Saturday, July 23, 2016

Fall 2016 Speaking Engagements: DOL Fiduciary Rules and More

PLEASE JOIN ME AT ONE OF THE FOLLOWING
UPCOMING EVENTS, PRESENTATIONS OR WEBINARS.

Tuesday, August 9, 2016: (Time TBD) FPA Kentuckiana Chapter Meeting
"DOL Fiduciary Rules: Overview and Impacts" - Louisville, Kentucky
Held at the Big Spring Country Club, 5901 Dutchmans Lane, Louisville, KY 40205
The agenda for the day is (all times ET):
9:15 AM: Registration. 9:30 AM: Welcome
9:30- 10:30 AM: Implementing Alternatives – Corey Hock, Vice President, Managing Regional Director, Natixis
10:30 – 11:30: Retirement Readiness & The Bottom Line – E. Thomas Foster Jr.
National Spokesperson, MassMutual Workplace Solutions
11:45 – 12:45 PM: Lunch & Roundtable Discussions
12:45 – 1:45 PM: Department of Labor Fiduciary Ruling –Ron A. Rhoades, JD, CFP®, Director of the Financial Planning Program and Asst. Professor - Finance, Gordon Ford College of Business, Western Kentucky University
1:45 – 2:30 PM: Practice Spotlight
Visit the FPA Kentuckiana web site for more information

Wednesday, August 31, 2016, Noon-1:15pm ET
Journal of Financial Planning: "Journal in the Round" - webinar on Fiduciary Issues
Ron will participate in a panel discussion of topics relating to the DOL Rule, with additional insights provided as a follow-up to his article appearing in the August 2016 edition of the Journal of Financial Planning. More information to follow from www.fpanet.com.

Tuesday, September 6, 2016, 4:00pm-5:00pm ET: NAPFA Webinar
"The DOL Fiduciary Rule: Implications for Fee-Only Advisers"
The DOL’s Conflicts of Interest Rule is scheduled for implementation in April 2017. The “BICE Lite” (streamlined exemption) mandates new due diligence and documentation in connection with IRA rollovers. Investment strategy and investment product due diligence are also likely to receive increased scrutiny. How is the securities industry adapting, and what steps might NAPFA members undertake in the months ahead? Ron Rhoades, Director of the Financial Planning Program in the Gordon Ford College of Business at Western Kentucky University, and a frequent writer and speaker on fiduciary issues, provides his unique perspective on these issues.
NAPFA members may register at www.NAPFA.org.

Tuesday, Sept. 13, 2016: 2:30pm-3:30pm Central Time
    (NOTE: SPECIAL TIME)
Diligent Inquiry Series: "The DOL Fiduciary Rule: Implications for Fee-Only Advisers"
The DOL’s Conflicts of Interest Rule is scheduled for implementation in April 2017. The “BICE Lite” (streamlined exemption) mandates new due diligence and documentation in connection with IRA rollovers. Investment strategy and investment product due diligence are also likely to receive increased scrutiny. How is the securities industry adapting, and what steps might Garrett Planning Network's members undertake in the months ahead? Ron Rhoades, Director of the Financial Planning Program in the Gordon Ford College of Business at Western Kentucky University, and a frequent writer and speaker on fiduciary issues, provides his unique perspective on these issues.
For Garrett Planning Network members only. www.GarrettPlanningNetwork.comTuesday,

Thursday, September 22, 2016, 9:00am-3:00pm: FPA of Oregon & Southwest Oregon
"FPA Fiduciary Day" - Featuring Ron Rhoades and John Lenz
Ron provides 4 hours of detailed discussion of the new DOL Rules and their impact on broker-dealers, registered representatives, insurance companies, insurance marketing organizations, insurance agents, and registered investment advisers.
For registration information, please visit: http://www.fpa-or.org/events

October 11, 2016: 3:00pm-4:00pm Central Time
Diligent Inquiry Series: “Investment Myths to Dispel”
A lot of investment “sales techniques” have, over time, led to some common investment myths. Join Ron as he discusses the Dalbar QUIB studies (and similar Morningstar studies), the Brinson-Hood paper (often misquoted), the inaccuracy of “portfolio turnover” reporting, what is required to truly “tax efficient” funds and ETFs, the notion that Benjamin Graham was a great investor, and a closer look at Warren Buffet’s track record. Also examined are the “safety” of corporate bond funds in an era of low returns, the impact of taxes upon real investment rates of return, why we should view historical market returns through the lens of real return, market volatility personal risk factors, investment time horizons, the role of (and limits of) diversification, the necessity of rebalancing, various misleading historical charts, the illusion of "average" rates of return, and longevity statistics.
For Garrett Planning Network members only. www.GarrettPlanningNetwork.com

Join me at the the NAPFA '16 Fall Conference, Wednesday, October 12 - Saturday, October 15, in Arlington VA. Drop me a line at ron.rhoades@wku.edu, and I'll be pleased to meet with you, or a group, to discuss the DOL Fiduciary Rules and to answer questions.
Attending a NAPFA Conference can pay big dividends - for you and for your clients. If you've never attended a NAPFA conference, you may not realize what you're missing.  But this year's Fall Conference, "Capitol Ideas - Leading in Times of Change", is one you should not miss. Sessions like Active Asset Allocation, Succession Planning, Advanced Student Loan Strategies and Helping Clients Adjust to Sudden Money, provide the basis for a conference filled with pragmatic information that will send you back to your office feeling like a frontrunner - well-informed, coached by a first-rate team and ready to spearhead change within your business.
And you won't want to miss NAPFA's lineup of celebrated keynote speakers: 
  • Ascend to the heights of leadership with Lt. Col. Rob "Waldo" Waldman, leadership consultant, decorated fighter pilot and "Wingman";
  • Learn what it's like to have your ear to the ground in Washington, DC with Judy Woodruff:  As a broadcast journalist, she's covered it for over four decades;
  • Discover multi-asset strategies with Jeffrey Sherman, Deputy Chief Investment Officer and member of the Executive Management Team at DoubleLine.
Just like in years past, networking will be a big part of the Fall Conference - we're planning for networking opportunities both during and after the conference day - as will the educational element.  You can earn over 20 CEs if you attend the entire program!
NAPFA conferences are easily affordable when you take advantage of advance registration promotions and discounts.  The cost for a member to attend is just $1,095.  But, if you register prior to September 9, you'll receive $200 off the full member price.  In addition, if you are a first-time conference attendee, you'll get $100 off the already reduced member price.* All attendees will have full access to all sessions, networking and exhibit hall activities.  It's the same conference at a lower rate.
You must register prior to September 9 to take full advantage of advance registration pricing.  For more information, to see a preliminary agenda, or to begin the registration process visit the NAPFA Conference home page.
*Please contact Dianna Leja (lejad@napfa.org) or Robin Gemeinhardt (gemeinhardtr@napfa.org) for information on how to obtain a first-time attendee discount. (Also, for new members of NAPFA, there's another special benefit that's huge!)

