(PUB) Investing 2016

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Big Changes in Store for Brokers and Their Clients Morningstar Research | Scott Cooley

If they cannot document that they serve investors’ interests, broker/dealers, 401 (k) plan providers, and other retirement advisors face potential private legal actions, including possible class-action lawsuits. (The DOL lacks the statutory authority to bring enforce- ment actions against retirement advisors, but it can require that they enter into contracts guaranteeing retirement investors the right to sue their advisors and plan providers.) In the 401 (k) space, where plan sponsors have long had fiduciary obligations, similar class-action lawsuits have likely pushed down fees by giving sponsors an incentive to ensure that they are offering the lowest-cost share class for which investors are eligible. The Final Fiduciary Rule One should approach an evaluation of such a complex and nuanced rule with a fair amount of humility. As one knowledgeable ERISA attorney told me, many of the things we think we know about the rule right now will turn out not to be true. But with that caveat in mind, here are two of the changes in the final rule that, in my mind, better protect the interests of investors. In short, the theme that runs through these and other improvements to the rule is that they ease the operational burden of the rule without compromising investor protections. First, for those investors who are currently in commis- sion-based retirement accounts, there is an improved grandfathering mechanism that should allow them to maintain this relationship if it is in the clients’ best interests. The original proposal would have made it very difficult to maintain a commission-based relationship. The DOL ’s 2015 rule grandfathered existing commission accounts only if the advisor did not provide additional advice on them. The original grandfathering provision would have pro- duced several problems. First, it seems odd that advisors could continue to collect trailing commissions on assets on which they provided no advice. Second, to the extent that an advisor did fail to provide advice but continued to collect a fee, this arrangement would arguably conflict with FINRA ’s requirement that an investment continue to be suitable for its owner. Third, in my view, the original rule would have led to

On April 4 , the Department of Labor published its long-awaited fiduciary rule, officially called “Definition of the Term ‘Fiduciary’; Conflict of Interest Rule— Retirement Investment Advice.” It should be no surprise that an agency that turns “fiduciary rule” into a 12 - word title was similarly verbose when it detailed how advisors should interact with their retirement clients: Where you and I would have said “Act in your clients’ best interests,” the DOL generated a manifesto that, with associated documents, explanations, and exemp- tions, runs to more than 1 , 000 double-spaced pages. a final rule that will advance investor interests without imposing excessive costs on the financial- services industry—which, of course, would have passed on the costs to investors. With that in mind— and despite some much-criticized concessions to the financial-services industry versus the DOL ’s May 2015 proposal—I believe that the final rule better protects investor interests. The Rule So, what does the rule do anyway? Any attempt to summarize such a complex rule will necessarily fall short, but in essence, the rule imposes a best- interest test on those who provide advice on retirement accounts, including IRA s and 401 (k)s. An advisor may still recommend that an investor roll over money from a 401 (k) into an IRA , may collect a commission on an IRA , or may even sell an investment product with high fees. But, among other obligations—and there are many—he or she will need to establish documen- tation showing that a particular investment decision was in the best interest of the client. Especially in the IRA space, that is a big change for brokers, who historically have needed to meet only a suitability— not a best-interest—standard. So, the DOL will not win any awards for brevity. But it does deserve some sort of prize for developing