• Blog
  • 6 Min Read
  • July 18, 2016

What You Need to Know About New DoL Regulations

Written by:
The Clearwater Team

On April 6, 2016, the Department of Labor (DoL) issued stricter rules for how some investment managers must provide retirement investment advice to their clients. Some variation of these rules have been a long time in the making; now that they’ve been formally outlined, many in the industry are questioning the practical implications. The following are answers to some frequently asked questions regarding the new rules.

What are the New Rules?

At the direction of President Obama, the DoL issued proposed rules to “address conflicts of interest in retirement advice, saving middle-class families billions of dollars every year.”[i]

According to the DoL’s factsheet, the proposed rules can be summarized in four parts:[i]

Backdoor Payments & Hidden Fees Often Buried in Fine Print Are Hurting the Middle Class: Conflicts of interest cost middle-class families who receive conflicted advice huge amounts of their hard-earned savings. Conflicts lead, on average, to about 1 percentage point lower annual returns on retirement savings and $17 billion of losses every year. The Department of Labor is protecting families from conflicted retirement advice. The Department issued a proposed rule and related exemptions that would require retirement advisers to abide by a “fiduciary” standard—putting their clients’ best interest before their own profits. The Proposed Rule Would Save Tens of Billions of Dollars for Middle Class and Working Families: A detailed Regulatory Impact Analysis (RIA) released along with the proposal and informed by a substantial review of the scholarly literature estimates that families with IRAs would save more than $40 billion over ten years when the rule and exemptions, if adopted as currently proposed, are fully in place, even if one focuses on just one subset of transactions that have been the most studied. The Administration Welcomes Feedback: The issuance of a notice of proposed rulemaking and proposed exemptions begins a process of seeking extensive public feedback on the best approach to modernize the rules of the road on retirement advice and set new standards, while minimizing any potential disruption to the many good practices in the marketplace. The proposal asks for comments on a number of important issues. We look forward to hearing from all stakeholders. Any final rule and exemptions will reflect this input.

Investment firms will be required to comply with the new rules by January 2018.

What is the DoL Trying to Accomplish?

In general, the DoL is attempting to protect retirement investors from some brokers and advisors who would (and have) recommended certain products that are especially profitable to sell, but bring in a smaller return than other investments. The narrow focus on retirement funds is an attempt to offer protection to middle-class investors whose retirement age and quality of life can be significantly impacted by the performance of the investments.

Along these lines, it seems that 401(k) rollovers in particular are a focal point of the new rules. These rollovers can be lucrative to broker-dealers, but do not always produce the best return for investors. In the future, firms will need to justify that recommending a fee-based strategy like a 401(k) rollover is truly in their client’s best interest.

What Are the Implications?

The key implication for investment managers is that according to the new rules, all firms advising clients on their retirement investments will now be held to a fiduciary standard.

According to the Employee Retirement Income Security Act (ERISA), “anyone who gives investment advice for a fee or other compensation with respect to any moneys or other property of a plan, or has any authority or responsibility to do so”[ii] will be held to the new fiduciary standard rule.

At its most basic definition, a fiduciary must offer financial advisement with their clients’ best interests in mind. That means offering advice on specific investment products and strategies that, to their knowledge, will best benefit their clients rather than their own profits.

Who Will It Affect?

Many investment managers are already held to the fiduciary standard. For instance, registered investment advisors (RIA) will not be directly affected because the new DoL rule simply extends the standards they already keep to other types of firms.

Broker-dealers and private wealth advisors, among others, will be affected by the ruling.

What are the Practical Implications of the Ruling for Investment Managers?

Whether or not firms already act as fiduciaries, the DoL ruling has potentially wide-reaching implications across the financial services industry. The new rules represent greater scrutiny into the advice that investment managers provide to their customers. The products that managers recommend and the fees they charge for them will need to be documented and justified more thoroughly than ever. Investment managers should plan for the likelihood of additional increased regulations in the future.

Industry Arguments For and Against the Ruling

Some in the investment manager industry have voiced concerns about potential negative implications from the new rule.

Complying with any new regulations generally comes at a cost for firms, especially those with lean operations teams. Any increased costs at the firm level will inevitably trickle down to clients, which would work against the very purpose of the new rule.

The fiduciary standard will also limit the number of products that firms can, or are willing, to provide to their clients. Complying with the new rule might encourage advisors to offer only the cheapest investments, which might not necessarily generate the best returns.

Some also argue that the new rule disregards individual client risk tolerance, investment sophistication, investment history, and investment performance goals. This, some advisors argue, wouldn’t allow for customization of retirement investments.

The Securities Industry and Financial Markets Association (SIFMA) has filed a lawsuit challenging the DoL’s new rules, which they characterize as an “over-reaching federal regulation that will restrict hardworking Americans’ access to retirement advice and planning services.”

SIFMA also argues that they are not opposed to a universal fiduciary standard, and would “support such a standard under the industry’s primary regulator, the U.S. Securities and Exchange Commission.”[iii]

How Can Investment Managers Prepare Now?

Specialized investment accounting technology for data aggregation, data management, and other operational process can help firms remain compliant with the new rules—and any future regulations—in an efficient and streamlined way.

Best-in-class data management and accounting technology can provide the following key benefits:

  1. Efficient operational processes for daily reconciliation, data aggregation, composite management, and others keep down costs as the firm evolves and expands.
  2. Compliance monitoring and maintaining a detailed audit trail of all policies. If any policy or transaction comes into question, firms can easily access a full audit trail of investment decisions, policies, violations, and resolutions.
  3. Third-party verification. Having a third-party vendor handle services like performance calculations, client-billing, and exposure reporting ensures regulators that a firm isn’t manipulating data.
  4. The aggregation of client data into one consolidated view provides investment managers with a complete picture of all client holdings, which can make strategic and prudent client investment decisions and recommendations much easier.
  5. Providing up-to-date reporting access to clients. Investment managers should provide their clients with access to their investment data on a daily basis, creating up-to-date transparency into investment decisions and their effects.

Clearwater is committed to monitoring relevant regulatory updates for investments managers. Subscribe to Clear Insights to stay up-to-date on the latest news and best practices.

[i] https://www.dol.gov/sites/default/files/documents/featured/protectyoursavings/factsheetcoi.pdf

[ii] https://www.dol.gov/ebsa/pdf/fsfiduciary.pdf

[iii] http://www.sifma.org/issues/savings-and-retirement/dol-fiduciary-standard/overview/

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