may decide not to serve smaller investors at all, because of the increased costs, while others will offer streamlined advice products similar to what's on offer from so-called robo-advisors or online automated wealth-management services.

"This is a process, not a light-switch kind of event," said Rostad. "Buyers still need to beware and demand cost and fee transparency from their advisors."

Elizabeth Davidson, president of Financial Finesse, which offers education and financial wellness programs to employees in 401(k) plans, thinks the DOL rule will promote more awareness of the costs and conflicts of interest that financial advisors can have.

It will encourage investors to consider the advice they get for their retirement accounts but also for their taxable accounts. "Some people don't want to ask how much their advisor is making on their accounts," she said. "This may break some taboos."

Davidson added: "Investors should seize the opportunity and ask questions about how their advisors are compensated."

— By Andrew Osterland, special to CNBC.com