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How the DOL Fiduciary Rule Makes Financial Advisors More Like CPAs

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Jul 20th 2017
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Not to worry. Financial advisors are not going to start dispensing accounting advice. However, a new US Department of Labor (DOL) rule compels them to act as fiduciaries where clients’ retirement accounts are involved. How does this make them more like you?

As a CPA, you act in a fiduciary capacity. The securities industry has a long-standing “prudent man” rule (based on 1830s Massachusetts law). “Don’t take unnecessary risks” sums it up. Over the years it evolved into the “prudent investor rule,” acknowledging diversification is sensible, even if it involves some risk. The interests of your client come first. 

As a CPA, you follow the spirit of this law very closely. You act on behalf of your client. You sit on the same side of the table. You talk about direct and indirect costs involved relative to investments they own elsewhere. You represent their interests.

Meanwhile, Over in the Securities Industry …
The financial services industry has long been governed by the suitability standard. This means financial advisors make recommendations appropriate for the client’s situation and objectives. Conflict arises when multiple alternatives are a good fit, yet some might be more expensive. 

Is this a big problem? Often it’s not. The vast majority of financial advisors are ethical. Large financial services firms usually offer a wide range of products, and they have compliance oversight as a backup.

How does backup work? Here’s an example: Years ago, the industry largely moved from a transactional business model, with commissions charged whenever you bought or sold stocks, to an asset-based pricing model. Investors were charged a percentage based on assets held in the account. They could trade as much or as little as they liked. The fee stayed the same. Compliance departments monitor trading activity. If a client held securities, they would likely never sell (low-cost basis blue-chip stocks). The compliance officer would question the advisor: “Is this client better served by holding these assets in a traditional account instead?”

Problems develop when the advisor’s firm offers a limited product selection (mutual funds only) or the advisor is only licensed to sell a narrow product range. Problems develop when the best solution to every investing scenario happens to be the only product the client can legally sell. Clients aren’t being shown the full picture.

The financial services industry faces yet another problem. Some advisors aren’t good at explaining direct and indirect costs. In general, the more complex the investment, the more complicated the fee structure. This is a serious problem when clients don’t ask the right questions.

How Will the Industry Change?
The fiduciary rule will change behavior across the industry. Here are a few likely outcomes:

1. Financial planning. Registered investment advisors (RIAs) and financial planners have long operated under the fiduciary standard. When a client completes a financial plan (which they purchase), the plan is portable. They can choose to implement the recommendations in the plan elsewhere. 

This will likely be highlighted when clients complete plans.

2. Alternative firms. Financial advisors will likely be required to mention other firms that offer securities, products, or services similar to theirs at different prices. However, if the client chooses to buy their investments elsewhere, it’s unreasonable to expect the financial advisor to provide investment advice and some degree of oversight if the assets are held away, unless the client specifically pays for this service. 

Most clients will likely choose to invest with the advisor who developed the financial plan because they are reasonably satisfied the advisor understands their situation.

3. Nonretirement assets. Although the DOL ruling at present applies only to retirement assets, it’s unlikely firms will want to create an environment where two standards apply. Competitors would quickly attempt to redefine the two standards as “acting in the client’s best interests” and “not acting in their best interests.”

Broad application of standard.

4. Pricing will standardize. Part of the DOL ruling requires clients to sign a “Best Interests Contract Exemption,” pledging the advisor will act in the client’s best interests and only earn reasonable compensation.

The easiest way to keep compensation reasonable is to price everything at almost the same level.

5. Pricing will be fully explained. Firms with 10,000-plus advisors working with millions of clients don’t want to run the risk that some advisors will ignore the new rules, opening their firm to liability. Most advisors do a great job at explaining pricing. They have been doing it for years. Firms will put backstop procedures in place. This might involve sending reports explaining pricing, printing “for more details on pricing … ” on monthly statements, and asking clients to acknowledge in writing that pricing has been explained to them.

Firms will determine what full disclosure means and find a way to automate the process.

6. RIAs will benefit. Independent advisors running their own shops will promote their fiduciary status for the entire relationship.

This industry segment will get a boost.

7. Some advisors will leave the industry. The advisor population is in decline, from its peak of 325,000 in 2008 to 285,000 in 2014. About half are age 55 or older. 

Not everyone will want to adapt to a new business model.

8. Release the hyenas. Law firms will advertise, seeking investors who feel wronged.

The laws will be tested. 

Will Financial Advisors Be More Like CPAs?
Advisors will be legally required to act in their clients’ best interests. They will need to apply the same scrutiny to fees as they would when considering their own investments. They would face legal consequences for malpractice. CPAs are bound by similar rules.

Related articles:

As a CPA, Are You Really a Fiduciary?
It’s Time for CPAs to Demand Their Clients’ Advisors Follow a Fiduciary Standard

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