What advisors need to know about the new fiduciary rule, Part 2
May 3, 2016 by Jeffrey Levine
Editor’s note: This is part two of a two-part series on the impact of the fiduciary rule on advisors. Part one focused on the Best Interest Contract Exemption. Part 2 focuses on who and what products are subject to the fiduciary rule.
Once the new fiduciary rule is in effect, many advisors who, previously, were not subject to fiduciary standards, will find themselves subject to these higher requirements. In order to determine to what extent you will be impacted by the rule, you can ask yourself the following three questions:
1. Are you making a “recommendation?” A recommendation includes advice relating to the advisability of acquiring, holding, disposing of, or exchanging investments, as well as advice related to rollovers (discussed in greater depth below).
2. Will you receive any fee or other compensation, whether directly or indirectly?
3. Is your advice being given to a “retirement investor?” According to the fiduciary rule, “Retirement Investors include plan participants and beneficiaries, IRA owners, and ‘retail’ fiduciaries of plans or IRAs (generally persons who hold or manage less than $50 million in assets, and are not banks, insurance carriers, registered investment advisers or broker dealers), including small plan sponsors.”
If the answer to ALL three of the above questions is yes, then unless you are specifically exempt from fiduciary status, you will be subject to the new rules.
Rollovers ARE advice — a key change for advisors
Perhaps the most significant change for advisors under the new rules, outside of their newfound (in many cases, at least) “fiduciary” status, is that the fiduciary requirements extend beyond just investment recommendations. In addition to recommendations made to clients to buy, hold, sell, exchange or manage an investment — which would obviously fall under the new fiduciary rule — recommendations related to the rollover process, itself, are also covered under the rule. In other words, if an advisor suggests to a client that they roll over their 401(k) into an IRA and purchase “X” investment, there are two recommendations there which would be subject to fiduciary standards. The recommendation to purchase investment X would have to meet those standards but, so would the actual recommendation to complete a rollover in the first place.
Per the final fiduciary rule, “recommendations with respect to rollovers, distribution, or transfers from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer or distribution should be made” will be subject to fiduciary standards.
This additional requirement places a new burden on advisors, but certainly not one that is unfair. Advisors of all types will now have to increase their knowledge of the benefits and drawbacks of various rollover options. Even a hypothetical infallible investment guru, who never makes even a single investment mistake, will need to make sure that he/she is properly evaluating the merits of a rollover in order to avoid potential regulatory issues.
Unfortunately, acting as a fiduciary and evaluating which rollover option is in a client’s best interest is no easy task. For starters, when a client retires or otherwise has access to plan funds, they may have as many as six potential “rollover” options. They are:
- Leave the funds in their existing employer plan
- Move the funds to a new/alternate employer plan
- Roll the funds over to an IRA
- Convert the funds to a Roth IRA
- Complete an in-plan Roth conversion (a.k.a. in-plan Roth rollover)
- Take a lump-sum distribution
Further complicating matters is the fact that there is no one-size-fits-all template that can be used to determine which option is best for a client. Each client — and in fact, each client’s retirement plan — must be evaluated individually, based on its own merit. And there is no shortage of variables to consider either. For instance, in recommending a rollover (or a “don’t rollover”) or distribution, an advisor should, among other factors, consider impacts relating to:
- Fees
- Available investments
- Services provided
- The 10% early distribution penalty
- Creditor protection
- Simplicity/convenience
- Required minimum distributions
- Estate planning
Who and what is not subject to the new fiduciary rule
While the new fiduciary rule is extremely broad and will subject many advisors to fiduciary standards on a wide range of recommendations, there will still be many situations where advisors will not be subject to such standards.
For instance, as noted above, the fiduciary rule only applies to retirement investors. Thus, if an advisor is working with a client with regard to a non-retirement account (other than health savings accounts, medical savings accounts and Coverdell savings accounts — which are subject to the same prohibited transaction rules as IRAs under the tax code), they will not be subject to the fiduciary rule. Note however, that, depending upon an advisor’s business model, they may still be subject to fiduciary status for other purposes (i.e., under the Investment Advisers Act of 1940).
This will, in many cases, create some odd dichotomies. For instance, the same advisor may use the same investment with the same client, but in two separate accounts; one an IRA and the other a non-qualified account. In many situations, the investment recommendation made with respect to an IRA would be subject to fiduciary standards, whereas the same recommendation could be subject to the less onerous suitability standard. Bizarrely enough, it’s conceivable that, at some point in the future, we could see arbitration proceedings where an advisor gets the stamp of approval for use of an investment within one account, while at the same time finding themselves subject to damages and/or other penalties for using the same investment in a different account.
The fiduciary rule will also fail to apply in circumstances where communication is not deemed to be a recommendation. Such circumstances include the following:
- Generic “hire me”-esque messages
- General information communicated to wide audiences, such as newsletters, talk shows and speeches
- Interactive investment materials, such as worksheets
- Certain generic asset allocation models
- General information about a plan’s options
Note the extensive use words like “generic” and “general” in the items above. It’s important for advisors to understand that the more specific the information they provide, the greater the likelihood that the communication may be considered a recommendation, thus falling subject to the fiduciary rule.
Final thoughts
By many accounts, including our own, the final fiduciary rule strikes a well-selected balance between protecting investors’ retirement savings and making sure that compliance costs and administration aren’t overly burdensome. That said, most advisors will have to make at least some subtle, but meaningful changes in response to the Department of Labor’s rule. Those that adapt the quickest, and invest in their education and in their businesses, are poised to reap the greatest rewards as throngs of baby boomers continue to retire each day. Those that don’t might want to think about just retiring, themselves.
