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The Fiduciary Rule: What does it apply to?

Finance and Securities

The Fiduciary Rule, implemented under the Obama administration, requires financial advisers, brokers, and insurance agents to act in the best interest of the client for retirement and 401(k) accounts rather than pursuing their own interests for financial gain; essentially they must act as fiduciaries. The Department of Labor initiated this rule as brokers frequently recommended retirees to invest in expensive mutual funds which gave them a greater commission. The fiduciary rule aims to limit the conflict of interest risk by requiring advisers to put the customer first and primarily push investment funds with flat fees to avoid such an issue.

On February 3, 2017, President Trump issued a Presidential Memorandum directing the Department of Labor (DOL) to review and revise the Fiduciary Duty Rule, which led to a delay in its implementation from April 10, 2017 to June 9, 2017 (and certain provisions postponed until January 1, 2018). While the substantive principles of the Rule were put into effect on June 9, 2017, the DOL is continuing with its investigation. Critics in the financial services industry argue that the Fiduciary Rule will be a burden to smaller investors as it would require them to increase fees, which can lead to them loosing client accounts. However, the DOL has not found an issue with the substance of the rule as it requires advisers to act ethically specifically to vulnerable clients. Mercer E. Bullard, a law professor at the University of Mississippi explains that “[t]here is no way they can repeal the essence of the rule, which is the fiduciary standard”. In February, Chief Judge Barbara Lynn for the U.S. District Court for the Northern District of Texas, upheld the Fiduciary Rule in Chamber of Commerce v. Edward Hugler, Acting Secretary of Labor.

Many have questioned what the Fiduciary Rule covers and what is now in effect since there are two implementation dates. As of now, the rule is applicable to retail investors’ (investors who buy and sell securities for their personal accounts) retirement accounts, 401(k) accounts, and specific 403(b) plans (government workers are not covered). As of June 9, 2017 advisers are prohibited from acting outside of the client’s best interest, and must adhere to the prudence standard, whereby advice meets a professional standard of care and loyalty standard, whereby all advice must be in the best interest of the client and not in the financial interest of the adviser. They must comply with the “impartial conduct standards” (consumer protection standards) to prevent any conflicts of interest. Advisers are also prohibited from charging unreasonable compensation and fees or making misleading statements regarding investment advice. The Department of Labor has issued FAQs on this matter answering general questions on the transition periods, implementation methods and adviser requirements. Advisers will also be introducing “clean shares” to clients, which are a class of mutual funds with a flat fee to prevent advisers from taking advantage of high commissions from expensive mutual funds. Clean shares were introduced to eliminate the conflict of interest between investors and advisers and also benefit investors with greater returns.

What are the limits of the Fiduciary Rule? The adviser must only act as a fiduciary in relation to new retirement and 401(k) accounts, not all investments. For existing accounts, clients can request a review of their accounts by their advisers to ensure it meets the fiduciary standard. If clients wish to have their advisers act as their fiduciary for all their accounts, they can request that the adviser agree to and sign a fiduciary pledge or oath. This would state that the adviser swears to act in good faith and the best interest of the client. The Committee for the Fiduciary Standard has created a sample oath for advisers to sign.

Chairman of the Securities and Exchange Commission (SEC), Jay Clayton, explained in a statement that the actions of the Department of Labor in regards to the Fiduciary Rule “may have significant effects on retail investors and entities regulated by the SEC. It also may have broader effects on our capital markets. Many of these matters fall within the SEC’s mission of protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation.” Clayton continued by expressing the SEC’s willingness to “engage constructively” when determining what elements will “best serve the interests of [the] nation’s retail investors in this important area.” Since 2006 the SEC has conducted various studies (RAND study, Dodd-Frank Act Section 913 staff study) on investment advice regarding greater disclosure and transparency and seeking a best interest standard for broker-dealers. To better assess the situation, the SEC has asked the public to contribute to their study by submitting general comments and comments in relation to the list of questions on their website regarding the fiduciary standard for advisers.

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