Thursday, October 20, 2016, 5:30pm-8:00pm: FPA of Southwest Florida
"The New DOL Rule - Fiduciary Standards for Advisors"
Ron provides a 2-hour presentation on the DOL Rules and Its Impact on All Types of Advisers, and Takes Questions from Attendees
Location: Estero County Club, 19501 Vintage Trace Cir, Fort Myers, FL 33967
For registration information, please visit: http://fpa-swfl.org/meetinginfo.php

Tuesday, November 8, 2016: 3:00pm-4:00pm Central Time
Diligent Inquiry Series: “Preparing the Investment Policy Statement”
Some legal/compliance consultants suggest a one-page IPS. But, can an IPS do more, to protect you against potential claims should a deep and/or prolonged stock market return take place? Yes! Ron shares his own Investment Policy Statement, highlighting various statistical data that can be incorporated into the IPS for purposes of client education and risk reduction. The responsibilities of the adviser and client are explored, as well as the process for monitoring the IPS.
For Garrett Planning Network members only. www.GarrettPlanningNetwork.com


The MarketCounsel Summit, at the Fontainebleau Miami Beach from December 5—8, 2016. Learn from the powerful agenda and speakers and, most importantly, engage in intimate networking among the industry’s leading growth-oriented firms. With the drastically-evolving regulatory landscape, a controversial election cycle, and emerging new business opportunities, this Summit will tackle all of the hot issues head on. Ron will participate in a panel discussion on Tuesday, December 6th. Learn more about the Summit.

Tuesday, December 13, 2016: 3:00pm-4:00pm Central Time
Diligent Inquiry Series: Advance Health Care Directives
Why should everyone possess an advance health care directive? What is the distinction between a “Power of Attorney for Health Care” and a “Designation of Health Care Surrogate”? What is a “Living Will” and what happens if you have one, or don’t have one? Are there ways to add value through better forms? What are DNROs? What is a grant of authority under HIPAA? Ron explores these topics in this foundational webinar on health care decision-making.
For Garrett Planning Network members only. www.GarrettPlanningNetwork.com


INFORMATION ON BOOKING RON A. RHOADES FOR YOUR EVENT:

About Professor Rhoades

Ron A. Rhoades, JD, CFP® is a researcher and frequent writer on all things fiduciary as applied to financial services. He is known for his "One Man Think Tank" column in RIABiz, blog posts at his popular Scholarly Financial Planner blog, and for many articles written for other publications.

A professor of finance and financial planning, estate planning and tax attorney, and investment adviser, he previously served as Co-Founder, Director of Research and CCO for a Florida RIA firm. After transitioning to his current full-time job as a university professor (now at Western Kentucky University's Gordon Ford College of Business), Ron continues to serve a select group of clients through Garrett Investment Advisors, LLC.

Ron received the inaugurual "Fiduciary of the Year" award from The Committee for the Fiduciary Standard for "changing the course of the fiduciary debate in Washington, D.C." He was also named one of NAPFA's "30 Most Influential" persons in NAPFA's 30-year history.

Ron has been extensively involved in discussions with policy makers and others regarding the DOL's Conflict of Interest Rule, and has traveled frequently to Washington, D.C. As the DOL Rule proceeds to implementation, he is tracking the ongoing developments and reviewing how firms are responding to the rule, and he is discerning and predicting best practices for the future.

Suggested Topics Re: DOL Conflicts of Interest (Fiduciary) Rule, BICE, 84-24, and More

The U.S. Department of Labor's Conflict of Interest Rule will pose new challenges - and opportunities - for financial services firms. The greatest impacts will be felt by broker-dealer firms, dually registered firms, and their registered representatives. Also greatly affected will be asset managers, insurance companies, insurance marketing organizations, and insurance agents. Even "fee-only" registered investment advisers face new compliance challenges. Ron addresses the DOL "Fiduciary Rules" and their impact, including:
  • Understanding the DOL's (Final) Conflicts of Interest Rule and its Exemptions, Generally
  • 1 to 2 hours, as desired. Topics may include:
    • DOL Rule Status: Legislation, Judicial Challenges and Impact of Presidential Elections
    • Effective Dates
    • Conflict of Interest Rule
    • BICE
    • BICE Light & IRA Rollovers
    • 84-24
    • Sales Exemption
    • Proprietary Products
    • Principal Trades
    • Conflicts of Interest:
    • Impartial Conduct Standards
    • Fees and Costs Matter
    • Divergent Interests: Firms vs. Advisers
    • Duty of Due Care: Prudent Investor Rule
    • Reasonable Compensation
    • Non-Waiver of Duties
  • How Firms Serving Retail Consumers Can Adapt to the DOL's Rules
  • 1-2 hours, as desired. Topics may include:
    • PART A: INVESTMENT STRATEGY & PRODUCT DUE DILIGENCE
    • Planning for a Firm's Adoption of a Fiduciary Culture
    • Investment Strategy Determination under the Prudent Investor Rule
      • Proving Adherence
      • Impact of Acting as a "Purchaser's Representative"
    • Investment Product Due Diligence under the Prudent Investor Rule:
      • Prudent Process (Procedural Due Care)
      • Expert Judgment (Substantive Due Care)
      • Open-End Mutual Funds
      • ETFs
      • Closed-End Funds
      • Unit Investment Trusts
      • Variable Annuities
      • Fixed Indexed Annuities
      • Fixed Rate Annuities
      • Real Estate Investment Trusts
      • Alternative Investments 
    • Proprietary Funds
    • Principal Trades
    • Standards When Also Advising on Taxable and/or Non-ERISA, Non-IRA Accounts
      • Contrasting the SEC's enforcement of the Advisers Act's "Best Interests" standard
      • The Impact of DOL Rules on Determining Common Law Fiduciary Status
    • PART B: IMPACT ON FINANCIAL SERVICES
    • Developments in AUM and Fixed Fee Platforms
    • The Evolution of Commission/Trial Arrangements
    • 12b-1 Fees: Why You Might Not Want to Build A Practice Around Them
    • Other Revenue-Sharing and Soft Dollar Arrangements Under the DOL Rule
    • Effect on Compensation Practices, including Incentives & Awards
    • DOL and Other Regulatory Developments Affecting Robo-Advisers
    • Rabo-Advisers:
      • The Inherent Limits of Risk Tolerance Questionnaires: The Interaction between Goal-Setting and the Need to Take on Risks
      • Threshold Questions on a Client's Proper Use of Each Client's Funds
      • Designing Financial Planning Solutions as Value-Added Services
      • Gaining Trust and Preserving Relationships via Client Profile Design, Maintenance, and Proper Presentation
      • Adding Value via Fixed Income Securities and Aggregating Purchases
    • The Migration toward Professional Services Form Business Models, and Its Challenge for Publicly Owned Firms
    • Preserving Value and Reducing Advisor Turnover through Shared Ownership of Client Relationships
    • Impact on Fiduciary Rulemaking at the SEC
    • Impact on the Emerging Profession of Financial Planning
  • How Practitioners Can Reduce Their Risks in the New Fiduciary Era (1 hour) 
    • It's All About Your Personal Reputation
    • A "Deep Dive" Into Understanding the Fiduciary Duties of Due Care, Loyalty, and Utmost Good Faith: Why Choosing "Good Products" and "Suitability" are Not Enough
    • Proper Management of Unavoidable Conflicts of Interest
    • Preparing the Client in Advance of Market Downturns
    • Documenting Adviser-Clients Interactions
Honoraria & Travel Reimbursements for Presentations:
    Ron Rhoades is available for live, in-person presentations for your conference or private firm event, for presentations in 1-hour, 2-hour, or half-day formats. His content can fit into either keynote or breakout sessions. Honoraria for presentations in the continental U.S. are shown below.

    For for-profit firms: 
     - $1,250 for first hour of presentations; and
     - $750 for each additional hour of presentations or part thereof.
    (Maximum 4 hours of presentations in any one day = max. $3,500)
    The above rate is in addition to reimbursement for coach airfare on Southwest or United, 1-2 nights of accommodations as necessary based on travel arrangements, parking at departure airport, and ground transportation to/from the conference location.

    For non-profit organizations, excluding universities: 
     - $500 for first hour of presentations; and
     - $250 for each additional hour of presentations or part thereof.
    (Maximum 4 hours of presentations = max. $1,250)
    The above rate is in addition to reimbursement for coach airfare on Southwest or United, 1-2 nights of accommodations as necessary based on travel arrangements, parking at departure airport, and ground transportation to/from the conference location.

