Saturday, January 23, 2016

How Can Broker-Dealer Firms Adapt to the New Fiduciary Regime?

If the DOL's fiduciary ("Conflicts of Interest") rule is finalized in 2016 (which appears likely), and if it is not repealed by a subsequent administration (possible, if Republican U.S. President is elected), then broker-dealer firms of all kinds face huge challenges. It is likely that 40% to 60%, and possibly more, of BD's asset base would be governed by fiduciary regulation. And SEC rule-making would likely follow in subsequent years, transforming even more to some type of fiduciary standard.

Essentially, this means an era of transformation for most broker-dealer firms. Some have already begun the transformation, via the adoption of nearly conflict-fee programs to serve their clients. Others have publicly stated that they have made changes, but the changes made are mere window-dressing. Still others have their heads in the sand. See "Who Moved My Cheese?" - Part 1.

In this blog post I explore strategies broker-dealer firms can undertake to respond to the upcoming shift from a sales-dominated financial services industry, to an era of fiduciary professionals providing investment advice.

Some changes should occur immediately. Other changes require wholesale changes to the firm's vision, mission, strategies and culture - which requires a concentrated effort at all levels of the organization, commencing with top management.


When the fee-based accounts rule was overturned in 2007, a huge number of brokerage accounts were shifted into investment advisory accounts. And a huge number of registered representatives became dual registrants. Since this takes time, and time is short, begin the process of getting Series 7-licensed reps their Series 66 licensure, immediately.


Let's face it: a few clients will not desire investment advice; they just want products. And some older advisers won't desire to change, and will rather deal with non-fiduciary accounts only than take on fiduciary status. Hence, a sales channel will need to be maintained, perhaps for at least five years (or more), as the "old guard" transitions to retirement, or departs the industry altogether.


Executives of broker-dealer firms first need to "go to school" - in the sense that they must learn about the fiduciary standard of conduct and the reasons for its imposition. Without an understanding of "why" fiduciary status is imposed, the nature of the fiduciary-entrustor (i.e., advisor-client) relationship, and the specific fiduciary duties that flow from fiduciary status, the next steps can't be accomplished effectively.

How? Unfortunately, many broker-dealer firms will turn to their longstanding law firms for guidance. But many of these firms, and the attorneys within them, possess as part of their own culture (after years of service to the industry) a pattern of advising broker-dealers on how to escape fiduciary status, or they have been called upon to issue opinions that suggest fiduciary standards are far weaker than they really are. So, perhaps outside sources should be looked at, instead.

For initial readings in this area, I suggest:


Of course, the decision must be made, at the very top level of the firm, to transition the firm to a fiduciary culture. The firm's Board of Directors must realize that the firm must adapt, and quickly, for its very survival.

Part of this will be the design and embrace of a new vision statement for the firm. And a new mission statement. These are not just minor adjustments, nor should they be taken lightly. Rather, the firm's vision and mission will form the basis for Step 3, below.

I predict that broker-dealer firms that adapt quickly, and correctly, will gain market share over their competitors. Their revenues will decline, on average per client, but market share gains can keep profitability measures high.

Broker-dealer firms that are late to the table will find their revenues falling precipitously, and will lack the resources to make the transition at some later date. These firms will likely be forced into mergers or acquisitions, in order to survive.

I gave a presentation to the "big firms" at a conference a couple of years ago. I suggested to the audience of mid-level executives gathered that the broker-dealer firms embrace a fiduciary culture and fiduciary principles, by altering their business methods. My message was met with incredulity. How, they asked, could they choose their clients interests over the interests of their shareholders? My reply was simple and direct - your market share continues to shrink; what will your shareholders think when your firm is but a footnote in history, 20 years from how, if you don't change?


Broker-dealer firms with exceptional leaders, able to transform the firm from a sales culture to a fiduciary culture, will thrive in the years ahead. Firms whose leaders do not understand the nature of the fiduciary-client relationship and the rationale for the imposition of fiduciary status, who do not understand the firm's new vision and mission, will stumble (and perhaps fail).

The process of instilling a fiduciary culture begins with senior leadership buy-in, followed immediately (i.e., the next day) by communications to, and training of, mid-level management. This is then followed immediately (i.e., the next day) by communications to all levels of the organization.

This communication process must be well-designed, and sustained. It will involve senior leadership visits to the firm's regional offices, for gatherings and discussion with both mid-level managers and rank-and-file, with two-way communications. It will also involve the wide deployment of motivational and training materials, including in larger firms internal webinars, internal conference calls, compliance training sessions, newsletters, and much more. The process will involve repeated communications of the benefits of change (for all stakeholders), the necessity of making the change, the desire to undertake the change "correctly and deliberately," followed by detailed discussions of fiduciary obligations, and repeated learning opportunities involving the presentations of hypotheticals.

I suspect that many individual advisers in the firm, especially younger ones, won't need much convincing. But, even then, they will not fully understand the fiduciary principle, nor how it is to be applied. And, even a few years of working within a sales culture can make it hard to adapt to a new fiduciary culture. So, don't assume that the level of resistance by rank-and-file will be low; be prepared to meet it via leadership and consistently messaged, repeated communications.


Concurrent with the communication of the firm's new fiduciary culture will be the roll-out of new policies, procedures and systems. These, of course, flow from strategic planning and the adoption of tactics.

