U.S. Department of Labor’s Fiduciary Rule: What Finance Professionals Need To Know

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In April 2016, the U.S. Department of Labor (DOL) announced the release of the final rule regarding how the law treats financial advisors and retirement investment. Based on an executive order issued in 2015 by President Barack Obama, the DOL worked to create executive legislation that would reclassify certain financial professionals and require them to operate under a different standard than they may already have been observing.

In brief, the DOL rule sought to crack down on possible conflicts of interest between financial advisors, the people they represent, and the investments they make. Under the DOL rule, anyone working as a financial advisor must adhere to a fiduciary standard in all actions related to retirement investment. That meant finance professionals would be required to justify any investment made or fees charged as one that is primarily within the client’s best interest.

The rule and its implications were complicated and controversial. However, the debate surrounding it was likely rendered moot Feb. 3, when newly inaugurated President Donald Trump signed his own executive order calling for enforcement of the rule to be put on hold pending further review. According to analysis from The New York Times, this effectively kills the legislation, given Trump’s and his advisors’ stated opinions on the matter. Gary Cohn, Trump’s chosen director of the National Economic Council and a former Goldman Sachs executive, was staunchly against the rule, according to quotes made by him in The Wall Street Journal.

While the rule itself may rest in limbo, its implications and reverberations remain palpable. In the run-up to finalizing the rule, many investment firms and brokerage services announced they would make sweeping changes to their operations in response. And many consumers who depend on these companies to responsibly manage their retirement funds became aware of issues they might not have previously known about.

Today, financial professionals need to make their own decisions about how the rule and its fallout will affect their business models and client conduct, even if that rule may no longer be in force. An Online Master of Science in Finance degree from Northeastern University’s D’Amore-McKim School of Business can give students the perspective needed to understand these changing regulations.

The consumer perspective

In the discussion about retirement investments and how to manage them, the stakes are undeniably massive. According to research from the Investment Company Institute, the combined value of every IRA in the U.S. stood at around $7.3 trillion in 2015. Other types of investments, like 401(k) funds, were valued at $6.7 trillion that year. All of this money is potentially impacted by the DOL’s fiduciary rule because, for the most part, it is managed in the same way.

IRAs and 401(k) funds allow workers to save for retirement by contributing regular amounts into these funds, which usually consist of a mixture of mutual funds and bonds. The investor has a degree of choice when allocating that money—for example, a 401(k) fund often offers a variety of index funds tied to the S&P 500’s performance, or only companies with a small market capitalization.

Once money is deposited into the fund of an investor’s choosing, however, the investor cedes a fair amount of control to the fund manager. That manager earns a fee based on the fund’s performance. Ideally, the fund manager will act in the individual investor’s best interest, since each party stands to gain from a growing pool of money.

But these fund managers are not technically beholden to a fiduciary standard, which explicitly states that “a financial adviser act solely in the client’s best interest when offering personalized financial advice.”

The Obama administration argued that as much as $1.7 trillion of all IRA assets are invested in products that could create a conflict of interest. The former administration’s Council of Economic Advisers also estimated that “a typical worker who receives conflicted advice when rolling over a 401(k) balance to an IRA at age 45 will lose an estimated 17 percent from her account by age 65. In other words, if a worker has $100,000 in retirement savings at age 45, without conflicted advice it would grow to an estimated $216,000 by age 65 adjusted for inflation, but if she receives conflicted advice it would grow to $179,000—a loss of $37,000, or 17 percent.”

How firms responded

When Obama issued his executive order in 2015, the response from the financial services industry ranged from acceptance to outrage. The New York Times noted that some firms, like Merrill Lynch, sought to use the proposal to their advantage, claiming they would gladly adopt the proposed changes, and “continue to implement a heightened standard of care for delivering personalized investment advice.”

Others were not enthusiastic about the measures, particularly representatives of the life insurance and annuities industries. Since these firms rely on a commission-based compensation model, it is argued that agents are selling these policies to customers who would not stand to benefit from them, or would even be worse off. Switching to a fee-for-service model, as some investment advisors and brokers considered before the rule went into action, would be similarly untenable for life insurance products that often require minimal management beyond the point of sale.

Where we stand now

A number of clarifications and exemptions were added to the DOL’s fiduciary standard rule before and after its rollout. However, now that its enforcement has been halted and it awaits several lengthy court battles, it’s unlikely that much will change for the time being.

Financial professionals should use this as an opportunity, however, since the rule has likely made many casual investors much more wary of how their retirement money is managed. Take note of the Securities and Exchange Commission’s official definition of a fiduciary standard, which still stands. Certified Financial Planners are among the classes of professionals who must adhere to the standard. Most lawyers and Certified Public Accountants also qualify as fiduciaries and must be able to prove that any actions taken on behalf of their client were done only in the client’s best interests.

The DOL’s fiduciary rule may be essentially toothless, but it did generate a great deal of discussion about an often ignored and misunderstood topic. Financial professionals of all kinds would do well to understand the rule and consider how they may use it to better serve their clients.

Recommended Readings:
Graduate Programs at the D’Amore-McKim School of Business
What the future of finance may look like


Northeastern University’s Online MSF Program