    For university financial planning programs:
    There is no charge for webinars provided to university students only.
    For in-person presentations to university students, travel costs only (see above).

    Contact Information:
    Ron A. Rhoades, JD, CFP®
    1441 Riva Ridge Ave.
    Bowling Green, KY 42104
    Phone:  270-904-2728 (assistant: Cathy)

    Thank you. - Ron

    Saturday, April 30, 2016

    DOL Fiduciary Rule: What "Best Interests" Means, Impacts on Financial Services

    Introduction.

    Congress will not stall the DOL Rule in 2016. What occurs in 2017 may well be determined by the upcoming Presidential election, and even then great uncertainty exists as to whether the DOL's Conflict of Interest Rule would or could be timely repealed by a new Administration. Court challenges to the DOL Rule will occur, but their likelihood of success is below 50/50. As a result, all firms and advisers should be seeking to adapt to the new Rule.

    In adapting, firms and advisers should take care to fully comply with the Impartial Conduct Standards required under the Best Interests Contract Exemption. Given the substantial academic research regarding the impact of fees and costs on investor returns, and the express language used by the DOL in announcing BICE, the receipt of additional third-party compensation - without fee offsets - may be problematic. The result will likely be a substantial movement toward AUM fees, and to the selection of low-cost investment products.

    Congress Continues to Serve Wall Street, Not Main Street - But Congress Will Not Stop the DOL Final Rule.

    As the Republicans in Congress continue to vote on resolutions and bills that would seek to stop the implementation of the DOL's Final Rule, permit me to briefly comment on this political state of affairs.

    I have always been for government of a small size. There are a great many things that government fails to do well. Yet, there are areas where laws and regulation, carefully crafted, are required.

    The DOL's "Conflict of Interest Rule" (a.k.a., "Fiduciary Rule") is altogether necessary. In this most complex financial world, the vast information asymmetry between financial/investment adviser and client cannot be overcome through financial literacy efforts, nor through disclosures. The application of fiduciary standards to such a relationship is a natural consequence, supported by many public policy goals. Just as attorneys are not permitted to take advantage of unsuspecting clients, neither should investment advisers.

    Congress is 2017 will not succeed. It will make many efforts, but all will stall in the U.S. Senate or be vetoed by President Obama. Republicans, in undertaking these many but doomed legislative efforts, will continue to be seen as under the control of Wall Street. (Although, to be fair, a large number of "corporate Dems" in Congress have also been viewed as under Wall Street's influence). It could be said that voters of tired of the compact between Congress and monied interests - hence the rise of such polarizing personalities as Donald Trump and Bernie Sanders.

    And, as I set forth later in this post, Congress has been misled by Wall Street on the DOL's rule-making effort. (As Congress has previously been misled by Wall Street and the insurance companies, many times over.) You think Congress would learn. Then again, monied interests continued to possess outsize influence over our policy makers.

    Other developments could stop the DOL's Final Rule. Lawsuits are certain to be filed, probably with the insurance industry leading the way. But I would put their likelihood of success, in stopping the DOL Final Rule's implementation, at less than 50/50.

    And, a new Administration could seek to enact a new rule in 2017, that effectively would repeal the DOL's April 2016 Final Rule. But there is no assurance that such would occur, regardless of who is elected. Also, government rule-making in adherence to existing laws defining the scope of review and public commentary, takes tremendous time - far more time than the 2-1/2 month window between the installation of a new Administration and the April 1, 2017 effective date of the core of the DOL's rule's requirements.

    A new Congress could also enact legislation that more quickly and effectively stops the DOL's Rule, but getting enough votes in the U.S. Senate, in which neither party will likely possess a fillibuster-proof majority, may be problematic.

    The DOL's Admirable "Sole Interests" Application of the Fiduciary Standard.

    As as a principles-based rule, the DOL Final Rule sets forth principles that must be followed in the course of a relationship of trust and confidence. Even Adam Smith, the founder of modern capitalism, supported ethical rules of conduct.

    Ignoring the several exemptions the DOL promulgated, the Final Rule, at its core, is an example of the best form of government regulation. It applies ERISA's tough sole interests fiduciary standard of conduct, by requiring conflicts of interest to be avoided. ERISA's tough prohibited transaction rules are also applied, in the context of the statutory exemption from same that permits "necessary" services for "reasonable compensation."

    In essence, the DOL's Final Rule is elegant in its simplicity and in its application. It is an example of government getting things right.

    "BICE" - The "Best Interests" Version of the Fiduciary Standard - Did the DOL "Get It Right"?

    In contrast to the core of the DOL's Final Rule, the DOL also issued or modified several class exemptions. These exemptions, requested by the financial services industry, are far more complicated than the rule itself. (Wall Street complains about this complexity, but the DOL was only trying to meet Wall Street's requests while still availing consumers of ERISA's mandate that they be protected.)

    The "Best Interests Contract Exemption" is an attempt by the DOL to accommodate the wearing of "two hats" by a fiduciary - i.e., serving as the purchaser's representative while also permitting the receipt of third-party compensation (commissions, 12b-1 fees, payment for shelf space, soft dollar compensation, and other revenue-sharing). It seeks to ban the worst practices (sales quotas, prizes and trips and awards for reaching certain sales targets for a product, etc.), while permitting compensation by different means. In so doing, despite many changes to the rule, it mandates many disclosures to individual investors (although we all know such disclosures are largely ineffective as a means of consumer protection).

    However, in the Best Interests Contract Exemption (BICE) the DOL quite explicitly applied its strict "Impartial Conduct Standards." When you read the language of the BICE release carefully, you will find a strong (and correct) application of the "best interests" fiduciary duty of loyalty. In essence, the client cannot be harmed by the receipt of third-party compensation. Given the substantial (some would say overwhelming) academic research that higher fees and costs associated with investment products lead to lower returns for investors, one can easily conclude that the only way for a firm to receive additional compensation and fulfill BICE's requirements is to offset additional compensation against other fees the client pays.

    I believe most advisers, and eventually most firms, will conclude that either fee-offsets must be undertaken (to return the arrangement to agreed-in-advance reasonable and levelized compensation), or they will simply switch to some form of level fee arrangement (assets-under-management percentage fee, annual retainer, fixed fee for discrete advice, subscription-based fees, and hourly fees). In other words, I suspect BICE will not be used all that much.

    There is much to like about the final version of BICE and some of the changes the DOL undertook. For example, I like the fact that the DOL abandoned having a "legal list" of investments, and instead relying upon the required due diligence of investment advisers to properly formulate investment strategies and to select investment products. I also admire the DOL's elicitation of the best interests fiduciary standard, and the DOL's resistance to Wall Street's many attempts to redefine "best interests" as a version of suitability.

    I remain concerned about BICE's enforcement. It remains to be seen whether broker-dealers will be subject to more (successful) class action claims, given the difficulty of certifying a "class." The removal of punitive damages as a remedy, with only compensatory damages available, may lead firms to regard the costs of failing to comply with BICE's fiduciary duties as just a mere "cost of doing business." (Sadly, many individual advisers will see their reputations ruined in the process, while firms just trudge along.) And, FINRA's mandatory arbitration - with its emphasis on a "fair" or "equitable" remedy (appropriate when dealing with the weak suitability standard) - may serve to substantially weaken the enforcement of the fiduciary standard of conduct, and especially the enforcement of the BICE's Impartial Conduct Standards.