Decisions will need to be made regarding divesture of certain aspects of the business, and a re-alignment of other parts of the business. For example:

  • Proprietary funds and other proprietary products. The most difficult issue present in applying the fiduciary standard to financial services firms is what occurs when the firm has proprietary products. In my view, given the availability of some many other pooled investment vehicles and separate account management platforms, it is hard to defend the "objectivity" of the firm, and the instillation of a new fiduciary culture, with proprietary product offerings. Divestiture should be considered.
  • Principal trading. Likewise, the fiduciary obligation appears inconsistent with principal trading.
    • The DOL's proposed Conflicts of Interest Rule provides a methodology to retain principal trading. Embrace it.
    • Consider the formation of a specific fixed income desk for fiduciary advisers to turn to, to ensure adherence to principal trading restrictions at all times. Without a dedicated desk, it's too easy to slip up.
    • Contrast the underwriting practices of the firm two decades ago, to the underwriting practices of today. Consider a return to the underwriting culture of the past, in which deals were often refused by the top firms if the security offering was not of high quality.
  • Revenue sharing. Firms face a difficult choice. Revenue received from asset managers should be credited against advisory fees or - better yet - avoided altogether. Discussions with asset managers should occur.
  • Investment committee re-formation. Gone will be an investment committee that considers as its primary mission tactical asset allocation decisions and individual stock selection. While some programs may still do this, the core of the investment committee should consider:
    • First, what investment strategies will the firm offer to its clients. Intensive research into investment strategies, the academic research behind such strategies, the back-testing (over prolonged time period, and if possible using multiple diverse data sets) of such strategies, and the likely future success of such strategies as the world of finance continues to evolve. If you want an investment committee that works effectively, seek out the best minds in finance, and combine them with the best minds from your trading desk.
    • Second, what investment products or other solutions can be identified that will best implement the chosen strategies. Realize that having "good" products is not enough; if you want to be an exceptional firm, in the new fiduciary environment, find the best investment products. Extensive due diligence is required.
    • Third, realize that there is a place for active management. Such as in tax-efficient pooled investment vehicles. And in low-cost active management strategies. But high-cost active management strategies are doomed to underperform. See my discussion of the fiduciary obligation's to control fees and costs.
    • Fourth, as the transition occurs, limit advisers to implementing the investment strategies set forth in your programs with the investment products that have been pre-approved for those strategies. Convey the reasons for these restrictions to your sales force, who may in the past have possessed greater flexibility. (Roll out the academics, from your investment committee.) Welcome feedback from salespersons of suggestions for products, and provide adequate and timely feedback after evaluating their suggestions.
  • Training. Gone are the days when training is centered around "how to close the sale." Rather, training will need to be intensified in all aspects of financial planning, as well as conveying the extensive due diligence undertaken in the selection of investment strategies and products. Extensive training in how to design and manage investment portfolios tax-efficiently should be undertaken.
  • Recruitment and Retention. Recruitment of new advisers to the firm will need to be intensified, as they will bring new skill sets to teams that you may form to better serve the holistic needs of clients. Identify the university programs that are producing top graduates in their financial planning degree programs - not only well versed in all aspects of financial planning, but also programs that push their graduates to work better in teams, to possess exceptional writing skills, and to possess strong verbal communication and presentation skills.
    • Commit to hiring the best talent. The best firms of the future will bring in the best people, today.
    • Partner with programs to provide "career path" presentations (by the younger members of your firm, preferably).
    • Sponsor visits to your firm by groups of students, in which several members of your firm provide 2-4 hours of presentations about everything from the firm's culture to "day in the life of a financial adviser" to "what I wish I knew in college, that I know now" to "your first year as a financial adviser."
    • Seek out interns. The best way to evaluate a prospective hire is to have them work at your firm for a few months. To recruit the top talent, pay interns well.
    • Consider sponsorship of Series 65 licensure for students who intern with you.
    • Ensure you possess a well-defined career path, for all professionals in your firm.
    • Consider whether deferred compensation arrangements really aid in retention, or not. Consider, as an alternative, a sharing of the ownership of client relationships. With 80% of clients typically following advisers, and with advisers often leaving to independent firms not part of the protocol (a trend likely to accelerate in years ahead), a "buy-out" of the firm's investment in a client relationship, paid out of fees received by the departing adviser over a period of years, seems much more likely to avoid loss of the majority of value of the client upon an advisor's departure. A bonus results from less litigation.
  • Compliance Leadership. Obviously, your compliance department has a huge role to play in the transition. Your Chief Compliance Officer plays a huge role in the transformation to come, and must be up to the task.
    • The Compliance Department's job will be huge, at first. But, if you transform to a fiduciary culture correctly, with conflicts of interest avoided, and with correct offerings and training, then over time the size of your compliance department will diminish. Client complaints also diminish, as will legal costs and liability insurance costs.
    • New fee structures should be considered. These include not only assets-under-management fees, but also annual retainers, fixed fees for certain projects, and even hourly-based fee engagements. Level (or "maximum") commission arrangements should also be explored with insurance product providers, where no-load insurance product offerings remain scattered. Fee-offsets might also be considered, where appropriate.

Here's where the market share gains can occur. But only if your firm is ready to implement the new practices, policies, procedures, and systems. And only if the roll-out to current clients is handled correctly.

It is likely that you will need to build a new brand, around a new offering (or an expanded offering, if it already exists).

You don't need to use the term "fiduciary" in your public communications. But consider ways to properly message the elements of fiduciary - experts, acting on behalf of the client as trusted adviser, with complete candor and honesty.

The media can be your friend, as you roll out the programs. If your program offering is truly a bona fide fiduciary engagement for the client.

Current clients must be transitioned properly. For example, where front-load commissions have been paid, credits might be provided for a few years against AUM fees.

Different programs will be needed, to address different market segments. Don't try to fit a $100,000 IRA rollover AUM client into the same program as a $5m client (executive, business owner) with diverse needs.


Of course, any plan of change must include multiple feedback loops, the formulation of new strategies and tactics, and adjustments to existing programs.

Ensure that feedback is sought from all stakeholders - managers, advisers, compliance staff, trading desk personnel, clients, vendors, etc. - proactively, as the transition occurs, and thereafter.


What will your firm look like, a few years from now?

Chances are, operating under a fiduciary standard, it will be streamlined, with far less central office staff. The number of executives will diminish, as will their compensation. Certain operations may have been divested.

For firms that embrace a fiduciary culture promptly, and correctly, gains in market share will follow. Top-line revenue may fall, but so will expenses, especially over time.

