April 04–New rules expected as early as this week by the U.S. Department of Labor could upend the way many financial advising firms do business — requiring changes that one Pittsburgh investment professional says could hit the industry with as much force as the Affordable Care Act did the health-care industry.
The new “fiduciary rule” is seen as one of the biggest shifts for the retirement system since 1974 when Congress voted the 401(k) plan into existence. Financial services firms are watching the developments closely.
“The problem is much of the industry is not ready for this,” said Robert Fragasso, chairman and CEO of Fragasso Financial Advisors, Downtown, who supports the change.
The goal of the new rule is to make money managers contractually obligated to put their clients first, rather than simply be encouraged to do so.
The stakes are high when it comes to retirement assets. Individual Retirement Accounts hold an estimated $7.4 trillion in assets and defined contribution plans hold about $6.8 trillion, according to the Investment Company Institute. Research firm Cerulli Associates reported new money from IRA rollovers contributed $377 billion to IRA assets in 2014, and projects the rollover figure to hit $516.9 billion by 2020.
The fact that individuals control that money, rather than the pension systems of decades past, makes it an area ripe for those offering financial advice.
The DOL wants to level the playing field for retirement investors who may get taken advantage of by advisers who are charging them commissions and fees that are not clearly disclosed. The rule will require advisers to only act in the best interest of the client and will impose penalties on those who side step the rule.
“Why wouldn’t an adviser have a client’s best interest at heart? Why do we even need a rule to enforce it?” asked Ed Gjertsen, national chairman of the Financial Planning Association in Denver. His organization along with the Certified Financial Planner Board in Washington, D.C., and the National Association of Personal Financial Advisors in Chicago formed a coalition to support the DOL rule.
“The industry has been doing business as usual for quite some time now,” he said. “Different firms will endure different pain points to adhere to the rule. Many firms will have to revamp their business practices to retrain all advisers to do what is in the best interest of clients.”
It comes down to the difference between two standards: a suitability standard and a fiduciary standard.
The suitability standard most often applies to stock brokers working on commission. They need not consider costs to the client as long as the investment they recommend is suitable. The definition for what is suitable is a broad one. For wealthy clients, almost every investment sold to them is suitable, yet the investment can be expensive, poorly performing, tax inefficient or have no business being in the person’s portfolio.
Advisers who charge flat fees typically operate under the fiduciary standard. A fiduciary is a full partner with no conflicts of interest who is on the client’s side of the table at all times.
Commission revenues impacted
For an industry that does not naturally embrace regulation, the impending fiduciary rule has divided players.
Many of the major Wall Street brokerage firms such as Merrill Lynch and Morgan Stanley rely heavily on commission sales of financial products. A fiduciary rule could not only impact a significant revenue stream, but also force them to retrain brokers and overhaul segments of their business.
Managers for Morgan Stanley’s Pittsburgh operation did not return telephone calls seeking comment. A manager for Merrill Lynch in Pittsburgh said the company was declining to comment on the fiduciary rule.
Hefron-Tillotson, the largest independent financial services firm in the Pittsburgh region with nearly $10 billion in assets under management, also would be affected by the new regulations since a sizable portion of its revenue is reliant on commission sales. Kimberly Tillotson Fleming, chairman and CEO, declined comment on the fiduciary rule until after it is released.
Mike Kauffett, president of Mt. Lebanon-based Bill Few & Associates, which earns revenue from commission sales, also declined comment.
Mr. Fragasso, chairman and CEO of Fragasso Financial Advisors, Downtown, said advisers at his firm do not work on commission and the firm serves clients by the fiduciary standard.
Three years ago, Mr. Fragasso visited Washington, D.C., as a former board member of the Financial Services Institute to lobby members of Congress to support the fiduciary rule. He said he understands why there is so much opposition to the proposed changes, but he believes retirement investors have much to gain.
“How do you turn around segments of the investment industry that live on high-commission products? This will hit the investment industry with the same force that Obamacare hit the health insurance industry,” Mr. Fragasso said.
He said one thing the new regulation is meant to cure is the practice of financial advisers encouraging retirement plan participants to roll money out of their plans and into high front-end commission products.
In the future, when individuals roll money out of a qualified retirement plan, the costs of the new investment must be structured similarly to what the person was paying while they were in the plan.
Mr. Fragasso said opponents of the fiduciary rule have argued that it will increase the cost to consumers for getting investment advice, but he disagrees.
“Those who claim that say investors will have to pay a fee for guidance when they did not have to pay before. But that’s only half the story,” he said. “The investor was seemingly getting free guidance. But they were paying commissions and/or higher internal product costs.
“Now all costs will be fully disclosed,” he said. “The commissions will go away and the internal costs will go down because of disclosure and competition. So, the investor may have to pay a modest fee for guidance, which will be fully disclosed. But that will be lower than the previously non-disclosed commissions and fees.”
Money on the line
Industry sources estimate there is more than $14 trillion being held in Individual Retirement Accounts and defined contribution plans, which are being managed by advisers who expect to earn a portion of that money as compensation.
With so much money on the line, there is still a large pot for financial advisers to survive on if the regulations go through — although their paychecks could shrink, especially if more retirees opt to leave their retirement money in company 401(k)s rather than roll it over to IRAs and annuity investments.
While retirement account owners will likely pay less fees, one of the unintended consequences could be that people with low account balances may be turned away by financial advisers who do not see enough profit potential in servicing the account. Many fee-only advisers require clients to have minimum liquid assets of about $500,000 and most would prefer $1 million or more.
Chicago-based securities lawyer Andrew Stoltmann said he believes the DOL’s fiduciary rule will stand up to the various court challenges that he anticipates will come from the securities industry.
“The average consumer already assumes there’s a fiduciary duty on the part of advisers,” he said. “So this rule will harmonize reality with what consumers already think.”
Another Pittsburgh area financial services firm that operates on a fiduciary standard is Green Tree-based Fort Pitt Capital Group. Todd Douds, director of research and operations, said the firm believes the regulation is a step in the right direction.
“In our opinion, all advisers should be acting in a fiduciary capacity for their clients. This regulation should clarify who is acting in a fiduciary capacity.”
Tim Grant: firstname.lastname@example.org or 412-263-1591.
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