In Whom We Trust

A new federal rule is about to shake up the business of retirement financial advice

Back Longreads Oct 25, 2016 By Steven Yoder

For a sense of how fungible the label “financial adviser” has become, talk to Mike Chamberlain of Chamberlain Financial Planning & Wealth Management, which has an office in Sacramento. “’Financial services industry’ is a very broad term,” he says, “and I don’t like being included in it. It’s embarrassing — if I tell someone I’m a financial adviser they immediately start to duck, thinking that I’m trying to sell them something.”

Consider the alphabet soup of titles that adorn those counseling people on their financial futures. They include Accredited Financial Counselor (AFC), Accredited Investment Fiduciary (AIF), Asset Protection Planner (APP) and Accredited Asset Management Specialist (AAMS). Those are just the A’s — the Financial Industry Regulatory Authority counts 167 such acronyms in all.

And a title doesn’t necessarily connote expertise. Some designations have real teeth. Among other requirements, a Certified Financial Planner (CFP) has to have advanced education in finance (like a Ph.D. in business or economics) and do 30 hours of continuing education every two years. Others, like Behavioral Financial adviser (BFA), just need to take two 2-month courses from a particular for-profit college and pass an exam.

Soon all planners who give retirement investment advice will have to adopt an additional designation, one that won’t appear behind their name: fiduciary. That means they’ll be legally bound to act in their clients’ best interest, not their own. A U.S. Department of Labor rule set to kick in next April will require retirement advisers to meet the fiduciary standard.

Chamberlain already operates as an accredited investment fiduciary — his fees don’t waver depending on which investment he recommends. That’s not true of many in the industry, who earn commissions based on selling specific products, some of them high-cost.

For fee-only advisers like Chamberlain, the effects will be few. For other local financial planners who work on retirement accounts, the change may well mean retooling how they make money, and some may not survive. The rule applies only to retirement accounts because only these accounts, such as 401(k)s and IRAs, are under the DOL’s purview. The agency doesn’t regulate regular investment accounts. Those are the province of the U.S. Securities and Exchange Commission, which so far hasn’t required all who give financial advice to operate as fiduciaries.

$17 Billion in Hidden Fees

Financial advisers get compensated in a range of ways, but the two big ones are fee-only and commission. Typically, those who earn fees charge a flat retainer that doesn’t change with the advice they give, a fee that’s a percentage of their client’s assets under management or an hourly rate. Those who earn commissions typically make money when they sell the customer a specific product. Those who advise retail investors say that generally, the interests of fee-only advisers are more likely to align with those of their clients because they don’t have the conflicts of interest that advisers on commission do.

Conflicted financial advice costs retirement savers millions each year. A 2015 White House Council of Economic Advisers analysis estimates that hidden fees and commissions drain away about 1 percentage point of their investments annually. That doesn’t sound like much. But if true, because of the power of compounding, an investor’s nest egg expands 25 percent less than it otherwise would over the course of 35 years. That means a $10,000 investment would grow to just $27,500 instead of $38,000 over that time frame, according to the council. All told, such losses cost U.S. savers $17 billion a year, the study concludes.

“The fees and disclosures have been awful in the IRA marketplace,” says Mike Genovese, partner at Genovese Burford & Brothers in Sacramento. “It’s been a tough go for the consumer in this country, because so many [advisers] are incentivized to get [clients] to roll over their money and pay exorbitant fees,” he says.

The new regulation applies to any advice on tax-advantaged retirement plans given by independent securities broker-dealers, insurance brokers, financial planners and other financial pros. It doesn’t ban commissions, but advisers have to be able to show that they didn’t benefit by recommending one product over another. Advisers who still want to earn commissions will have to present their clients with a contract stipulating that, among other things, the adviser will act in the client’s best interest, receive only reasonable compensation and disclose how he or she gets paid.

But there’s one feature that makes the best-interest contract important: It gives clients the right to sue their advisers if they breach the fiduciary standard.

‘A Game-Changer’

Major insurance industry players have made big moves to escape potential liability. In January, insurance giant AIG sold off its 5,000-person financial adviser group. A month later, MetLife did something similar, selling its entire retail sales force of 4,000 life-insurance agents who also act as financial advisers. “The rule change is huge. It’s a game-changer as far as the brokerage industry goes,” says Thomas Potter, an attorney who represents broker-dealers and investment banks in regulatory compliance issues at Burr & Forman, a firm that serves the Southeastern U.S.

“If I tell someone I’m a financial adviser, they immediately start to duck, thinking that I’m trying to sell them something.”