For firms that fail to be proactive in the embrace of a fiduciary culture, they are likely to encounter an acceleration of the loss of market share. The firm will not attract nor retain the best talent. The future of such firms is both predictable, and poor.

CHANGE IS COMING. Don't dawdle. "Who Moved My Cheese?"

Ron A. Rhoades, JD, CFP® is the Program Director for the Financial Planning Program and an Asst. Professor of Finance at Western Kentucky University, at its beautiful main campus in Bowling Green, KY. He is a CFP certificant, a regional board member of NAPFA, a consultant to the Garrett Planning Network, and a member of the Steering Group for The Committee for the Fiduciary Standard. Ron previously served as Reporter for the Financial Planning Standards of Conduct Task Force and Fiduciary Task Force, and as member or chair of other various industry organization committees. He also previously served as a consultant to a major financial services firm on a project involving IRA rollovers, 

An estate planning and tax attorney (Florida), and a fee-only investment adviser, Professor Rhoades currently spends the majority of his time providing instruction to highly motivated students at Western Kentucky University in courses such as the Personal Financial Planning Capstone, Applied Investments, Estate Planning, and Retirement Planning. He has previously taught courses in Insurance and Risk Management, Advanced Investments, Employee Benefits Planning, Business Law I and II, and Money & Banking.

This blog represents Professor Ron Rhoades' personal views and is not necessarily indicative of the views of any institution, organization or firm with whom he may be associated.

Ron is scheduled to provide two presentations in early 2016 on the DOL's rules and the general impact of the fiduciary standard on the financial services industry:
Connect with Ron on LinkedIn.

Connect with WKU's Finance Dept., alumni, and students on LinkedIn.

To receive notifications of future blog posts, follow Ron on Twitter: @140ltd

Public comments to this blog are welcome, provided that no advertising occurs and that decorum is maintained.

To reach Professor Rhoades directly, please e-mail him at: Thank you.

Part 9: Fiduciary's Duty of Care for QRP Rollovers to IRAs ("Who Moved My Cheese" Series)

This is Part 9 of a series, "Who Moved My Cheese?"  In this series I explore the ramifications of the U.S. Department of Labor's likely finalization of its "Conflict of Interest Rule," which will impose the fiduciary standard of conduct upon nearly all providers of investment advice to plan sponsors and plan participants of ERISA-governed defined contribution plans, as well as upon providers of investment advice to all IRA account owners. Transformation is coming to the world of financial services. Are you prepared?

A prospective client is retiring and seeks out the assistance of a fiduciary adviser (however registered) with respect to the client's 401(k) plan. The client inquires, "What should I do?"

Currently, if the prospective client inquires of a discount brokerage firm or mutual fund company, often the answer is: "Rollover your 401(k) to an IRA with us." And the paperwork is initiated to do just that. Similar answers are provided by broker-dealer firms and insurance companies who, more often than not, operate under the suitability standard alone, and not as fiduciaries to the client. Under the suitability standard there exists no duty of due care, in advising the client to undertake a rollover. In fact, the suitability standard abrogates the duty of due care that nearly all other providers of services to Americans possess.

A 2013 GAO Report uncovered alarming evidence of the tactics that financial services firms engage in through the IRA rollover process to secure workers’ assets. For example, financial firms aggressively encouraged rolling 401(k) plan savings into an IRA, and did so with only minimal knowledge of a caller’s financial situation. They also often claim that 401(k) plans had extra fees and that IRA’s “were free or had no fees,” or argued that IRAs were always less expensive, notwithstanding that the opposite is generally true. The report also found that investment firms sometimes offer financial or other incentives to financial advisers who persuade workers to perform a rollover. [401(K) PLANS: Labor and IRS Could Improve the Rollover Process for Participants, GOVERNMENT ACCOUNTABILITY, OFFICE, March 7, 2013. 

Disturbingly, many registered investment advisers, already bound by the fiduciary standard, don't appear to be adhering to their fiduciary duties of due care, loyalty, and utmost good faith, when advising upon IRA rollovers. For example, at one robo-advisor, if you click on IRAs, a “Do a 60-Second Rollover” link pops up. There is no indication in that robo-advisor's Form ADV, Part 2A, that financial planning advice is offered. Such firms might argue that the client has waived the firm's obligation to provide financial and/or tax advice pursuant to disclosures found in the firm's Form ADV, Part 2A and the terms of the clients fee agreement. Indeed, such waivers have arisen from the SEC's weak application of the anti-waiver provisions found in Section 215 of the Investment Advisers Act of 1940). Yet, as I've explained before, the concepts of waiver and estoppel possess limited application in fiduciary relationships under trust law (from which ERISA "sole interests" fiduciary standard is derived) as well as under state common law (from which the Advisers Act "best interest" standard is derived). Moreover, pursuant to the U.S. Department of Labor's proposed "Conflicts of Interest Rule," waivers of core fiduciary duties are not permitted.

The IRA rollover decision is a complex one, and it deserves the scrutiny of an expert adviser operating under the fiduciary standard of conduct. Instead of the representative of a mutual fund company, brokerage firm, or insurance company, automatically stating: "Yes, rollover that IRA with us," the reply should be: "Let's examine your circumstances, so that we may advise you to undertake the actions that are most prudent for you."

