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The way we plan for retirement in the United States has changed drastically in recent years. In the past, employees could rely on pensions, which were typically managed by a financial expert, to support them through retirement. Today, for most of us, pensions are things of the past, and we are responsible for making the financial choices that shape our retirement. While this system provides retirement savers the flexibility to make financial choices that are uniquely tailored for their situations, this method of saving is fraught with pitfalls since most of us lack the skills needed to invest 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 allow us to reach our retirement goals.
While most of us have good relationships with our financial advisors, statistics suggest that there is a segment of financial advisors who abuse the trust of their clients by putting their own financial gain above their clients. The Department of Labor (“DOL”) and the White House Council of Economic Advisors (“CEA”) estimate that on average conflicts of interest between unscrupulous financial advisors and their clients cause retirement savers to earn one (1) percentage point less annually than would be expected based on the status of the economy and returns. Furthermore, the DOL estimates that such advisors cause their clients to waste upwards of $17 billion of retirement savings yearly on exorbitant fees and lost revenue associated with the purchase of ill-advised financial products resulting from a conflict of interest. Conflicts can occur because financial advisors are not currently held to a fiduciary standard under the law, and have no duty to provide advice that aligns with the client’s financial goals. In fact, it is 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 products, gives the advisor financial incentive to sell specific products. Because advisors are not fiduciaries, they may advise clients to purchase certain financial products for which they may receive a commission or financial benefit, without repercussion, regardless of whether purchasing the product is 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 clients. While many advisors already adhere to a fiduciary standard, advisors and retirement savers alike should be aware that under the Final Rule advisors will have between April 10, 2017, and January 1, 2018, the “transition period,” to conform their practices to the Final Rule. During the transition, firms and advisors are required to comply with the DOL’s “impartial conduct standards,” which are intended to ensure that advisors comply with fiduciary norms and standards of fair dealing in the interim before the Final Rule takes full effect in 2018. Specifically, these standards require that an advisor must provide prudent guidance based solely 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.
The main points of the Final Rule, effective on January 1, 2018, include:
A. Advisors receiving compensation for making investment recommendations will be considered a fiduciary, and will be required to give impartial advice that is in the best interest of the client.
B. A fiduciary 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.
C. 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:
Provide advice that is in the client’s best interest.
Charge only reasonable compensation for services.
Avoid misleading statements about fees and conflicts of interest.
Adopt policies and procedures ensuring that advisors provide advice that is in the client’s best interest.
Disclose compensation arrangements.
Provide clients with complete fee information.
D. Limits the existing “Insurance Exemption” to recommendations of “fixed rate annuity contracts.”
E. Provides clients with a cause of action should there be a potential breach in fiduciary duty.
While there is 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. The process will take time and could open the door for litigation of the issue, between now and April 2017, financial advisors and their clients should take steps to familiarize themselves with the Final Rule’s guidelines to ensure their compliance under the Rule come 2018. As questions and concerns arise during this timeframe, and clarification on how planners are required to interact with their clients is needed, parties are encouraged to seek competent legal counsel about the changes that 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.
