A recently approved rule from the Department of Labor (“DOL”) is a complex regulation that would apply to financial professionals who provide financial advice to participants or sponsors of retirement savings plans, including 401(k) plans, IRAs and rollovers. The new rule, commonly referred to as the Fiduciary Rule, changes the legal relationship between an adviser and a client.

Many retirement advisers do not consider themselves fiduciaries. Default Router login Under the new rule’s definition, any individual receiving compensation for providing advice that is individualized or specifically directed to a particular plan sponsor, plan participant, or IRA owner for consideration in making a retirement investment decision is a fiduciary. The rule will require advisers to act in their clients’ “best interests,” a stricter standard than the current requirement whereby they must place their clients in “suitable” investments.

The new rule will not only make more advisers fiduciaries, but it also gives clients a legal recourse which they did not have before. The Fiduciary Rule has a “best interest contract exemption (BICE)” which will allow customers to bring a private right of action for breach of contract. download gbwhatsapp apk Whereas before, if an adviser gave advice regarding IRA investments, neither the Department of Labor nor the client could bring an action to hold the adviser accountable. One bright note for advisers is that the contract can limit an individual’s recourse to arbitration. This proponent of the rule will minimize advisers from spending time and resources in defending themselves in heavy litigation. However, the contract cannot restrict a group of clients from bringing a class action lawsuit.

In addition to a new legal recourse for clients, the Fiduciary Rule also affects compensation. Among the various types of compensation that advisers and financial institutions providing such advice will have to receive are level fees, asset-based compensation, and level commissions.

More than likely, under the new rule, it will be impermissible for advisers and financial institutions to receive variable pay based solely on the amount of third-party payments or increased pay based on selecting an investment product that provides the highest third-party payments The Department of Labor’s rule also includes a new prohibited transaction class exemption that may permit some limited forms of traditional compensation for advisers, but only when specific conditions are met, significantly limiting permissible compensation, requiring new disclosures of anticipated and incurred fees and expenses, and greatly expanding legal liability.

The five core principles of the new rule are as follows below:

  • Put the client’s best interests first;
  • Act with prudence, that is, with the skill, care, diligence and good judgment of a professional;
  • Do not mislead clients–provide conspicuous, full and fair disclosure of all important facts;
  • Avoid conflicts of interest; and
  • Fully disclose and fairly manage, in the client’s favor, unavoidable conflicts.

It has been predicted that there could be significantly increased costs to firms and advisers through the implementation of measures to comply with the proposed rule. Industry executives and analysts predict that the new rule is likely to accelerate firms’ shift toward fee-based accounts and away from commissions; a trend in which smaller firms generally lag behind their bigger rivals. Smaller firms also tend to have more small accounts that might become uneconomical to serve in a fee-based model, and they have fewer clients across whom to spread the potential additional compliance costs.

As a means to try to prepare for the implementation of the Department of Labor’s new rule, firms and advisers should review their accounts to identify those to which the Fiduciary Rule will apply. It would also be good practice to have discussions with potentially impacted clients about the implication of the new rule and how it might affect their accounts and the advice provided to them. To get a good grasp on the changes, firms and advisers should begin to work on the required disclosure document and contract that will be entered into with clients.

Please see our other posts on the subject for more information on the Fiduciary Rule.