Any fiduciary adviser providing advice on an IRA rollover should fully understand, and be able to apply, the often complex tax and other considerations that may affect the decision, including but not limited to:

(1) the availability under many qualified retirement plans (QRPs) to undertake distributions commencing at age 55, rather than the age 59½ requirement imposed upon IRAs;

(2) the existence and best methods for undertaking a series of substantially equal periodic payments from traditional IRA accounts using the 72(t) election;

(3) the 2-year-from-inception restriction on distributions from SIMPLE IRA accounts;

(4) the ability to distribute appreciated employer stock from certain QRPs and receive long-term capital gain treatment upon its later sale, under the technique commonly referred to as “net unrealized appreciation;"

(5) the most tax-efficient manner to design, implement and manage a client’s entire portfolio, which might consist of QRPs, traditional IRAs, Roth IRAs, nonqualified annuities, life insurance cash values, taxable accounts, 529 college savings plans accounts, HSA accounts, and other types of accounts, generally, in order to best secure for the client the likely attainment of the client’s objectives;

(6) the ability to undertake due diligence on the investment options within a QRP account, including but not limited to the potential availability of guaranteed investment accounts (and the risks and characteristics of same, including the reduced exposure to interest rate risk which might be present);

(7) the restrictions which exist on the availability of foreign tax credits and/or deductions for foreign stock funds held in certain types of accounts;

(8) the best manner to minimize future potential income tax liability for both the clients and the client’s potential heirs, including the role of stepped-up basis;

(9) the availability of tax-managed or tax-efficient stock mutual funds in taxable accounts;

(10) the marginal rates of tax (federal, state and local) which might be imposed upon ordinary income and long-term capital gain income, and qualified dividend income, both in the current year and in future years;

(11) the ways to avoid realization of short-term capital gains and long-term capital gains;

(12) the harvesting of losses in accounts and how such losses may offset either various types of capital gains or ordinary income (up to certain annual limits);

(13) whether Roth IRA conversions should be considered, and if so when and to what extent, whether
separate Roth IRA accounts might be established during conversions for different investment assets, and whether re-characterizations might take place thereafter;

(14) whether distributions might be undertaken to generate additional ordinary income, in order to mitigate the effect in any year of the alternative minimum tax;

(15) the increased amount of premiums for Medicare Part A which might result should the client’s modified adjusted gross income exceed certain limits;

(16) the effect of additional income resulting from QRP or IRA distributions, or from other investment-related income, on the taxation of social security retirement benefits;

(17) the interplay between the timing of taking social security retirement benefits, income tax itemized vs. standard deduction strategies, the receipt of various forms of income, and the taking of QRP or IRA distributions, given the various marginal income tax rates the client is likely to possess, then and in the future, for both federal and state tax purposes;

(18) the ability to take investment advisory fees from certain types of accounts, the best methods to allocate fees and pay them from various types of accounts, the potential for deductibility of fees when paid from certain types of accounts, and avoidance of prohibited transactions which might otherwise result if fees for non-investment advisory services are incorrectly paid from QRP or IRA accounts;

(19) the ability to delay QRP distributions past age 70½ in certain circumstances, for certain clients;

(20) the availability of lifetime annuitization options for a portion of any QRP or IRA, both inside the QRP and in a rollover IRA, including an evaluation of the single life, spousal (with and without reduced benefits to the survivor), term certain, and combinations of the foregoing, and including further an evaluation of the possible use of CPI adjustments in the annuity contract to keep pace with increased spending needs, and including further the possible use of a staggered approach to annuitization, and including further the available of deferred annuities with payouts commencing at later ages, and including further the risks and return characteristics of certain annuities, the costs and fees associated with same, the possible applicability of premium taxes, the various riders which might be employed and their costs and benefits and limitations; and

(21) the best method to ensure asset protection of the rollover IRA, such as by segregating it from
contributory IRA accounts.

The foregoing is not a finite list of the issues that might come into play. I invite readers to post comments with other issues that might be considered when opining on a rollover to an IRA.

In a prior post I opined: "In essence, [fiduciary] investment advisers to individual consumers are financial planners, first, and investment advisers, second. We must understand that investment advice to individuals cannot be delivered in a vacuum. Hence, I would opine that some level of financial planning is therefore a necessary prerequisite to the investment of client funds." Applied to the 401(k) [or other qualified retirement plan] rollover to an IRA, there is clearly a need for financial planning to occur, prior to the IRA rollover decision.

Plan participants and IRA account owners seek to overcome the challenges of today’s far more complicated modern financial world, with its myriad of investment options and significant number of traps for the unwary. Our fellow Americans are in full need of the protections of the fiduciary standard of conduct.

As the U.S. Department of Labor progresses forward with the finalization of its "Conflict of Interest" rule, with a likely full implementation date in late 2016, those providing advice on IRA rollovers must adapt. Training will be required of call center employees. Additional time will need to be spent with prospective clients, to gather more information, undertake the analysis, and to provide advice, before the IRA rollover can proceed. In most instances, this will require less than an hour of additional time, by a person trained in the planning issues present. But in other situations, greater time will be required. New service methodologies will be required, along with possible new fee structures to reflect the level of advice provided.

The IRA rollover decision is one of the major financial and investment issues present in the lives of the American worker. Given such, it deserve the application of the requisite degree of knowledge and skill, to identify and provide advice upon possible opportunities presented that can significantly aid the client's financial future.

CHANGE IS COMING. Don't dawdle ... "Who Moved My Cheese?"

Ron A. Rhoades, JD, CFP® is the Program Director for the Financial Planning Program and an Asst. Professor of Finance at Western Kentucky University, at its beautiful main campus in Bowling Green, KY. He is a CFP certificant, a regional board member of NAPFA, a consultant to the Garrett Planning Network, and a member of the Steering Group for The Committee for the Fiduciary Standard. Ron previously served as Reporter for the Financial Planning Standards of Conduct Task Force and Fiduciary Task Force, and as member or chair of other various industry organization committees. He also previously served as a consultant to a major financial services firm on a project involving IRA rollovers, 

An estate planning and tax attorney (Florida), and a fee-only investment adviser, Professor Rhoades currently spends the majority of his time providing instruction to highly motivated students at Western Kentucky University in courses such as the Personal Financial Planning Capstone, Applied Investments, Estate Planning, and Retirement Planning. He has previously taught courses in Insurance and Risk Management, Advanced Investments, Employee Benefits Planning, Business Law I and II, and Money & Banking.

This blog represents Professor Ron Rhoades' personal views and is not necessarily indicative of the views of any institution, organization or firm with whom he may be associated.

