On February 3, 2017, President Donald Trump signed an executive order that asks for a Labor Department review of the fiduciary rule, which will almost certainly delay its implementation beyond the currently-scheduled April 10, 2017 date. Here's what you need to know about the fiduciary rule, and why there is strong opposition to it within the financial industry.
What is a fiduciary?
In a financial context, a fiduciary is required to act in the best interest of the person or party whose assets they're managing. Many people mistakenly think that all financial industry professionals are bound to this standard, but that's not the case.
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One of the biggest benefits to hiring a fiduciary to handle your investments and other assets is that a fiduciary must put his or her client's best interest ahead of their own profit. For example, investment professionals who are not bound to a fiduciary standard have been known to recommend investment products to their clients because they offer the highest commissions, and not because the products were actually in their clients' best interest.
If your investment advisor is a Registered Investment Advisor, they have a fiduciary responsibility and are required to act in your best interest. However, many brokers, insurance professionals, and others in the financial industry do not. Registered Investment Advisors are bound to a fiduciary standard that was part of the Investment Advisors Act of 1940, which essentially says that an advisor must put the client's interests over their own. In addition to the example of not selling high-commission investment products, advisors cannot make trades in client accounts for the sole purpose of generating higher commissions, and cannot buy securities for their own accounts prior to buying them for a client.
In addition to these examples, fiduciaries must:
- Make sure all investment advice is accurate and complete, to the best of their knowledge.
- Avoid and disclose all potential conflicts of interest.
- Clearly disclose all fees and commissions.
- Make investment recommendations that are consistent with the goals, objectives, and risk tolerance of their clients.
The fiduciary standard is much stricter than the "suitability standard" that applies to brokers, insurance agents, and other financial professionals. All the suitability standard requires is that as long as an investment objective meets a client's needs and objectives, it's appropriate to recommend to clients (essentially the last bullet point in the fiduciary list only).
What is the fiduciary rule and who does it affect?
In a nutshell, the fiduciary rule is designed to make all financial professionals who provide retirement planning advice or work with retirement plans accountable to the fiduciary standard, as opposed to the more relaxed suitability standard.
The point of the fiduciary rule is to ensure that retirement planners and other related professionals will be legally obligated to put their clients' best interest first -- not just to find investments that meets the clients' objectives. The rule would cover professionals who work with defined-contribution retirement plans like 401(k)s and 403(b)s, as well as defined-benefit plans (pensions) and IRAs.
The fiduciary rule was formally proposed by the Department of Labor in April 2016 and was passed shortly thereafter. The rule is currently scheduled to be phased in from April 10, 2017 through January 1, 2018.
Pros and cons
The fiduciary rule sounds great for investors. It would protect millions of investors from paying unnecessarily high commissions on investment products, and from buying investment products and making decisions that aren't in their best interest. In fact, a 2015 report from the White House Council of Economic Advisers estimates that conflicts of interests by brokers cost retirement investors up to $17 billion per year.
However, there is strong opposition from many people in the financial industry. For starters, many retirement planning professionals are obviously not big fans of the fiduciary rule. Many would rather be held to a suitability standard, as the fiduciary standard would cost them money, both in terms of commissions and the added cost of complying with the new regulations. In fact, it is estimated that the implementation of the fiduciary rule could cost the industry an estimated $2.4 billion per year.
One of the biggest arguments against the fiduciary rule is that it could unfairly impact smaller and independent retirement advisors, who might not have the ability to afford the costs of complying with the new regulations. The U.K. passed similar rules in 2011, and the number of financial advisors has since dropped by 22.5%. The fear is that a similar thing could happen here.
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