Proposed rules regarding retirement savings are creating jitters in the financial services industry – and they will affect retirement planning for years, financial advisers and consultants say.
“Any practice handling individual retirement accounts will be affected significantly by this,” said Evan Fabricant, incoming president of the Richmond chapter of the Society of Financial Service Professionals.
The proposed rules by the Department of Labor are scheduled to take effect April 10, 2017, with some provisions implemented by January 2018.
The rules, in a 1,023-page document, are aimed at stopping unethical practices and billions of dollars a year that the government claims investors lose in exorbitant fees.
The rules apply a fiduciary standard to all advisers who provide financial advice, products and services for retirement plans. That means advisers must act in the best interests of their clients.
“When we look back 10 years from now, I am hopeful we will say this was good for the consumer and for the industry,” said Fabricant, a chartered life underwriter and chartered financial consultant with Legacy Partners LLC, a financial services firm in Henrico County.
Advocates say the rules are overdue and will weed out charlatans. Critics worry it will reduce investment options, cut access to financial advisers for small investors, and become the next class action litigation craze.
“I don’t think you can go wrong in acting in the best interest of clients,” said Michael Joyce, president of JoycePayne Partners, a financial planning firm in Richmond. “The pushback is a little mystifying.”
Joyce sees the change as the right thing to do for plan participants, financial consumers and the financial industry. “This is the most significant modification of the rules that have governed the retirement investment industry for 40 years,” he said.
Others see the new rules as heavy-handed regulations mandated by the government. Some question whether the Labor Department has authority over individual retirement accounts, while many worry about unintended consequences.
“It has its good and bad points,” said Andrew K. Sledd, a certified public accountant and senior manager at Keiter, an accounting firm in Henrico. “It depends on the class of investor.”
What works for one investor may not work for another, he said. “The Department of Labor is saying it wants everyone on a level playing field,” Sledd said.
The government, for example, is steering the industry toward fee-based compensation instead of commissions. It requires that compensation at all times be “reasonable.” Industry experts interpret “reasonable” to mean an annual fee of 1 to 1.5 percent of any given retirement portfolio.
That means commission products such as a variable annuity with high up-front fees could be overhauled or discontinued. A variable annuity is a tax-deferred product that pays the participant a level of income in retirement based on the performance of the investments. A fixed annuity pays a guaranteed payout.
For a young person who plans to hold an investment for 30 to 40 years, it could be cheaper to pay an up-front commission of 6 to 8 percent than a 1 percent annual fee, Sledd said.
Registered investment advisers already are bound by the fiduciary agreement. That’s about where it stopped in the past.
Most broker-dealers, product providers and insurance agents have been required to sell “suitable” products by matching a product with a client’s needs. Now, they will be covered by the rule to meet fiduciary standards – to act in the best interest of the client.
The rules cast a wider net in the type of investments. Not just limited to traditional Employment Retirement Income Security Act (ERISA) plans – such as pensions and 401(k)s, as in the past – the new regulations will cover traditional and Roth IRAs, IRA rollovers, and health savings accounts.
Legal and congressional challenges to the rules may continue, said Steve Parrish, an independent consultant for financial service organizations and an adjunct professor at Drake University and The American College.
However, the proposed rules – even if modifications are made – will take effect, he predicted.
“I don’t think you get the genie back in the bottle,” Parrish said at a recent meeting of the Richmond chapter of the Society of Financial Service Professionals.
Such companies as State Farm Insurance, Edward Jones and Ameriprise Financial are changing policies and procedures to comply with the new regulations.
Ameriprise spent $11 million in compliance in the second quarter related to the Labor Department rules. State Farm is eliminating sales of variable annuities. Agents for Edward Jones will be able to sell annuities and certain stocks and bonds but not mutual funds.
Since 2010, the Labor Department has sought to apply a uniform fiduciary standard and stiffen the definition between suitability and fiduciary, Parrish said.
“The ruling will shake out losers that shouldn’t be in the business,” he said. “It will kick out the product-pushers. It may encourage some people to move toward other markets, such as business insurance and business planning. I think we can live with this.
“Now the bad stuff,” he said to a group of about 50 Richmond-area financial advisers. “Everyone must now act in the best interest of their clients, and that has real legal meaning. … It’s not enough to provide a suitable product.”
Central to the new regulatory system is a “best interest contract exemption” or BICE, that requires a contract between the retirement investor and the adviser.
The contract spells out the financial institution’s fiduciary duty to the investor. It includes a disclosure of compensation and fees and a warranty that the adviser will not make misleading statements about a transaction, and it outlines steps the institution will take to mitigate potential conflicts of interest, according to the National Association of Insurance and Financial Advisors.
“A contract is a big deal,” Parrish said. “It applies to variable annuities, mutual funds, indexed annuities. Those of you only selling fixed annuities, you didn’t escape this. It applies to you as well – just a different set of rules.”
One of the biggest questions involves enforcement, he said. “The Labor Department doesn’t have the budget to enforce it. The Internal Revenue Service can impose a 15 percent penalty for rule infractions, but it doesn’t have enforcement powers.”
That leaves enforcement up to plaintiffs’ attorneys, Parrish said. “A daughter-in-law doesn’t think her father-in-law received fair treatment from his financial adviser and sues over the whole thing. That is scary.”
Class action lawsuits filed recently against Duke, Johns Hopkins and Yale universities, for example, claim the schools failed in their fiduciary duties to protect employee retirement plans from excessive fees charged by plan management.
Although these suits – and there have been many – arose out of the old fiduciary standards, they show the danger of giving enforcement powers to the courts instead of to the regulatory agencies, Parrish said. “Like asbestos or tobacco, this is the new fun thing to go after.”
Financial advisers, facing the possibility of more litigation, could be leery of taking on small- or middle-income investors, he said.
The concern is the factory worker who retires with $25,000 in a qualified plan will be “robo-advised” – given a choice of computerized investment options – and not personal advice, Parrish said. Or worse, the retiree cashes in his plan, he said.
The middle class often is defined as households with yearly incomes up to $100,000 or assets outside of the home up to $250,000. For many advisers, the legal risk could be too great and the value of the portfolio not worth the 1 percent fee, Parrish said.
The Labor Department is trying to provide a mechanism to make sure people are provided with appropriate investment advice and products, said Evelyn S. Traub, an attorney with Troutman Sanders in Richmond who specializes in ERISA law.
“There are a few bad actors out there who take advantage of individuals who don’t have the savvy or wherewithal to understand what they are getting into,” Traub said.
Some people are charged excessive fees and are unaware of the impact on their retirement savings.
“Those bad actors (like the good ones) are already regulated by the Securities and Exchange Commission and licensing boards,” she said, adding that the unethical ones frequently are prosecuted. “This rule is really a reaction to the few.”
One benefit will be more transparency, Traub said. Disclosures under the old rules are opaque. It can be difficult to determine how much an adviser is paid from a mutual fund, for example, or whether an investor is advised to put money into one fund because the adviser gets paid more.
While the new rules are intended to protect small investors, “I don’t know if it will add to consumer protections or complicate them,” Traub said. “The devil is in the details.”
Whatever the outcome, the industry will take on more regulatory costs as a result of the new rules, and more consolidation is expected as small broker-dealers sell to large companies to deal with expanded regulations.