    I would also have preferred to see BICE sunset, in 6-7 years, as a temporary measure as the industry adjusts; I fear that, over time, BICE will be interpreted incorrectly and will then permit certain nefarious practices. We can only hope that a future Administration will repeal BICE, while preserving the Final Rule itself, once the industry has move much further toward the provision of advice under levelized compensation arrangements.

    The Interrelationship Between BICE's Impartial Conduct Standards and Academic Research

    A further "deep dive" into BICE is appropriate, in considering how to comply with its many requirements.
     
    A key aspect of the U.S. Department of Labor's Final Rule ("Conflicts of Interest") and its related Best Interests Contract Exemption (BICE) Final Rule deserve further analysis: "What does the term 'best interest" mean? And, how is it possible to comply with BICE'S Impartial Conduct Standards?"

    I was struck by an article appearing at WealthManagement.com written by David Armstrong, "Fiduciary Rule Takes Center Stage in Nashville," regarding comments made at the NAPA 401(k) summit in mid-April 2016. Leaving aside the credit that NAPA took for getting the streamlined exemption in place for level-fee advisers (the credit goes to many others, in my opinion, who were far more influential in both identifying the need for this and in promoting it to the DOL), the article stated:
    • "Leaders of the association, the largest trade group for retirement plan advisors in the country, kicked off the three-day event with a muted victory lap."
    • "'Ultimately, firms are going to have to decide if they are 'full BIC or BIC light' ... There is no third option.' There is more flexibility in how an advisor is compensated if they are using the full best interest contract exemption, but also more liability from trial lawyers. There’s less flexibility in compensation under the streamlined level-to-level version, but less liability.'”
    • "RIAs will go for the BIC light version, while deep-pocketed wirehouses will likely chose the full BIC version. 'How hybrid firms thread that needle remains to be seen,' Graff said."
    • "“One thing the DOL did not take away was the ability of trial lawyers to file class-action lawsuits” against firms thought to be in violation of the best interest contract exemption. “We have to see it as a cost of doing business,” he said.
    Additionally, over the past couple of weeks, I have spoken to many securities lawyers and compliance consultants. Many of these attorneys and consultants seem to be focusing on BICE's "policies and procedures," rather than the substantive requirements of the Impartial Conduct Standards applicable under BICE.

    Consultants have further stated to me that insurance company executives are "O.K." with BICE, and that insurance company executives are not troubled by its greater transparency requirements. And others have stated that BD executives believe not much will change, for their firms, in the end - under BICE.

    It seems to me that far too many BD and insurance company executives, and even the compliance / securities law consultants that provide advice in this area, have opined that it will be largely "business as usual" in dealing with IRA accounts. I suspect they are wrong. Please permit me to explain why.

    ERISA's sole interest standard is tough - it prohibits any conflicts of interest. In turn, the prohibited transaction requirements of ERISA serve to strengthen this requirement. If it were not for the statutory 408(b)(2) exemption, even fee-only advisers could not provide services to plans covered by ERISA.

    Yet, ERISA permits the DOL to issue class exemptions from the prohibited transaction rules - as the DOL has done with the Best Interests Contract Exemption (BICE). Yet, the requirement for a class exemption is that the exemption is "in the [best] interests of the plan and its participants and beneficiaries." Another requirement for a class exemption is that the exemption is "protective of the rights of particiapnts and beneficiaries of such plan." 29 U.S.C. Sect. 1108(a).

    Under state common law, and English law from which American common law is derived, technically the existence of a conflict of interest is a breach of a fiduciary duty. Under the sole interest (trust law-based) fiduciary standard, there is no method to cure for the breach by the fiduciary. Any conflict of interest is, per se, wrongful. And recession of the transaction, even when the entrustor (beneficiary, or client) is a remedy frequently applied.

    But, under the common law's best interest fiduciary standard, the conflict of interest are strongly disfavored, but is permitted in certain instances. A conflict of interest is a breach of one's fiduciary duty, but the assertion of a defense to the breach can occur. In essence, the breach of the fiduciary obligation can be "cured" - by only by demonstrating that the clients' best interests were not subordinated. Several steps are required for such a cure, including: (1) affirmative disclosure of the conflict of interest and all material facts regarding it; (2) ensuring the client understands the conflict (a burden placed on the adviser, not the client, recognizing that the duty to read when receiving advice from a fiduciary is somewhat abrogated, and that even with extensive counsel some clients may not be able to understand the material facts and the conflict of interest and its ramifications); (3) the client's informed consent; and (4) even then, that the transaction remain substantively fair to the client. And the courts take the view, properly so, that clients would never provide informed consent to be harmed.

    If you delve into the Final Rule and BICE, the DOL in its releases has a lot of language which sets forth that, although commission-based compensation might be acceptable (although I have concerns about the reasonableness of compensation for larger transactions), and differential compensation can be paid to a firm, still the client cannot be harmed.

    Just consider these excerpts from the DOL's release:
    • The advice must be provided “without regard to financial or other interests of the Adviser, Financial Institution, or any Affiliate, Related Entity or any other party.
    • Financial Institutions must refrain from giving or using incentives for Advisers to act contrary to the customer’s best interest.
    • Stated differently, “[t]he Adviser may not base his or her recommendations on the Adviser’s own financial interest in the transaction.”
    • However, the DOL noted that BICE’s “goal is not to wring out every potential conflict, no matter how slight, but rather to ensure that Financial Institutions and Advisers put Retirement Investors’ interests first, take care to minimize incentives to act contrary to investors’ interests, and carefully police those conflicts that remain."
    • As to the use of the phrase “other party,” the DOL stated that it “intends the reference to make clear that an Adviser and Financial Institution operating within the Impartial Conduct Standards should not take into account the interests of any party other than the Retirement Investor – whether the other party is related to the Adviser or Financial Institution or not – in making a recommendation. For example, an entity that may be unrelated to the Adviser or Financial Institution but could still constitute an ‘other party,’ for these purposes, is the manufacturer of the investment product being recommended.”
    • The DOL noted that “full disclosure is not a defense to making an imprudent recommendation or favoring one’s own interests at the Retirement Investor’s expense.”
    • The DOL provided a specific example of the application of these requirements: “[F]or example, an Adviser, in choosing between two investments, could not select an investment because it is better for the Adviser’s or Financial Institution’s bottom line, even though it is a worse choice for the Retirement Investor.”
    • The DOL also cited several decisions addressing the requirements when a conflict of interest is present: “Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982) (“the[] decisions [of the fiduciary] must be made with an eye single to the interests of the participants and beneficiaries”);
    So, here's the rub. Where does additional (differential) compensation paid to the firm come from? From the products that are recommended. And, all things being equal (i.e., same asset class, same characteristics), that product will have higher expenses, to pay for such additional compensation to the firm recommending the product under BICE.

