Fiduciary Standard

Fiduciary Rule

A fiduciary is a person or organization that is bound both legally and ethically to act in your best interest.  The Investment Advisors Act of 1940 required Registered Investment Advisors like Phoenician Financial Planning, LLC, to act as a fiduciary for clients.  Additionally, certain professional organizations and certifications require members to uphold a higher fiduciary standard.  The Certified Financial Planner™ Board of Standards requires CFP® designees uphold this higher standard.

On June 9th, 2017, the Department of Labor implemented the Obama Administration’s “Fiduciary Rule”.  This rule expanded the definition of an investment advice fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA).  Advisors must now follow “impartial conduct standards” and act as a fiduciary for retirement investors.

The new standard could be short lived, however.  Most large banks and investment firms have lobbied against the rule.  The Department of Labor has responded by weakening the rule and it does not intend to begin enforcement until January 1st, 2018.  Originally, the rule was set to be in effect on April 10th, 2017, but the Trump administration postponed the requirements.  The Department of Labor does not plan to enforce or implement the final phase of regulations until a final review of the rule is completed January 1st, 2018.

Suitability Standard

While Registered Investment Advisors, Certified Financial Planners, and members of some financial planning associations require members to act as a fiduciary, financial salespeople at brokers and insurance firms were only required to work under what is known as the suitability standard.  This standard requires that the salesperson base investment recommendations on a reasonable, customer specific basis after general information has been collected from that client.

As an example, Merrill Lynch required salespeople to document a client’s liquidity, assets, liabilities, time horizon, risk tolerance and investment objective prior to selling investment products.  The salesperson could recommend any investment that broadly fit with the client’s situation.  Unlike the fiduciary standard, however, the product could be one that benefited the salesperson over the client.

If two products are equal in every way except for price, the fiduciary standard requires an advisor use the product that costs less.  Under the suitability standard, salespeople often sell clients the product offering the highest commissions.  This is obviously more profitable for the salespeople and their firms, which is why the industry has pushed back against the implementation of the fiduciary rule.

Impact of the Fiduciary Rule

The Fiduciary rule will not longer allow salespeople to follow the suitability standard when investing a client. It has been estimated that implementing the fiduciary rule will cut retirement saver’s investment expenses by billions. The White House Council of Economic Advisers under President Obama found that biased advice cost investors $17 billion in 2015. The fiduciary rule change will make it difficult for financial advisors to justify high cost or commission based products such as mutual funds or annuities. 

On the other hand, financial intermediaries will see higher compliance costs along with lower profits.  The rule change could cost investment firms upwards of $5 billion to implement and over $1 billion annually.  The concern here is that these costs could price all but the highest net worth investors out of the market.  Those with less than $750,000 saved for retirement may find investment and financial planning advice inaccessible.

Investments are Covered by the Fiduciary Rule

Retirement Plans the Fiduciary Rule will cover

  • Define-Contribution plans – 401(k) plans, 403(b)7 plans, employee stock ownership plans, Simplified Employee Pensions (SEP IRAs) and savings incentive match plans (simple IRAs)
  • Defined-Benefit plans – Pension plans
  • Individual Retirement Accounts (IRAs)

What the rule does not cover

  • Governmental 457 plans and 403(b)7 plans not subject to ERISA (church and government plans including the Arizona State Retirement System)
  • Client inquiries about specific products or investments that do not constitute financial advice
  • Financial advisors providing general education and advice based on a person’s age and income
  • Taxable brokerage accounts funded with after-tax money