Ron is scheduled to provide two presentations in early 2016 on the DOL's rules and the general impact of the fiduciary standard on the financial services industry:
Connect with Ron on LinkedIn.

Connect with WKU's Finance Dept., alumni, and students on LinkedIn.

To receive notifications of future blog posts, follow Ron on Twitter: @140ltd

Public comments to this blog are welcome, provided that no advertising occurs and that decorum is maintained.

To reach Professor Rhoades directly, please e-mail him at: Thank you.

Wednesday, January 20, 2016

11 Questions from Readers on the Implications of Fiduciary for Firms & Advisers ("Who Moved My Cheese" Series)


Q.1. What is the status of the U.S. Department of Labor's (DOL's) "Conflict of Interest" (Fiduciary) Rule?

 Q.2. Will the DOL's Final Rule Be Significantly Changed from its April 2015 Proposed Rule?

 Q.3. Will "Differential Compensation" Be Permitted under the DOL's Fiduciary Rule?

Q.4. What Constitutes a "Reasonable Fee" Under the Fiduciary Standard?

 Q.5. Is Asset Management Becoming Commoditized?

Q.6. How Can We Scale Our Financial Planning Practice?

Q.7. Will "Investment Advice" Become Distinguishable from "Financial Planning" Advice?

Q.8. Will My Broker-Dealer Firm Permit Me to Meet the DOL's Requirements?

 Q.9. I'm Uncomfortable with the "Sales Culture" of My BD/Dual Registant Firm / Insurance Firm. What Should I Do?

Q.10. I'm an Executive at an Independent, Regional Broker-Dealer Firm. What is the Best Way to Begin to Comply with the DOL's Rules, and the Expansion of Fiduciary Standards, Generally?

 Q.11. I work in an asset management firm (i.e., a mutual fund / ETF complex). What should we be doing?


Since my appearance on Barry Ritholz's "Masters in Business" Bloomberg Radio show (released Saturday, Jan. 15, 2016), I've heard from many listeners ... several of whom posed questions - the answers to which may interest others in the financial and investment advisory communities.

Registered representatives (RRs) of broker-dealer (BD) firms, as well as dual registrants (possessing licensure as both RRs and investment adviser representatives) have reached out to me to seek to understand their fiduciary obligations. A few brokers/dual registrants have stated that they feel uncomfortable working in their firms' "sales cultures."

A couple of independent broker-dealer (BD) firm executives have questioned me on how they might survive the transformational changes coming in the years ahead, as the fiduciary standard is applied.

Fee-only advisers have generally applauded my comments, as have advisers from the UK and Australia and Canada. Each of these countries continues to move toward a bona fide fiduciary standard of conduct for those who provide personalized financial planning and/or investment advice.

Permit me to advance my previously planned closing post in this series, "Who Moved My Cheese? - The Future of Financial Advice," in order to respond to some of these specific questions.

Q.1. What is the status of the U.S. Department of Labor's (DOL's) "Conflict of Interest" (Fiduciary) Rule?

I anticipate the rule to go to the White House's Office of Management and Budget (OMB), for an economic review, by January 31, 2016. While the OMB has 90 days to review the rule, I expect that an expedited review will occur, and that the "Final Rule" will be issued by the DOL in March 2016. Look for an implementation date of many of the rule's provisions some 8 months later - i.e., around November 2016.

It is possible that the U.S. Congress could enact legislation to stop the DOL. The fourth (or fifth?) attempt in the past several months, now pending in Congress and likely to be marked up in the U.S. House of Representatives in late January or early February, is the combination of the The Strengthening Access to Valuable Education and Retirement Support (SAVERS) Act, by Rep. Roskam, and the Affordable Retirement Advice Protection (The ARAP) Act, by Rep. Roe. The combined effect of the bills would be to stop the DOL processes. I'll write about the substance of these bills, in a later blog post or article in an industry publication. Suffice it to say for now that the combined effect of these bills would result in a worse outcome for consumers of investment advice than exists under present law.

However, Wall Street is not "in favor" on Capitol Hill these days. While the bills will likely pass in the House, it seems unlikely (but not impossible) that 60 votes will be secured in the U.S. Senate to pass the legislation. Even then, insufficient votes would exist to overturn a promised Presidential veto.

I anticipate another attempt after the Final Rule from the DOL comes out, and possibly more attempts after that, later in 2016. Having recently visited with Congressional staff, it is readily apparent that Capitol Hill is experiencing the most comprehensive, expensive lobbying effort it has seen in several years - courtesy of many firms in the broker-dealer community, life/annuity insurance companies and agents, and certain asset managers.

Yet, there does not appear to be any "must pass" legislation President Obama needs, between now and the end of his term. In other words, there does not exist any good reason for President Obama to horse trade, on another issue, and give up his strong support (to date) of the DOL bill.

Of course, anything can happen, on Capitol Hill. Yet, there are many groups working together (including the Financial Planning Coalition, CFA Institute, AICPA/PFP, and the Save Our Retirement Coalition) which oppose the concerted effort by Wall Street and the insurance companies.

Still, for every one visit members of these groups make to Capitol Hill, there seem to be 30, 40 or even 50 visits by Wall Street BD firms, certain asset management firms, insurance companies, and their armies of paid lobbyists. 

In conclusion, while the prospects for the DOL rule are now quite strong, there still remains a small risk of Congressional intervention prior to the rule's implementation date.

Q.2. Will the DOL's Final Rule Be Significantly Changed from its April 2015 Proposed Rule?
Not likely.

We don't know the text of the DOL's Final Rule yet (when discussions with the DOL occur, the DOL does not reveal its hand, nor are drafts of the Final Rule ever circulated outside the DOL), so this is tough to answer. But I'll provide some of my own thoughts.

I don't expect a huge amount of changes. Some of the disclosure obligations may be lessened. A new exemption might be enacted relating to rollovers of defined contribution plan accounts to IRAs by fee-only investment advisers (which technically results in a prohibited transaction, in many instances). At the same time, some strengthening of parts of the rule might occur. For example, certain exemptions (the "Best Interests Contract Exemption" or BICE, and the Education Exemption) could be sunset after a period of years (this is an idea I've floated; it's far-fetched, but possible). Expect nonpublicly traded REITs, hedge funds, and a slew of other investments to be prohibited under BICE.