    Please note that an overwhelming body of academic research reveals (and, I would say, concludes) that higher fees and costs for mutual funds (and, by extension, to other products) results in lower returns to the investor. Witness the following research in this regard:
    • Actively managed funds tend to underperform their benchmarks after adjusting for expenses, and the probability of earning a positive risk-adjusted return is inversely related to expense ratios. (Haslem et al., 2008).
    • Although a small number of early studies find that mutual funds having a common objective (e.g., growth) outperform passive benchmark portfolios, Elton, Gruber, and Blake (1996)  argue that most of these studies would reach the opposite conclusion if survivorship bias and/or adjustments for risk were properly taken into account.
    • Expense ratios and turnover are negatively correlated with return. (Carhart, 1997 ; Dellva & Olson, 1998 ; O’Neal, 2004).
    • Loads are also negatively associated with fund performance (Carhart, 1997 ; Dellva & Olson, 1998 ).
    • Load funds underperform no-load funds by an estimated 80 basis points (bps) per year (Carhart, 1997).
    • Transaction costs also decrease the potential benefit of active management (Carhart, 1997).
    • Opportunity costs exist due to cash holdings by funds. Hence, part of this underperformance is because actively managed mutual funds have higher liquidity needs for frequent purchases and redemptions. (O’Neal, 2004).
    • Lower performing fund have higher fees, and high-quality funds do not charge comparatively higher fees. (Gil-Bazo & Ruiz-Verdu, 2008).
    • As a result of lower expenses, broad index funds tend to outperform actively managed funds with equivalent risk. Therefore, the best way for most investors to improve performance is to have a broad index fund with minimal costs (Malkiel, 2003).
    • As stated in a 2011 paper, using data on active and passive US domestic equity funds (the sample included a total of 13817 funds while the CRSP Mutual Fund Database) from 1963 to 2008, the authors observed: “Similar to others, we first show that fees are an important determinant of fund underperformance – that is, investors earn low returns on high fee funds, which indicates that investors are not rewarded through superior performance when purchasing ‘expensive’ funds. We explore a number of hypotheses to explain the dispersion in fees and find that none adequately explain the data. Most importantly, there is very little evidence that funds change their fees over time. In fact the most important determinant of a fund’s fee is the initial fee that it charges when it enters the market. There is little evidence that funds reduce their fees following entry by similar funds or that they raise their fees following large outflows as predicted by the strategic fee setting hypothesis. We also do not find evidence that higher fees are associated with proxies for higher service levels provided to investors. Overall, our findings provide little evidence that competitive pricing exists in the market for mutual funds.”
    • Vidal et. al., 2015: High Mutual Fund Fees Predict Lower Returns. “[We confirm the negative relation between funds´ before fee performance and the fees they charge to investors. Second, we find that mutual fund fees are a significant return predictor for funds, fees are negatively associated with return predictability. These results are robust to several empirical models and alternative variables.” Marta Vidal, Javier Vidal-García, Hooi Hooi Lean, and Gazi Salah Uddin, The Relation between Fees and Return Predictability in the Mutual Fund Industry (Feb. 2015).
    • Sheng-Ching Wu, 2014: High-Turnover Funds Have Inferior Performance. “[F]unds with higher portfolio turnovers exhibit inferior performance compared with funds having lower turnovers. Moreover, funds with poor performance exhibit higher portfolio turnover. The findings support the assumptions that active trading erodes performance….]
    • Blake, 2014 (UK): Average Fund Manager in UK Unable to Deliver Outperformance Using Either Selection or Market Timing. “[U]sing a new dataset on equity mutual funds [returns from January 1998–September 2008] in the UK … [we] find that: the average equity mutual fund manager is unable to deliver outperformance from stock selection or market timing, once allowance is made for fund manager fees and for a set of common risk factors that are known to influence returns; 95% of fund managers on the basis of the first bootstrap and almost all fund managers on the basis of the second bootstrap fail to outperform the zero-skill distribution net of fees; and both bootstraps show that there are a small group of ‘star’ fund managers who are able to generate superior performance (in excess of operating and trading costs), but they extract the whole of this superior performance for themselves via their fees, leaving nothing for investors.”
    • Ferri and Benke (2012). Using the “CRSP Survivor-Bias-Free US Mutual Fund Database … maintained by the Center for Research in Security Prices (CRSP®), an integral part of the University of Chicago Booth School of Business … In all portfolio tests, there was some benefit to using low-cost actively managed funds, but not as much as we expected, given the reported impact that fees have on individual fund performance. The probability of outperformance by the all index fund portfolios remained above 70% in all scenarios … We speculate that filtering actively managed funds may shift the probability curve closer to an all index fund portfolio as in the low-expense example, but we are not convinced that any filtering methodology will significantly alter the balance in favor of all actively managed funds. This may be an area for future research … A diversified portfolio holding only index funds in all asset classes is difficult to beat in the short-term and becomes more difficult to beat over time. An investor increases their probability of meeting their investment goals with a diversified all index fund portfolio held for the long term.”
    Please note that I am not stating that index funds are required to be utilized. I don't believe the body of research regarding the use of low-cost actively managed funds has been fully developed, yet. And, some index funds suffer from substantial market impact costs during reconstitution. More research in this area is required, and I believe we might suggest that low-cost index funds are (usually) a prudent choice for advisers. Yet, very low-cost actively managed funds might also be prudent, and some research appears to support this view.

    Yet, given the strong academic evidence available, I believe it is reasonable to conculde that, to the extent investment advisers believe that they can recommend higher-cost products that pay their firm more, with no harm to the client, these investment advisers are not acting as expert advisers with the due care required of a fiduciary. And, if those higher-cost products result in additional compensation to the adviser's firm, that's also a breach of the fiduciary duty of loyalty.

    So, under BICE - the allowance of differential compensation cannot, under the express language the DOL has utilized in its release, in several places - harm the client. Yet, the academic research is clear - higher compensation flows for recommending higher fee/cost products which, all things being equal, result in lower returns to the investor. Many experts from the world of academia will be available to testify for this proposition.

    The DOL did set forth examples on how to cure the breach of fiduciary duty that flows from the conflict of interest resulting from differential compensation. For example, the receipt of additional compensation could serve to offset other fees - essentially returning to a level-fee arrangement. When banks were permitted around the early 1990's to convert common trust funds to proprietary mutual funds, the approach taken by many (but not all) state legislatures was to require proprietary fund management fees to be credited against trustee fees. (Although, the presence of relatively high fund administrative fees, paid in part to affiliates, reveals a weakness in enforcement of the principles involved, by the FDIC and OCC.)

    In essence, the way I read the DOL's Best Interests Contract Exemption, most firms and advisers should embrace AUM fees. However, for the very small clients (perhaps with accounts of $25,000 or less) a commission-based platform could be used - provided the commissions for all products on the platform are the same (at least for similar products) (otherwise, a conflict of interest exists that cannot be properly managed).

    I have heard BD execs say, "We are not worried about increased transparency" or "higher disclosure burdens." Of course, this is because disclosures are largely ineffective.

    I have also heard BD/insurance company execs state that should clients complain about the conflicts of interest / higher-fee products, that resolving such complaints is just a "cost of doing business." The DOL Final Rule prohibits punitive damages, which would serve to deter bad conduct. And rescission as a remedy is also unavailable. [Class actions are permitted, but under what circumstances can you certify a class of IRA owners? That's an open question.]

    Additionally, concerns exist regarding the efficacy of arbitration. One might argue that arbitration, with FINRA's instruction to arbitrators to be guided by equity (i.e., to do what is "fair"), can easily diminish the fiduciary protections, which should be strictly enforced. This remains to be seen. (One can also argue that the pursuit of "fairness" also helps complainants, in arbitration, to prevail when the low "suitabiity" standard would not permit recovery.)

    This sets up an interesting dynamic. Firms won't fully comply with the Impartial Conduct Standards' requirements, in order to secure more profits. And they will litigate/settle complaints, as a cost of doing business, given that the size of any compensatory damages awards would be far less than the additional profits firm make by ignoring the Impartial Conduct Standards. Any reputational risk at the firm level is mitigated - first by settlement "keep quiet" clauses - and next by large advertising budgets and the short memories of the public.

    Yet, advisers will see preservation of their reputation as a most important factor driving their business and everyday decisions. Individual advisers will not want to see complaints that lead to their U-4s being tarnished.

    Also, note that differential compensation will be paid to the firm, but not passed on to the adviser, as under BICE the individual advisers cannot be incentivized to do harm.

    So, what will happen? If BD firms don't move to fee offsets, or (preferably) AUM platforms with low-cost investment products (with no product provider compensation to the BD firm), then in all likelihod individual brokers will be conflicted - and worried about their reputation. And these individual brokers will speak with their feet - by departing the firm.

