The Fiduciary Rule

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On April 6, 2016, the Department of Labor introduced a long-awaited ruling which requires advisors to put the interests of their clients above their own, adhering to a fiduciary standard of advice.

The Best Interest Contract Exemption (BICE) allows advisors to receive commission and other sales fees while still complying with the fiduciary standard. All of which means commission stays, but how easy this will be for advisors to implement is uncertain.

The rigidness of the BICE guidelines has eased significantly since conception. Originally, the exemption limited the scope of permissible assets to recommend (non-traded REITs were not permitted for example) and required extensive disclosure on fees and costs. The implementation period of the rule has also changed, with the full compliance deadline extended one year until January 1, 2018.

These developments should ease some of the concerns over the regulatory costs of the rule but will not fully eliminate them. The financial industry has warned the cost of the rule will make advice more expensive and that the financial burden will fall upon consumers — as was the case when similar regulation was introduced in other countries.
Opponents of the rule argue smaller clients will be faced with unaffordable fees, thereby limiting the access that middle-class investors have to advice. Previous CoreData analysis revealed that about seven in ten advisors in the UK said the Retail Distribution Review (RDR) had made it more challenging to work with low balance clients. To combat this, a third said they would consider adding an execution-only service for low balance clients.

Indeed, similar regulation in the UK and South Africa has steered middle-class investors away from advice. Previous CoreData studies show about one in five advisors in the UK and one in four in South Africa reported a decrease in the number of clients they advise. Regulation has also impacted investment products. About four in ten advisors in the UK and South Africa said regulation had influenced the investment products they advise on.

Advisory firms in the US are expected to hire new staff to help implement the rule. This would mirror the example of advisors in the UK and South Africa who reported taking on new staff (and the associated costs) to help comply with regulation. About one in five in the UK and South Africa cited regulation as reason for hiring new people.

Under the new rules, the BICE heightens brokers’ liability risk. This impacts the cost-benefit analysis of the commission model. If advisors want to continue earning commission, they must sign a legally binding contract with clients detailing their fiduciary responsibilities, revealing any potential conflicts of interest and stating firm policies to mitigate conflicts of interest. While the contract aims to hold advisors accountable, the cost of implementation is high.

If advisors are to demonstrate the advice they give is in the best interest of clients, they will have to develop a solid understanding of client needs in order to justify their recommendations. Many think this will result in advisors spending more time meeting clients. This certainly holds true for the UK, where four in ten said they met with clients more following regulatory change.

Even though commission-based advice is still allowed under the new US rule, many firms with revenues heavily derived from commission will look at redressing the balance between upfront fees and commission. Although the DOL rule has evolved into a more diluted version of the original proposal, advisors should nevertheless reconsider their compensation policies for the long-term in light of increased regulation and scrutiny of the industry.

How President-elect Donald Trump will approach the fiduciary rule remains uncertain. Before the election, the rule was set to progress forward.