I do expect that the DOL's rule will continue to apply to nearly all defined contribution plans governed by ERISA (such as 401k plans, some 403b plans, etc.), and to all IRA accounts (including traditional IRAS, Roth IRAs, SIMPLE IRAs, and SEP IRAs). Add it up, and 40% of all publicly traded investments will be covered by DOL's fiduciary standard (DB, DC, and IRA accounts). Add in foundation/endowment accounts, and investment advisory accounts, and we are clearly over 50% of assets governed by the DOL's rule. This is clearly a tipping point.

If, as expected, the "Best Interests Contract Exemption" (BICE) remains part of the rule, it is technically possible for BDs to continue to sell investment products on a commission basis, and for which the firm receives other third-party compensation (12b-1 fees, payment for shelf space, and other revenue sharing arrangements). While some of the initial and ongoing disclosure obligations under BICE may be minimized in the final rule, BICE is likely to retain three key requirements:

    First, under the mandatory standards of impartial conduct, that the compensation received be "reasonable."

    Second, under the mandatory standards of impartial conduct, that the recommendations by the adviser be in the client's best interest. “Best Interest” is defined to require the Adviser and Financial Institution to “act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person would exercise based on the investment objectives, risk tolerance, financial circumstances, and the needs of the Retirement Investor.” The "Best Interest" standard is ERISA-based and the DOL stated that it expects the "Best Interest" standard to be interpreted “in light of forty years of judicial experience with ERISA’s fiduciary standards and hundreds more with the duties imposed on trustees under the common law of trusts.” Under it, the Adviser and Financial Institution must make recommendations without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party.

   Third, that the client is provided certain warranties by contract, which include but are not limited to:
  • that the financial institution has adopted written policies and procedures reasonably designed to mitigate the impact of material conflicts of interest and ensure that the advisers adhere to the impartial conduct standards;
  • in formulating its policies and procedures, the financial institution specifically identified material conflicts of interest and adopted measures to prevent the material conflicts of interest from causing violations of the impartial conduct standards; and
  • neither the financial institution nor an affiliate or related entity uses quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that would tend to encourage advisers to make recommendations that are not in the best interest of the retirement investor.

While individual advisers (RRs, dual registrants, insurance agents) are not permitted to receive differential compensation, the BD firms and insurance companies can, in theory, receive differential compensation.

The U.S. Department of Labor provided, in its April 2015 proposed rules, five examples of how the receipt of commission-based or other third-party compensation by a firm could occur. These include two non-differential compensation methods: (1) AUM-based level compensation; and (2) fee offsets, such as crediting 12b-1 fees or other compensation received against other fees received, to maintain level compensation.

Another example permits "differential payments based on neutral factors" (such as greater time required to explain a product or undertake due diligence on same). Another example provides that a firm's compensation structure is "reasonably designed to align the interests of the Adviser with the interests of the Retirement Investor." I expect the DOL will "tighten up" both of these examples, in the Final Rule, so that these examples are not interpreted in such a manner that the essence of the rule is negated.

Q.3. Will "Differential Compensation" Be Permitted under the DOL's Fiduciary Rule?

In essence, differential compensation is permitted for certain investment advisers under the Investment Advisers Act. For example, look at hedge fund fee arrangements, which provide additional compensation dependent upon the returns of the funds.

However, unlike performance-based compensation schemes, the plain truth is that higher compensation - to firms (Financial Institutions) and/or to their individual advisers - typically results when the investment product has higher management fees (leading to certain forms of revenue sharing, 12b-1 fees, or other fees. And, as I've discussed previously in this series, the academic evidence is compelling that a mutual fund (or ETF, or variable annuity sub-account, or other pooled investment vehicle) that has higher fees and costs is highly likely to underperform, especially over the long term. And the DOL fully understands this relationship between higher fees and lower returns.

In my view, firms and advisers are permitted to be paid different types of compensation, but the DOL's rules are likely to be interpreted in such a fashion that differential compensation becomes problematic. You simply can't adhere to your fiduciary duty to act in your client's best interests if you charge a higher fee for the sale of one product versus another product, all other things being equal. Outside of the area of performance-based fees (such as those seen in hedge funds), the more compensation you receive, the less the returns are likely to be for the client. You might seek to "disclose" this fact to the client, but the reality is that disclosure, alone, is insufficient; the fiduciary standard requires the informed consent of the client to any conflict of interest - and no client would consent to be harmed. Additionally, the fiduciary duty of loyalty also requires that the proposed transaction remain substantively fair to the client, and it is not "fair" if the higher compensation you (or your firm) receives results (as is extremely likely) in lower returns for the investor.
  • The receipt of additional compensation for recommending one product over another is a conflict of interest. As I've written about previously, a conflict of interest is a breach of one's fiduciary duties. The "best interests" standard present in the Best Interests Contract Exemption permits you to seek to "cure" this breach - but only by following a very strict set of steps.

Firms will need to adopt level compensation arrangements. For example, a fee agreement for serving a smaller client (say, $25,000 or less to invest) might state: "Our fee will be a 5.75% commission, or less, upon the sale of the mutual fund."

Alternatively, level compensation arrangements in the form of assets under management, retainer fees, subscription fees, and hourly fees (or some combination thereof) will likely be adopted for larger clients. And that means Series 65/66 licensure for the individual adviser, if not already obtained.

In either instance, I believe asset management firms and broker-dealer firms will need to quickly adapt, in order to avoid payment for shelf space and most other revenue-sharing arrangements.

The DOL is unlikely to overtly challenge the making of 12b-1 fees. However, the reasonableness of such fee payments is certainly an issue under BICE's requirements, especially for larger accounts. In fact, there are so many potential problems with 12b-1 fees that I would advice asset management firms to phase them out, altogether. And I would suggest to RRs and dual registrants that they don't build their practices around the continued receipt of 12b-1 fees.

