by Amy Martinez
Updated 6 yearss ago
Under rules that have been in place since the 1970s, stockbrokers can receive commissions for stocks, mutual funds and other investment products they sell, as long as the investments are considered "suitable" for the client's age, risk tolerance and other factors.
Meanwhile, professionals known as registered investment advisers, who typically charge a fee for their services and do not take a commission on product sales, follow different guidelines. They must adhere to a more rigorous "fiduciary" standard that requires them to act in the client's "best" financial interests.
In April, the U.S. Department of Labor roiled the financial world when it proposed regulations that would require anyone giving retirement investment advice to follow the fiduciary standard.
In announcing the proposed rule, the Labor Department says brokers have long been allowed to steer investors toward products with "backdoor payments and hidden fees." It estimates that Americans lose $17 billion a year to what it calls conflicted advice — brokers guiding clients toward investments that serve their own interests rather than those of their clients.
The proposal is aimed, in particular, at protecting savers from bad advice when rolling over a 401(k) upon retirement or during a job change. Americans annually roll over more than $300 billion to IRAs, often incurring significantly higher fees, according to a report by the president's Council of Economic Advisers. It says a retiree who receives conflicted advice in a rollover will lose, on average, 12% of the savings value if drawn down over 30 years.
"It's a very simple principle. You want to give financial advice, you've got to put your client interest first. You can't have a conflict of interest," President Obama said at an event hosted earlier this year by AARP, one of the proposal's main supporters.
Trade groups representing stock and insurance brokers are fighting the proposal. They say it would expose them to unfair lawsuits, require billions in compliance costs and create unintended consequences.
Kenneth Bentsen, president and CEO of the Securities Industry and Financial Markets Association, says the rule will force brokers to switch from working on commission to a percentage-of-assets fee model, raising the likelihood that they'll drop clients with modest investable assets or charge more for their services. It could "ultimately raise the cost of saving and hurt all Americans trying to save for retirement," he says.
Barbara Roper, director of investor protection at the Consumer Federation of America, challenges industry claims that it costs more to work with a fudiciary adviser. She also suggests that opponents are bluffing when they say middle-income investors will be abandoned. "There's no reason to believe that the industry will walk away from a multitrillion-dollar market," she says.
The fact that the proposal is coming out of the Labor Department reflects the political backdrop.
The Dodd-Frank Act of 2010 authorizes the Securities and Exchange Commission — seen by many as friendlier to the brokerage industry — to impose a new fiduciary rule, but it hasn't.
The Labor Department — considered more ideologically aligned with the Obama administration — asserts that it has jurisdiction over retirement accounts issued through work under the 1974 Employee Retirement Income Security Act (ERISA).
The Labor Department first floated the idea of extending the fiduciary standard to brokers in 2010, then backed off and spent five years revising its proposal. Labor Secretary Thomas Perez says the new proposal is "intended to provide guardrails but not straitjackets."
At the heart of much of the debate is the Labor Department's proposed "best interest contract" exemption. The exemption would allow brokers to still be paid on commission, but with tradeoffs: Brokers would have to act in their clients' best interest, be upfront about possible conflicts and disclose compensation arrangements. While brokerages could require that disputes go to arbitration, the exemption could also expose them to class-action lawsuits by clients.
Scott Stolz, a senior vice president at Raymond James Private Client Group in St. Petersburg, predicts that if the rule is enacted, many brokers will simply steer clear of the exemption. He says they'll forgo commissions and work for a flat hourly rate or a fixed fee, a payment model usually associated with affluent customers.
"The end result will be one-size pricing for all clients on all products," Stolz says. "Smaller clients will be left with the choice of paying too much or not getting any advice at all." He adds that some will turn to a growing number of automated online services.
And while that may be fine if all they need is basic asset-allocation strategies, it won't work for everyone, he says. "If they need advice with college savings, retirement planning, insurance needs, when to collect Social Security — or just plain hand holding when the next bear market arrives — they will be left to fend for themselves."
Ray Ferrara, chairman and CEO of ProVise Management Group in Clearwater, counters that the "consumer benefits far outweigh the costs" of a fiduciary standard, noting that ProVise has "successfully served middle-class clients" under it for years. He says the idea that the brokerage industry will forgo the huge market for middle-income retirement advice "is simply not credible."
For anyone claiming to not be able to serve smaller investors under the fiduciary standard, he says, his firm and others across the country "would be happy to fill the gap."
It remains to be seen if the administration can complete the rulemaking process before next year's presidential election. Republicans in Congress, who consider the proposed rule "regulatory overreach," are trying to block it, using legislation that would cut the Labor Department's budget in such a way as to prevent it from finalizing and implementing the proposal.
In August, Labor Department officials listened to more than 70 experts on both sides of the debate during a four-day public hearing. Assistant Labor Secretary Phyllis Borzi pointed to the changing retirement landscape as a reason for the new fiduciary standard.