    As a result - in order to retain advisers (and reduce compliance and litigation costs) - I suspect that some, perhaps the majority, of larger BD firms will embrace largely conflict-free AUM platforms for their registered reps to use. These AUM platforms will use low-cost ETFs and low-cost funds that provide no additional compensation to the BD firm or its representatives.

    But, many BD firms will not properly adopt a true fiduciary culture - and the reps in those firms will suffer, or depart, or both.

    If I am correct, then the DOL rule - with its application of the fiduciary standard to DB, DC and IRA accounts - about 60% of publicly traded investments in the US (if you exclude bank deposits) - will be transformational in financial services. It will accelerate the move toward fee-based compensation that was already largely underway.

    In the end, the DOL's rule-making efforts will force investment products to compete on their merits, not on the basis of how much commission is paid or how much revenue sharing or "marketing support" payments are paid to the BD firm.
    The DOL's Fiduciary Rule: Impacts Upon Financial Services.

    The DOL's Fiduciary Rule, if properly applied and enforced, will serve to transform the financial services industry. We have already seen a major shift in recent years toward levelized compensation arrangements, and the DOL's Rule will only accelerate this process. We have already seen low-cost products gain market share, and we have seen competitive pressures (via new applications of technology, and otherwise) force adviser's compensation lower.

    As the DOL's rule is applied, and firms continue to adjust, greater competitive pressures will emerge over time. leading to even lower fees and costs associated with investment products and the receipt of investment advice. This is good for consumers. And, as greater capital accumulations will result, this is good for the U.S. economy.

    The provision of investment advice continues to migrate toward a professional services business model. Yes, there will still be "mega-firms" of advisers, much of the same size of the largest broker-dealer firms today. But, similar to the legal and accounting professions, many mid-size regional and local firms will continue to expand in number. And, it is likely that the majority of advisers will reside in 1-5 person firms.

    One huge consequence of the DOL's Final Rule is the need to justify (and document), in the IRA rollover context, the value of the services provided. As a result, firms will continue to expand their value-added service offerings, including all-important financial and tax planning services. With the rise in financial planning services will come increased demand for new financial planners; this bodes well for our universities as they accelerate enrollment in their undergraduate financial planning programs.

    Additionally, all advisers need to get better at due diligence, in both investment strategies and investment product selection. Greater scrutiny is required of the strategies and products already utilized by advisers, and greater inquiry is needed into the universe of strategies and products to discern the very best that can be employed to serve client needs.

    Finally, if we continue to evolve toward a model in which consumers can trust their financial services providers, and if we continue to get better in our expertise, there could well be an explosion in the demand for financial planning advice over the next decade.

    Eventually financial planning may become a true profession, bound together by the fiduciary principle. Many steps remain, but the DOL Fiduciary Rule is a significant advancement toward that goal.

    Thursday, March 10, 2016

    DOL Conflict of Interest Rule: A Message to Congress

    Executive Summary: What Wall Street Does Not Want Congress to Know.
    • Brokerage firms and insurance companies are already adapting to the DOL's Conflict of Interest (Fiduciary) Rule - rolling out programs to serve clients both large and small with reduced-fees-and-cost, largely conflict-free platform offerings.
      • Some firms started to adapt even before the release of the Final Rule in early April 2016.
      • Many brokerage firms have already lowered, or are in the process of lowering, the fees of their advisory platforms.
      • Many brokerage firms are reducing their account minimums, so that they can serve even smaller clients.
    • It is clear that the Rule will benefit business owners (plan sponsors), by substantially reducing the risks they face in excessive fee litigation cases. Expect more 401(k) plans to be offered.
      • Business owners currently possess little or no recourse against their "retirement plan consultants," most of whom escape liability under the weak "suitability standard" that largely protects brokerage firms and insurance companies from liability for the advice they provide. As a result of the DOL fiduciary rule, business owners won't be "left hanging and out to dry" for relying upon the recommendations made by these "retirement plan consultants."
      • Both large and small business owners should be entitled to rely upon the advice they receive, as to the investment options to include in their company's retirement plan.
      • The fiduciary standard operates as a constraint on greed. "Bad choices" - i.e., expensive, inappropriate, rent-seeking investments - will be done away with under the fiduciary standard.
      • With the ability to trust the investment adviser to the plan, and with reduced risks, more business owners are likely to start and maintain qualified retirement plans.
    • Because the level of trust in financial services will rise, and lower fees and costs will mean greater returns for investors, a new era of increased capital formation will occur. This, in turn, will accelerate the growth of the U.S. economy over the long run, further boosting prosperity for all Americans.
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    Dear Members of the U.S. Congress:

    In the ongoing battles over the U.S. Department of Labor's enactment of its "Conflicts of Interest" (fiduciary) rule, over and over again I have observed Wall Street firms, insurance companies, and their lobbying organizations (SIFMA, FSI, and NAIFA) spout various misleading and often downright false statements.

    In this blog post I point to many of the sources in which Wall Street's lies are unmasked, and their double-talk is revealed.

    I hope you will do your own review of the evidence, and ascertain that - once again - Wall Street is intentionally misleading you.

    Prior to examining Wall Street's statements in more detail, please permit me to dispel any misconceptions you may possess about the SEC and the DOL working together - they intensively engaged in meaningful, cordial discussions, and their dialogue led to a better rule.

