Jordan Walsh: Let’s talk retirement: Final Rule on fiduciaries

The way we plan for retirement in the United States has changed drastically in recent years. In the past, employees could rely on their pension, which was typically managed by a financial expert, to support them through retirement. Today, for most of us, pensions are things of the past, and we, as individuals, are responsible for making the financial choices that will shape when and how we may retire.

While this system provides retirement savers with the flexibility to make financial choices that are uniquely tailored for their situations, this method of saving is fraught with pitfalls for retirement savers because most of us lack the expertise, time, and confidence, to invest our savings in a manner that will allow us to efficiently meet our retirement goals. Accordingly, we look to financial advisors to assist us in making smart financial decisions that will allow us to reach our retirement saving goals.

While most of us have good relationships with our financial advisors, statistics suggest there’s a segment of financial advisors who abuse the trust of their clients by putting their own financial gain above that of their clients. The Department of Labor (DOL) and the White House Council of Economic Advisors (CEA) estimate on average conflicts of interest between unscrupulous financial advisors and their clients cause retirement savers to earn one full percentage point less annually than would be expected based on the status of the economy on their returns.

Furthermore, the DOL estimates such advisors cause their clients to waste upwards of $17 billion of retirement savings every year on exorbitant fees and lost revenue associated with the purchase of ill-advised financial products resulting from a conflict of interest. These conflicts of interest can occur because financial advisors aren’t currently held to a fiduciary standard under the law, and for this reason, they owe their clients no duty to provide advice that aligns with the client’s financial goals. In fact, it’s common for firms and purveyors of financial products to provide financial incentives to advisors whose clients invest in certain financial products.

Industry practice creates a situation where honest and unscrupulous financial advisors alike can find themselves in a direct conflict of interest with their clients because their firm or a purveyor of a financial product ties a financial incentive from which the advisor will benefit to the purchase of that product by the advisor’s client. This practice incentivizes advisors advising their clients to purchase specific products instead of incentivizing the advisor’s provision of successful investment advice to clients.

However, because advisors aren’t fiduciaries, they may advise clients to purchase certain financial products for which they may receive a commission or other financial benefit when the product is purchased, regardless of whether purchasing the product is in the client’s best interest. The result is for a subset of unscrupulous advisors, there’s no repercussion for providing clients with financial advice that may not be in the client’s best interest.

To crack down on this abuse, the DOL is implementing a Final Rule which will require retirement investment advisors to meet a “fiduciary” standard when advising their clients. While many advisors already adhere to a fiduciary standard when advising their clients, advisors and retirement savers alike should be aware under the Final Rule advisors will have between April 10, 2017 and Jan. 1, 2018, the “transition period,” to conform their practices to the standards and guidelines outlined within the Final Rule.

During the transition period, firms and advisors are required to comply with the DOL’s “impartial conduct standards,” which are intended to ensure advisors comply with fiduciary norms and standards of fair dealing in the interim before the Final Rule takes full force and effect on Jan. 1, 2018. Specifically, these standards require an advisor to give advice that’s in their client’s best interest, meaning the advice must be prudent and based on the interest of the client. Further, the advisor may not charge any more than reasonable compensation and is forbidden from making statements about investment transactions, compensation, or conflicts of interest which are misleading.

When the Final Rule takes effect on Jan. 1, 2018, the following is a simplified list of the main changes affecting financial advisors/client relationships:

Advisors receiving compensation for making investment recommendations will be considered a fiduciary, and will be required to give impartial advice that’s in the best interest of the client.

A fiduciary under the Final Rule may not accept any payment which would create a conflict of interest between the individual and the client, unless the individual qualifies for an exemption.

The Final Rule clarifies the Best Interest Contract (BIC) Exemption, which allows firms and their advisors to continue receiving commissions and revenue sharing payments associated with financial products so long as the firm and its advisors comply with the following:

Provide advice that’s in their client’s best interest.

Charge only reasonable compensation for their services.

Avoid misleading statements about fees and conflicts of interest.

Adopt policies and procedures ensuring advisors provide clients with advice that’s in the client’s best interest.

Disclose compensation arrangements to clients.

Make clients aware of their right to receive complete fee information.

Limits the existing “Insurance Exemption” to recommendations of “fixed rate annuity contracts.”

Provides clients with a cause of action which may be used to hold firms and advisors accountable if they breach their fiduciary duty to the client.

While there’s a question as to how the Trump administration will enforce the DOL’s Final Rule, the rule will remain in effect until the administration takes affirmative steps to change or otherwise defang the rule. As this process will take time and could open the door for litigation of the issue, between now and April, financial advisors and their clients should take steps to familiarize themselves with the Final Rule’s guidelines so they can ensure their compliance under the rule come Jan. 1, 2018.

As questions and concerns arise during this time frame, and clarification on how planners are required to interact with their clients is needed, parties are encouraged to seek competent legal counsel and guidance about the changes the Final Rule may have on their advisor/client relationships.

Jordan Walsh is an associate with Allison MacKenzie Law Firm with primary practice in the areas of Labor and Employment Law and Civil Litigation. Jordan was admitted to practice in Nevada and California in 2014. Jordan can be reached by calling 775-687-0202 or by email at JWalsh@AllisonMacKenzie.com.