Forty years ago, traditional pensions were the most common type of employer-sponsored retirement plan. Today, pensions account for roughly a third of all retirement assets, eclipsed by 401(k) plans and IRAs.
In lieu of a guaranteed pension, Borzi says, most workers "now have substantial responsibility to manage their own money." As a result, she added, they need professional advisers more than ever to reach a secure retirement.
"Simply put, we want to create an enforceable best-interest standard that requires advisers to put their customers' best interest first," she says. "That's our North Star."
Financial Planners: 'Fiduciary'
"Consumer benefits far outweigh the costs" of a fudiciary standard.
— Ray Ferrara, chairman/CEO, ProVise Management Group
Ray Ferrara, chairman and CEO of ProVise Management Group, a fee-based financial planning and investment management firm in Clearwater, testified in favor of the proposed rule. He recaps his testimony for FLORIDA TREND:
" The Department of Labor's reproposed rule would hold a financial adviser to a fiduciary standard of care when giving individualized advice to a retirement plan participant or IRA owner. In short, the rule would require the adviser to put the "best interests" of the participant ahead of his or her own. Don't all advisers do that now? While many consumers think so, the short answer is no.
Some financial professionals are registered as investment advisers with either the Securities and Exchange Commission or the state in which they practice and are required by law to operate as fiduciaries by placing their clients' interests ahead of their own. Typically, they are paid a fee for managing a client's assets or for preparing a financial plan — or both.
Other financial professionals simply hold insurance licenses or are registered representatives with the Financial Industry Regulatory Authority to sell securities products on a commission basis. While many of those paid solely by commission strive to operate in a 'best interests' manner, they are only required to recommend products that are 'suitable.' The distinction is an important one.
The lower suitability standard is not always in the client's best interest. A consumer may be suitable for two mutual funds of similar comparison. However, Fund A pays the salesperson more and has higher expenses than Fund B. The salesperson recommends Fund A, which is suitable, but it is not in the client's best interest.
The majority of the financial services industry opposes the reproposed rule, saying that it's overly complex and costly and will cause them to abandon middle-income consumers. They also recognize that by opposing the new rule, they risk looking like they don't care about their clients, and so they profess to support a 'best interests' standard. But they stop short of a willingness to work with the DOL to create one that has meaning.
While the proposal is not without its faults, and the department says it is open to changes, its underlying intent to provide unbiased advice shouldn't be challenged. Our firm has successfully served middle-income clients on both a fee and commission basis for decades. We have borne the small additional costs of serving as a fiduciary to our clients and have not experienced undue compliance issues.
If we can do it, why can't everyone? We have grown to manage $1.2 billion of assets and serve almost 1,000 clients in over 30 states. Working under a 'best interests' standard hasn't slowed us down one bit. In fact, it's good for business because it observes the Golden Rule: Just do the right thing. Consumers seem to appreciate the transparency that such an approach brings."
Scott Stolz, a senior vice president overseeing investment products at Raymond James Private Client Group in St. Petersburg, testified before Labor Department officials in August to oppose new regulations for financial advisers.
Following is an excerpt of his testimony: "Most of those in favor of this proposal want to frame the debate solely on whether or not a financial adviser should put their client's best interest before their own. After all, who could possibly argue with that?
As an example, a recent DOL e-mail to federal employees asking them to support the proposal stated the following: 'When you go to a doctor, you expect that they will treat you in your best interest. When you hire an attorney, you pay for them to represent your best interest. Shouldn't the same be true for financial advisers who manage our hard-earned savings?'
Similarly, the AARP petition that garnered 31,000 signatures reduced the issue down to a mere 189 words. We would argue, however, that this debate is not about whether advisers should be required to put their clients' best interests first. We wholeheartedly agree with that — as will, I'm sure, almost every witness the DOL will hear from this week.
Rather, the debate is really about the road we take to get there. Once one fully understands the 600-page proposal that the department has put forth to achieve this mutually agreed upon goal, the only possible conclusion is that the rule as written is overly complex, would be incredibly expensive to implement and would expose hundreds of thousands of trusted and well-meaning financial advisers to unfair legal liability.
By opposing this proposal as written, we fully understand that some will argue that we are not interested in putting our clients' interests first. This conclusion, however, could not be further from the truth. Two decades before the DOL first proposed a revised fiduciary standard, we (Raymond James) developed a Client's Bill of Rights that is given to every client when they become a customer of the firm. Among these 10 rights are the following:
• You have the right to expect financial and investment recommendations based solely upon your unique needs and goals, consistent with the objective of enhancing your financial well-being.
• You have the right to reasonable investment alternatives selected based on your individual objectives and presented with full disclosure of risks and benefits.
• You have the right to know all costs and commissions associated with an investment, as well as fees our firm charges for services.
I think anyone would agree that our advisers and our associates could not live up to this standard if we did not put our clients' interests first each and every day. We provided the department with this document at our recent meeting and suggested that such a document could be used by others as a guide to the fiduciary 'North Star' that the department seeks."