Department of Labor Implements New Fiduciary Rule

By Kevin Shea

On April 6, 2016, the Department of Labor rolled out the new “fiduciary rule” which will heighten brokers’ standard of care when making investment recommendations in their clients’ retirement accounts.

It’s no secret that Americans are depending more and more on their IRAs and 401(k)s to support themselves in retirement. It’s also no secret that retirement savers and particularly retirees are disproportionately the victims of financial exploitation—vulnerable not only to unscrupulous fraudsters and scammers, but also, unfortunately, to the very people charged with protecting their investments: their brokers.

Until now, a broker’s duty to his or her clients when recommending an investment in their retirement accounts was mere “suitability”, a determination based on a number of factors including but not limited to age, risk tolerance, and investment objectives. While the suitability standard for retirement accounts provided some level of protection to investors, brokers were under no duty to recommend investments that were in the best interest of their client. Conflicts would arise when brokers recommended suitable investments with higher commissions for themselves and their firm over investments that were cheaper and more appropriate for their clients. The White House Council of Economic Advisors estimates that consumers lose $17 billion each year to conflicted investments.

Labor Secretary Thomas Perez says that the implementation of the new rule puts in place “a fundamental protection into the American retirement landscape” and that it is a “huge win for the middle class”. However, the rule is not without its critics. There has been some opposition from both the financial industry and economic think tanks who have gone so far as to characterize the rule as “Obamacare for your IRA”, and an example of “government paternalism, [where] people can’t make their own choices and if you like your broker you may not be able to keep them”. There are also concerns about the Department of Labor creating regulation in an area traditionally relegated to the Securities and Exchange Commission.

While the rule is ultimately designed to protect investors, some groups have speculated that implementation could result in up to $80 billion in lost savings from pushing new regulations on small investment portfolios. The argument is that brokers would have to charge higher fees because the rule creates a presumption against brokers taking third-party commissions from mutual funds, and since many portfolios are too small to justify the cost of a management fee, the brokers will stop servicing them altogether.

Other critics speculate that the rule might even have deleterious effects for financial talk show hosts like Dave Ramsey, Jim Cramer, and Suze Orman. The new rule defines a fiduciary as any individual receiving compensation for making investment recommendations that are individualized or specifically directed to a particular plan sponsor running a retirement plan, plan participant, or IRA owner for consideration in making a retirement investment decision. While the rule provides an exemption for investment advice given to the general public, it is not clear if a TV or radio host, who is compensated by their station, and who gives specific advice to a caller or audience member about an investment is covered by the exemption, and therefore may be held to a fiduciary standard.

Whether they like it or not, firms have until January 1, 2018, to come into full compliance with the new regulation, and the long-term effects will play out thereafter. The hope is that the protections this rule creates will benefit retirement savers by reducing investment costs and requiring that brokers put their client’s interests before their own. Senator Cory Booker, who consulted on the rule, drew the comparison to seatbelt legislation of the past: “It’s like the auto industry fighting seat belts and then, all of a sudden, the auto industry is advertising their safety.”