    I've scanned the 2,500+ pages of emails and correspondence between the two agencies. My scan reveals two agencies working together well, offering thoughtful insights and suggestions to each other.
    • The fiduciary standard under ERISA is a "sole interests" standard, augmented by ERISA's prohibited transaction rules. The fiduciary standard under the Investment Advisers Act of 1940 is a "best interests standard." While similar in most respect, differences exist. Hence, absent major Congressional action that changes either ERISA or the Advisers Act, the U.S. Department of Labor's application of the fiduciary standard will be different from that of the U.S. Securities and Exchange Commission.
    • Despite these differences, the DOL and SEC have conferred on the DOL's rule-making, extensively. While the Majority Staff of the U.S. Senate Committee on Homeland Security and Governmental Affairs issued a 40-page critical of the extent of communication, one need only review the over 2,500 pages of e-mails, drafts circulated between the DOL and SEC (and comments thereon), attendee lists of joint meetings of the DOL and SEC staff, and much more, to ascertain both the huge breadth and depth of the communications between the two agencies over several years time. 
    • Furthermore, while the Majority Staff report was critical of a dialogue between two economists, who has never known two economists to not disagree? Additionally, from the perspective of this writer (a professor of finance and financial planning), the DOL's economist's statements in the two economist's written exchanges were correct, while the SEC economist appeared to lack knowledge of how the financial services industry works, the huge body of academic research relating to the behavioral traits of consumers, and much more.
    Let's More Closely Examine Wall Street's Many Misleading and False Statements about Fiduciary Rule-making.
    • A STATEMENT COMPLETELY UNTRUE AND THE REVERSE OF WHAT WILL ACTUALLY HAPPEN: "SMALL BUSINESS OWNERS WILL BE HARMED." Yet, all logic dictates otherwise, as I've explained here and here). The reality is that business owners both large and small are exposed to excessive fee litigation lawsuits, often with no recourse against their "retirement plan consultant" who hide behind the "suitability shield" and who do not possess fiduciary obligations to the plan sponsor (i.e., business owner). The DOL's Conflicts of Interest Rule corrects this situation, so that plan sponsors are not "hung out to dry" for relying upon the recommendations of a "retirement plan consultant." I predict that more 401(k) plans will be formed by small businesses, not less, given the greatly reduced liability exposure of plan sponsors when such plan sponsors (small business owners, generally) receive advice as to investment selections for the plan under a fiduciary standard.
    • A GROSSLY FALSE ASSERTION: "FEES AND COSTS WILL RISE FOR INVESTORS." This is exactly the opposite of what will actually occur, as explained by numerous economic studies. This is also confirmed by my own personal observations, from observing hundreds and hundreds of clients over the past 15 years. I observe that clients' total fees and costs fall usually in the range of 30% to 70%. Fees and costs matter to the returns investors secure, as I've explained here. Under the fiduciary standard, the adviser becomes the steward of the client's wealth, with the obligation to incur only reasonable fees and costs. (See also the discussion below, where new fee structures have already emerged under the fiduciary standard from broker-dealer firms, in which fees have been lowered.)
    • A STATEMENT CONTRARY TO ALL THE EVIDENCE! "SMALL INVESTORS WON'T BE SERVED." Yet, I provide insights into entire networks of fiduciary, fee-only advisers that already serve small investors, in "How to Choose A Financial/Investment Adviser: A Checklist for Consumers." In addition to these networks, as well as newer online investment advice platforms that have emerged, we have seen many existing firms already adopt new platforms to serve smaller clients:
      • The Wall Street Journal reported on March 16, 2016, that brokerage firms are actually LOWERING their minimums, and LOWERING their fees, for SMALL CLIENTS! 
        • "The brokerages are trying to avoid losing small-balance, commission-based retirement accounts because of the rule, while also positioning themselves to gather more fee-based revenue. LPL Financial Holdings Inc., based in Boston, said ... that it would lower its minimum for certain fee-based accounts by $5,000, to $10,000, this year, while also cutting some of the costs associated with those accounts."
        • "Edward Jones plans to roll out new low-cost accounts that charge an annual fee to investors with as little as $5,000, according to Jim Weddle, the firm’s top executive. D.A. Davidson & Co. of Great Falls, Mont., is in the process of developing a similar product, according to an executive."
      • Ladenburg Thalmann, one of the country's largest independent broker-dealers, is rolling out $ymbil, its new digital advice platform. The self-service portfolio account will be made available to its advisor network and will require a minimum  of only $500 investment to open an account.
      • Margarida Corral of Financial Planning magazine reported on March 31, 2016: "CUSO Financial Services and Infinex Financial Group are planning to not only lower minimums and adjust pricing on advisory accounts but are making arrangements to partner with digital advice providers – all in an effort to serve the widest range of customers in the new regulatory environment, including small investors with modest savings." 
      • Further evidence of the adjustments already taking place at broker-dealer firms can be discerned from a May 15, 2016 article from GlobeNewswire, where it was noted: "FolioDynamix offers a solution that can help firms transition their commission-based business into advisory accounts. There are even options for smaller-balance accounts that might not normally meet managed account thresholds. Key firms have already begun taking advantage of this solution ...."
      • Industry consultant Cerulli Associates "anticipates large broker/dealers (B/Ds) will use developing technology to serve smaller accounts on a flat-fee basis, and insurance companies will be forced to lower variable annuity expenses and commissions to be in line with other financial products."
        • "CUSO Financial Services  and Infinex Financial Group are planning to not only lower minimums and adjust pricing on advisory accounts but are making arrangements to partner with digital advice providers – all in an effort to serve the widest range of customers in the new regulatory environment, including small investors with modest savings.
        • With the expected shift to fee-based advisory business, firms want to make sure that their advisory offerings are competitive in terms of both their account fees and minimums.
        • Infinex, for instance, is in the process of lowering its minimum balance requirements on all of its advisory products so that it "can offer advisory products to a wider audience," says Stephen Amarante, president and CEO of the broker-dealer.  He noted that Infinex is rolling out more tiered pricing to appeal to a broader range of clients, despite the fact that the firm's pricing is already extremely competitive, especially on the lower end.
        • CUSO Financial is also looking into changes to its advisory offering with a view to helping smaller clients who don't have assets to meet program minimums. "We have been looking at tweaking programs and developing new programs that will have lower minimums and lower fees to work best with this segment of our clients," says Peter Vonk, CUSO's chief compliance officer and executive vice president of business services. 
        • For the smallest customers, both CUSO and Infinex are planning to use robo technology platforms.  An investor who is adding just $50 a month to his 401(k), for example, might be better served under a digital platform, Amarante notes. While these smaller accounts would be served using automated technology, they would still be managed by an advisor, he says.
        • CUSO is in discussions with several digital advice providers and anticipates having a platform implemented long before the final rule becomes effective. "We expect to have solutions to continue to meet everyone from the ultrahigh-net-worth to the folks who are just starting out on their investment journey," Vonk says."
      • Large Wall Street Firms Have Already Transitioned Much of Their Business to Fee-Based Accounts! The Wall Street Journal's columnist, Jason Zweig, wrote on April 4, 2016: "Giants like Morgan Stanley and Bank of America Corp.’s Merrill Lynch are already moving away from commissions, because fee-based revenue is more stable and less tied to market swings. Morgan Stanley’s wealth-management division, for example, already has 40% of client assets in accounts that charge an annual fee. That helped it generate $8.5 billion in fee-based revenue last year, or 70% of its total. In January, Morgan Stanley projected a 5% to 13% increase in pretax profitability at its wealth unit in 2017, partly as a result of its continuing shift to fee-based accounts."
    • ANOTHER MISLEADING STATEMENT: "CHOICE IS ELIMINATED." Only bad choices will be limited. At its core, the fiduciary standard operates as a restraint on greed, as I've explained here. Even Adam Smith recognized the need for standards of conduct! And, the fact of the matter is that new, lower-cost products will emerge for investors - as has already occurred both before and after the announcement of the DOL Final Rule!
    • A MISLEADING STATEMENT. IN FACT, IF "COMPLEXITY" IS A PROBLEM, IT'S ONE OF WALL STREET'S OWN MAKING! - "THE RULE IS TOO COMPLEX." At its core, the application of the fiduciary standard to retirement accounts (qualified plans and IRAs) is done through a principles-based standard grounded in centuries of legal precedent. The core rule is simple, straightforward, and elegant.
      • The "Best Interests Contract Exemption" (BICE) - which Wall Street and the insurance companies complain about as being "too complex" - only exists because of the DOL's effort to accommodate Wall Street's business practices. Even then, the core of BICE - found in its Impartial Conduct Standards - remains a straightforward, elegant elicitation of the core fiduciary standards of conduct. Wall Street decries BICE, however, for its "complexity" and the requirement of "more disclosures." Yet, if Wall Street does not desire to operate under BICE, all they need to do is operate under ERISA's principles-based standard, with no additional exemption required - as thousands and thousands of investment advisers already do, every single day!
    • AN UTTERLY FALSE STATEMENT: "THE RULE DETERS CAPITAL FORMATION." Wall Street argues that capital formation will be deterred. But, the opposite occurs, as more wealth is accumulated as excessive rent-taking is reigned in, thereby accelerating the retention and growth of capital. This in turn provides the fuel for future U.S. economic growth, as I've explained here). An added bonus is that the capital markets become more efficient in allocating capital, as greater due diligence is undertaken among various investments by expert advisers.
    Wall Street's hypocrisy gets even worse. Let's examine conflicting statements from ICI.