Mike Chamberlain, certified financial planner and accredited investment fiduciary,Chamberlain Financial Planning & Wealth Management

Locally, brokers and insurance agents who work on commission or receive other types of contingent incentives are still figuring out how they’ll adapt. “Some of them are hoping this will be repealed, and others are reading it and scratching their heads to figure out how they’re going to implement this,” says Sacramento benefits lawyer James Paul of Paul Benefits Law Corporation.

Local brokers affiliated with a national broker-dealer like Merrill Lynch or LPL Financial likely will find that their main offices will handle the transition and give them marching orders, Paul says. But the brokers are going to see changes — if they’re not operating as fiduciaries, their national office may assign a fiduciary to oversee them when they’re dealing with a customer’s retirement account, he says. Not so for insurance agents, who typically have looser arrangements with the firms whose products they sell. They may be on their own to come up with a detailed, revised client agreement spelling out their fiduciary responsibilities, Paul says.

Some may bail out of the retirement plan business altogether, or revise their business plan. Jan Pinney of Roseville-based Pinney Insurance says the new rule won’t damage his own company to the same extent because 95 percent of the investments he sells aren’t retirement products and so aren’t affected. The other 5 percent, mostly retirement annuities, presumably will be subject to it, meaning Pinney Insurance will need to sign best-interest contracts with those clients. But he says it’s likely he’ll just quit selling those. Since best-interest contracts give clients the ability to sue, Pinney thinks the liability risks are just too high to keep selling annuities.

As for purely fee-only advisers, even though they won’t face major changes, there’s one type of transaction they should pay close attention to under the rule: rollovers. When a customer seeks advice on rolling money out of a 401k to an IRA, the planner will need to be able to document that the advice given was in the customer’s best interest, says David O’Brien, board member at the fee-only National Association of Personal Financial advisers. They should also check that their client agreements comply with the language called for in the rule, he says.

As for businesses that offer retirement plans, Paul says they should pay close attention since they could be on the hook too in a lawsuit or a DOL compliance check. The rule change means it’s more important than ever that they’re transparent with employees — showing fees as a line item on retirement plan statements and ensuring that the company’s retirement plan adviser is a fiduciary. “The DOL does investigate retirement plans,” he says. “You have to be able to demonstrate that you made a prudent decision and have that documented.” And if your adviser hasn’t at least had a conversation with you about the DOL rule change, you should be concerned, he adds.

A few sectors can expect the new regulation to bring in new clients. For attorneys specializing in benefits law, business is going to be very good, Potter says. And one local firm, Auburn-based Riskalyze, is promoting tools that it says are tailored to help advisers adapt. Among other products, the company has developed software that allows advisers to set a risk number for each client based on their goals, automates the development of a portfolio that aligns with that risk number and creates documentation showing how each investment decision was aligned with that customer’s best interest — which will be critical in reducing advisers’ liability, says Riskalyze Co-Founder Michael McDaniel.

(The Financial Planning Association of Northern California had no members willing to comment on the new rule. And several local advisers representing the country’s largest independent broker-dealers either didn’t respond or referred inquiries to their central offices, which didn’t respond.)

The First Domino

There’s an outside chance the new regulation won’t survive. Three federal lawsuits have been filed against the Department of Labor by national investment adviser groups and business advocates. On the other side, a coalition representing large financial planner associations has filed supporting documentation and arguments defending the DOL.

Similarly, the rule has cleaved opinion among some Sacramento retirement professionals.  Pinney believes inserting a cumbersome new rule into the marketplace will result in brokers dropping small investors; if so, those customers won’t have access to retirement advice, goes the argument. If a customer has even $500,000 to invest and the broker is charging a ½-point fee, that account will generate $2,500 a year — not enough to justify the legal risks, he says.

On the other side, Chamberlain doesn’t think it goes far enough. Customers won’t bother to read the new best-interest contract that the adviser asks them to sign, he says. And he points out that the rule covers only retirement accounts. That means customers won’t necessarily know that when their adviser switches to discussing their non-retirement accounts, that advice doesn’t have to meet a fiduciary standard.

That separation of the financial-advice world into retirement and non-retirement territories could end soon. In May, Securities and Exchange Commission Chair Mary Jo White said her agency would propose a more sweeping rule next spring that will require all financial advice — whether related to retirement plans or not — to be subject to the fiduciary standard. O’Brien thinks the DOL rule has opened the door to that more dramatic change: “It’s the first domino,” he says.