Soft dollar compensation payments might still be permitted, but we will have to see if the DOL imposes any restrictions on them - such as verification that the total amount of the soft dollars reflects a price for the research supplied by a BD to an asset management firm that is reasonable, given the marketplace for such research. Even if the DOL does not explicitly impose such a requirement, the BD might need to make a determination of such reasonableness, given the requirements of BICE.

Q.4. What Constitutes a "Reasonable Fee" Under the Fiduciary Standard?

While regulators don't like to opine as to what is "reasonable" or "not reasonable" as to compensation arrangements, the interpretation of "reasonable" in a fiduciary context is altogether different than that found under FINRA's rules. The fact of the matter is that fiduciaries are regarded as professionals, and the compensation received must be reasonable given the time and expertise required to provide the services, as well as considering the risks assumed by the adviser.

Just as an example, it is highly unlikely that the sale of a $500,000 variable annuity, paying to a firm a 5% commission ($25,000), during the IRA rollover process, would be considered "reasonable." At the same time, a 5.75% commission on the sale of a $24,000 mutual fund, leading to $1,380 in commission, may well be reasonable.

Similarly, a 2% asset-under-management fee, assessed on a $10,000,000 account, resulting in $200,000 of compensation each year to a registered investment adviser (RIA) firm or dual registrant firm, is unlikely to be considered reasonable, without documentation of a wide array of time-consuming services to the client as part of such fee.

The "reasonable fee" requirement will likely only be resolved, over time, via the use of experts, in the context of litigation (or, more likely, arbitration). 

(Be forewarned that FINRA's standards for maximum compensation are highly unlikely to be adopted as "reasonable" compensation for a fiduciary, especially when larger amounts of assets are being managed.)

Benchmarking of fees will likely occur during expert testimony. However, in each instance the amount of services provided, and the skill with which those services were delivered, will be significant factors. As a result, there won't be a set "maximum fee schedule" adopted by the industry, nor by finders of fact in the context of dispute resolution.

 Q.5. Is Asset Management Becoming Commoditized?

I don't know if "commoditized" is the correct word. It implies a level of uniformity and plentifulness among investment options that does not exist at present (except, arguably, for S&P 500 Index funds).

While low-cost index funds exist that can be recommended to clients, not all index funds track the same indexes (even with an asset class), and other distinctions exist (such as the amount of cash holdings, use or non-use of securities lending and whether securities lending revenue is shared with affiliates, etc.)

Some funds [such as those of Dimensional Funds Advisors (DFA) might be considered "actively managed" by some advisers, while others consider them "passive" funds. DFA's funds  don't track commercial indexes (in order to avoid the advance publication of index reconstitution, and its deleterious effects on prices during the subsequent reconstitution process). Rather, in essence, DFA has privately constructed portfolios, although they are very well-diversified (like many index funds) and appear to apply certain quantitive rules as to stock inclusion in the "private index." Even then, trading rules exist for DFA funds (as a means of lowering transaction costs, and/or taking advantage of the momentum effect) that cause deviation even from its own "private" list of desired fund holdings. Addtionally, the long-term track record of many of DFA's funds shows a substantial outperformance over commercial indexes (of some 50 basis points or greater), over many rolling time periods.

To a far lesser extent, some evidence exists that Vanguard's actively managed funds outperform its own index funds, although the amount of such average outperformance is so small as to be statistically insufficient to support the conclusion of the superiority of Vanguard's active managers (at present, given the limited amount of historical data).

Perhaps the better phrase is that asset management services provided by investment advisers are less time-intensive, given the use of rebalancing and other software solutions, and that it is "scaleable" to a large degree. Hence, I anticipate continued downward pressure on investment adviser fees, especially when the adviser's business model is to select and then management a portfolio of mutual funds or other pooled investment vehicles.

While some advisers might be tempted to manage individual stock portfolios, as a means of receiving greater compensation (i.e., by capturing the fees that would otherwise be paid by a client for low-cost mutual funds), caution must be exercised. Substantial diversification necessary to minimize the risks of underperformance of a benchmark requires hundreds of individual stocks - not just a few dozen. While many bank trust departments continue to run "30-stock" portfolios, under the observation that the standard deviation of a 30-stock portfolio is near that of a highly diversified stock fund, it must be recognized that standard deviation is only one measure of risk (and often a poor measure, at that). Additionally, transaction costs must be effectively managed, such as through block trading and other techniques; many mutual funds possess substantial expertise in their trading desks to enable transaction costs to be minimized (although, for larger funds, especially large index funds, market impact costs can be quite high).

I'm not stating that individual stock portfolio management is not possible under the fiduciary standard. With economies of scale achieved in some manner, and by keeping trading costs to minimal levels (made more possible, among large cap U.S. stocks, due to lower bid-ask spreads resulting from decimilizaton and the impact of high-frequency trading), it is possible to run a portfolio of individual stocks for clients - at least in the U.S. large-cap asset class space. Yet, the costs of doing this may well outweigh the benefits - for both a firm and for the client - unless substantial economies of scale are achieved and transaction costs are strictly controlled.

The major dilemna for advisers is their value proposition when it comes to fund selection. If the adviser undertakes due diligence in mutual fund / ETF / separate account selection (whether adhering to a passive or active investment philosophy), given the scaleability present an increasing number of clients question the assets-under-management fees charged for such activities. In essence, clients desire to receive the benefits of the scaleability present, rather than the firm keeping most of scaleability's benefit for itself.

Q.6. How Can We Scale Our Financial Planning Practice?

I think that financial planning can be made more efficient, in some of its phases. Such as data collection, and the dissemination of reports and other information to clients, via good web interfaces and software deployment.