    Insights can be gleaned from the Investment Company Institute (ICI) in its Nov. 15, 2013 letter in opposition to the California Secure Choice Retirement Savings Program. ICI represents large asset managers, many of whom will see their revenues fall as a result of the rule and the shift to lower-cost investment products. While ICI now opposes the DOL's fiduciary rule, and its application of ERISA's fiduciary standards to 401(k), certain other qualified retirement accounts, and IRAs, just look at what ICI stated in 2013 regarding the benefits of ERISA:
    • "ERISA's purpose is to protect the benefits of private sector workers and we see no justifiable reason to deny these fiduciary protections to workers ....";
    • "Many financial services providers .... offer low-cost 401(k), 403(b) and IRA-based plans to employers large and small";
    • "We question whether denying Program participants the fiduciary protections or ERISA would benefit private-sector workers"; and
    • "In our view, to essentially give workers participating in the Program no recourse to hold any party responsible for the decisions made and actions taken with respect to their retirement savings would be unfathomable" [yet, this is what occurs, de facto, under the current extremely low "suitability" standard of conduct, which lowers the standard of care of brokers and permits them to sell often-high-cost and inappropriate products to consumers, as I explained here].
    Many Others are Pointing out Wall Street's Misleading Statements and False Assertions.
    • fi360 and ThinkAdvisor have for several years conducted a survey of financial advisors. The survey summarizes its findings: "The fiduciary model works for advice and money management – registered investment advisers have been profitably providing advice that’s in the best interest of their clients since 1940. However opponents of the fiduciary standard say some brokers would leave the industry, or charge investors more for advice, or wouldn’t work with small investors if regulators extended the fiduciary standard. Findings of the fi360 Fiduciary Standard Survey do not substantiate those fears."
    • Senator Warren and Representative Cummings blasted the insurance companies in theIr Feb. 11, 2016 letter to the DOL and OMB. Pointing out the insurance companies' contradictory statements,  Sen. Warren and Rep. Cummings stated: "In contrast to their public doomsday predictions, industry leaders have told their own investors that they 'don't see this as a significant hurdle,' 'will once again respond to marketplace or regulatory changes effectively,' and that they are well-positioned to 'adapt to any regulatory framework that emerges.'"
    • "Senator Warren Calls for SEC Investigation Into Financial Services Providers Over Contradictory Statements on the DOL Conflict of Interest Rule": Senator Warren, in a March 31, 2016 letter to the SEC, questioned whether insurance companies (who also act as broker-dealer firms, through a subsidiary) were violating federal securities laws by making misleading statements to shareholders. Senator Warren pointed out that, in one instance, a firm "saying almost simultaneously [to the DOL] that the rule would be 'unworkable' and [to its shareholders] that the rule would not be "a significant hurdle." Senator Warren's letter further set forth these examples:
      • In July 2015, Dennis Glass, the president and CEO of Lincoln National said in his comment letter that the proposed rule was "immensely burdensome" and "extremely intrusive," and would be "so burdensome and unworkable that financial advisors and firms will not be able to use it."; while two months earlier, Mr. Glass told investors that he didn't "see [the proposed rule] as a significant hurdle for continuing to grow that business."
      • In July 2015, the president of Jackson National Life Insurance Company said in his DOL comment letter that the proposed rule would "be very difficult, if not impossible for financial professional and firms to comply" with; then, in August 2015, the president of Jackson's parent company told investors that a similar rule in the United Kingdom actually led to an increase in retail sales and that the company was positioned to "build whatever product is appropriate under that set and adapt faster and more effectively than competitors."
      • In July 2015, the president and CEO of Transamerica' s Investment and Retirement Division said in a comment letter that the proposed rule was "unworkable"; then, a month later, the president of Transamerica's parent company told investors that the company had "shown ... flexibility and ... expect[ed], with that flexibility, [to] remain very strongly positioned in a market that is providing products that millions of customers in the U.S. continue to need."
      • In July 2015, Prudential Financial's Executive Vice President and General Counsel wrote in a comment letter that some of the proposed rule's provisions posed a "significant challenge" that "will significantly increase" the firm's servicing expenses; that same month, another Prudential Financial official told investors that the proposed rule would not stop the company from "mak[ing] these offerings available on terms that work for everybody." 
    • Industry commentator Bob Clark recently unveiled how Wall Street speaks double-talk about commissions resulting in lower fees to investors, when in reality commissions (and other revenue-sharing arrangements, in addition to commissions) result in far greater compensation to brokers (and, as a result, less returns to investors).
    • Josh Brown, a former broker - now a fiduciary - unveils "The Most Horrendous Lie on Wall Street"- stating in part: "The incentives paid by fund companies to brokerage firm sales forces across the country are a cancer that must be rooted out."
    CONGRESS - IT'S TIME TO DO THE RIGHT THING!

    The fact of the matter, the rule is good for individual consumers, and good for the future economic growth of America, and the prosperity of all Americans.

    This is an example of prudent regulation that possesses huge benefits for Americans and America, far in excess of the one-time costs associated with its implementation.

    The DOL's rule may possess an impact on some broker-dealer firms, some insurance companies, and some asset managers - but only if they don't change their conflict-ridden business models. Those firms that embrace change and react proactively to the rule will likely gain market share, attain a more stable stream of revenue, and thereby increase the value of their business entities.
    • [By way of explanation, brokerage firms charging commissions, predominately, are typically valued at 1x gross revenue. But firms charging primarily fees, such as annual asset-under-management fees, because of the stability of the income stream and the greater depth of relationships with their clients, typically are valued at 2x-5x gross revenues. Brokerage firms can actually increase the price of their shares, and benefit their shareholders, by moving to fee-based accounts.]
    As discussed above, the fact of the matter is that many broker-dealer firms and insurance companies are already adjusting to the new rules. Some are even lowering minimums for new clients - as well as lowering fees!

    In summary, the DOL's Conflict of Interest Rule will:
    • restore the trust of Americans in their financial and investment adviser;
    • reduce the excessive rent-taking by Wall Street from individual investors;
    • benefit business owners, both large and small, by reducing the risks they face in connection with qualified retirement plan accounts;
    • lead to substantially better retirement outcomes for our many friends and neighbors as the reduced fees and costs result in higher returns for individual investors; and
    • result in greater capital accumulation, fueling an explosion of economic growth in the United States over the long term.
    Members of the U.S. Congress - Do The Right Thing! ... Support the DOL's Conflict of Interest Rule.
    Support a government action that is long overdue, and that fosters a hugely positive and beneficial result for your fellow Americans.

    Support an elegant rule that will promote America's future economic growth. 

    Ron's past speaking engagements, webinars and articles/posts since the DOL Final Rule was announced:
    • Financial Planning magazine, webinar with other participants
    • Garrett Planning Network, webinar (April 2016) (membership in GPN required)
    • AICPA - podcasts and white paper (April 2016) (registration required)
    • The Wall Street Journal - Ron answers questions with other experts about the DOL's Final Rule in this series of articles:
    Please note the upcoming speaking engagements by Professor Ron A. Rhoades. Attend these presentations to learn more about the DOL Conflicts of Interest (Fiduciary) Rule and its impact on financial services and business practices:
    • FPA Kentuckiana, Louisville, KY - Sept. 2016 (date tentative)
    • FPA of Portland and SW Washington - Sept. 2016 (date tentative)
    • FPA of Southwest Florida - Estero Country Club - Oct. 20, 2016 presentation
    [If your organization is interested in having Professor Rhoades speak about the rule, please contact Ron at: Ron.Rhoades@wku.edu. Thank you.]


    Dr. Ron A. Rhoades is an Assistant Professor of Finance and Director of the Financial Planning Program, Gordon Ford College of Business, Western Kentucky University, in Bowling Green, Kentucky. Over the past decade he has undertaken substantial legal research and writing regarding the fiduciary standard of conduct, as applied to investment and financial advisors. Dr. Rhoades is a frequent speaker on the fiduciary standard at financial planning and investment industry conferences.

    (This blog represents the personal views of the author, and not necessarily the views of any institution, organization or firm with whom the author may be associated.)