Breaking Down the DOL Fiduciary Rule

You may have heard in the news recently that President Trump is trying to roll back the Department of Labor (DOL)’s new fiduciary rule. This rule would affect retirement investors' advisors and, therefore, the investors themselves. Here’s an overview of what the rule entails and why there’s been pushback. 

 

The Suitability vs. the Fiduciary Standard 

To understand the fiduciary rule, it’s important to know the two standards of care that exist for advisors in the financial services industry. 

The first is the fiduciary standard, which applies to Registered Investment Advisors (RIA’s). The fiduciary standard requires these advisors to always act in the best interest of the client. This includes striving to avoid conflicts of interest and fully disclosing them when they do occur. It also includes providing full disclosure of fees and compensation. Typically, RIA’s choose to be “fee-only”—meaning never accepting any compensation that does not come directly from the client, such as commissions from insurance or mutual fund companies. 

The second, less stringent standard is the suitability standard, whereby advisors are only required to recommend products that seem suitable for the investor’s needs. Broker dealers, insurance salespeople, and other financial company representatives who fall under this standard are typically paid commissions on the sales of investment products, and do not have to adhere to a fiduciary standard. In other words, the products they sell don’t have to be in the best interest of the client.  

 
 With advisors, as with water, transparency is key.

With advisors, as with water, transparency is key.

 

What the Rule Entails & Its Reception

The fiduciary rule would require all financial advisors that provide investment advice to retirement plan holders and IRA owners to act as a fiduciary to their clients, with all the requirements of this standard as described above. 

This seems like common sense, right?  So why has it been met with hostility by some in the financial services industry? 

  1. Increased Cost  Some advisors in the industry claim that compliance costs will increase given that they would have to prove to their regulatory agency that they are indeed acting in their clients’ best interests—and this means more time, paperwork, and essentially, money. 

  2. Reduced Income  Money, once again, is a second driver. On the brokerage side of the business, it is often difficult to discern total fees paid to the advisor. Mutual fund and insurance companies often pay commissions to advisors as an incentive to place business with the company. This often presents a conflict of interest when one company offers higher commissions than another for a virtually identical product.   

The fiduciary rule requires advisors to tell clients all sources of compensation. Fees will have to be more clearly explained, and advisors will have to disclose the existence of less expensive investment alternatives. For many advisors, full disclosure carries the risk of a client deciding not to work with them given the higher fees.  

On the other end of the spectrum, many advisors have met the rule with optimism and see it as a positive step for the industry. In fact, some companies have preemptively switched to fee-only compensation in advance of the rule’s implementation as a best practice. 

 

Where This All Came From… 

The fiduciary rule was originally drafted in 2010 as one of the pieces of financial reform in the wake of the Great Recession, which (as the grisly joke goes) turned 401K’s into 201K’s. According to the Employee Benefit Research Institute, nearly 1 in 4 of near-retirement 401K holders had over 90% of their account balances in equities at the end of 2007, and nearly 2 in 5 had over 70%. 

Equities have greater potential upside to an investor. However, with this upside comes greater risk of loss. Equities make up the “offensive” side of a well-diversified portfolio. But, as an investor approaches retirement, “defensive" strategies, such as active management and bonds, should be added to help mitigate the possibility of catastrophic losses.  

The fiduciary rule was implemented to help protect investors. The near-retirement investors who had over 70% of their holdings in stocks in 2007 may have not seen their retirement income take such a hit if their advisors had been held to a fiduciary standard when making portfolio recommendations.  

 

…And Where It’s All Going 

Recent news reports from the White House have been confusing. Contrary to some reports, Trump has not delayed the fiduciary rule. The rule was, in fact, passed last year, and the upcoming April deadline is when certain parts will begin to be enforced. 

However, on February 3, Trump issued a Presidential Memorandum to the Secretary of Labor, mandating an “economic and legal analysis” of the impact of the rule on investors and retirees. This memorandum stipulates that if the rule is found to “harm investors or retirees,” the Secretary shall publish “a proposed rule rescinding or revising the rule.”  It’s still not clear exactly what the law allows on this front; hence, it’s still not clear where Trump’s actions will lead. 

 

What Does This Mean For Me? 

We established Alexis Advisors as a fee-only Registered Investment Advisor and are strong proponents of the fiduciary standard. We do not hold the view that the rule will “harm individual investors,” as some industry experts suppose. Rather, we believe that the rule will help investors more clearly understand services rendered for fees paid and be able to make an informed decision about whether these seem fair and equitable. What can possibly be wrong with this? 

If you’re not sure if you work with a fee-only RIA (note, this is not the same as “fee-based"), ask your financial advisor. If they aren’t, ask how they feel about the fiduciary rule. Also make sure you fully understand the compensation structure between you and your advisor. This should be an easy question for your advisor to answer. 

Be informed.  

Roberta Keller

Alexis Advisors is a fee-only firm offering financial planning and investment advisory services. We work with families, women and businesses to integrate their personal and social values with their financial goals. We are one of the few independently owned and operated financial advisory firms, with no dealer group or corporate associations that require us to revenue share or meet sales goals. This means that we have the flexibility to operate with complete transparency, fewer conflicts of interest, and in your best interest.