At the same time, I think many financial planning decisions still involve the time of an experienced, expert planner who looks at the "big picture" before final recommendations are made. I have not yet run across financial planning software that accurately determines a client's need (rather than tolerance) for risk. Nor does financial planning software do an outstanding job of "connecting the dots," particularly as to the interplay of various risks present in a person's life. And financial planning software is not as impactful in the delivery of advice; a good adviser can, through emphasis and body language, persuade a client toward a course of action, in a way that a piece of paper or an electronic screen cannot.

Hence, while certain efficiencies can be achieved, I don't believe that financial planning is "scaleable" - certainly not in the way that investment management is scaleable. Rather, efficiencies can be brought to various aspects of the financial planning process (at the risk, at times, of losing the "human touch"). And, through the use of associates and junior partners, senior partners can achieve some leverage. In other words, financial planning is best undertaken using the business model of a professional services firm.

Q.7. Will "Investment Advice" Become Distinguishable from "Financial Planning" Advice?

Yes, and no.

No, in the sense that a certain level of fundamental financial planning, in my view, is a prerequisite to the delivery of financial advice.

For example, suppose a prospective client comes to you with $100,000 cash, just inherited, and wants you (the investment adviser) to invest those funds. Yet, in the process of gathering client data (required to meet your fiduciary obligations to the client), you discern that the client has a $20,000 credit card bearing 18% interest, a $15,000 car loan bearing 6% interest, and that the client has a 95% loan-to-value $120,000 mortgage on which private mortgage insurance is being paid. Additionally, the prospective client has no cash reserve. Also, you discern that the prospective client is not contributing to her 401k account, and that the employer provides a match up to 3% of salary. The client also has insufficient term life insurance, and insufficient personal liability insurance. If the aforementioned credit card debt and car loan were paid off, and the mortgage amount reduced to avoid PMI, enough income would be freed up to easily foster 401k contributions as well as purchase term life and personal liability insurance. What should you do?

The legal aspect of this question revolves around whether you can, as a fiduciary, limit the scope of your engagement (advice) to simply designing and implementing an investment portfolio. And, for the answer to this question, perhaps we should look to the investment adviser representative (Series 65 exam) topic list, which includes among its many topics the following:
  • Client profile
    • 1. financial goals and strategies:
      • a. current income;
      • b. retirement;
      • c. death;
      • d. disability;
      • e. time horizon.
    • 2. current financial status:
      • a. cash flow;
      • b. balance sheet;
      • c. existing investments;d. tax situation.
Arguably, gathering the information for a proper client profile - as suggested by the topics in the Series 65 exam, and in your role as a fiduciary adviser - is done with a purpose in mind. And that purpose is to achieve a proper use of available funds, whether they are used to pay off or down debt, fund a cash reserve or retirement accounts, or implement insurance purposes to reduce some of life's major risks.

In essence, investment advisers to individual consumers are financial planners, first, and investment advisers, second. We must understand that investment advice to individuals cannot be delivered in a vacuum.

Hence, I would opine that some level of financial planning is therefore a necessary prerequisite to the investment of client funds. At a minimum, you may be required to refer the client to a financial planner (assuming you don't possess those skills, or that you don't desire to undertake those services).
  • In recognition of the need to provide an arrange of services to clients, in order to meet the clients' needs, many larger RIA firms and dual registrant firms are establishing teams. The roles may vary from business development to trading to portfolio decision-making to financial planning. Many RIA firms also provide tax compliance (i.e., tax return preparation).
Let me now turn to the "yes" part of this answer. Yes, I believe financial planning fees will likely become separate from investment advisory fees, at some point in the future.

Financial planning fees may well become bifurcated from investment advisory fees. As stated above, investment advice is scaleable. But financial planning requires the time of a professional, and while efficiencies can be achieved through selective use of various software solutions and leveraging can be obtained via the use of associates or junior partners, it is difficult to scale professional services.

This may appear contrary to my stated view that investment advice does not exist in a vacuum, and that financial planning is also required. Yet, financial planning is, rather, a prerequisite and co-requisite with investment advice; the functions themselves are divisible within a firm. And investment advice is to a large degree scaleable, which permits different fee arrangements than largely non-scaleable financial planning.

Financial planning is time-intensive, and a substantial level of expertise is required. I often tell my students that I can turn you into an excellent investment adviser within a year (of working in a firm), but that it will take 5-10 years for you to become an experienced and excellent financial planner. There exists both breadth and depth of the financial planning knowledge required, and it takes time to be able to "connect the dots."

A simple example involves how a decision in one area (such as the purchase or non-purchase of long-term care insurance, the amount purchased, the quality of the insurance company, the presence of state partnerships for LTCI, etc.) could affect another area of financial planning (the amount of savings required for retirement, Medicaid advance planning, the use of trusts between spouses, etc.).

 Q.8. Will My Broker-Dealer Firm Permit Me to Meet the DOL's Requirements?

Yes, and no. It depends on the firm.

I believe that most advisers want to do the right thing for their clients. But, over time, the incentives they receive - for pushing certain products, for achieving certain sales goals for a particular product, etc., combine to unconsciously influence their decision-making. (And it is this "unconscious influence" of conflicts of interest that so many jurists warn fiduciaries about, including the U.S. Supreme Court's warning about such influences contained in its landmark SEC vs. Capital Gains Research Bureau 1963 decision.)

Alternatively, even those advisers who resist temptation often are directed, by their firms, to push certain products that provide higher commissions, or which provide 12b-1 fees or payment for shelf space of other additional compensation to the firm. In perhaps the worst transgression, some firms push their advisers to sell proprietary mutual funds or other proprietary products. (I'll write about the inherent problems of proprietary products, in a later post.)

There are several dynamics at play, in the relationship between a broker-dealer firm (or dual registant firm) and its registered representative (or dual registrant adviser).

First, the firm's reputational risk is usually far below that of the individual adviser. Advertising and promotion, along with arbitration and private settlements of disputes, mean that firm's reputational risks are minimized, or that their reputations can be quickly restored (the public has short-lived memories). In contrast, a single complaint against an individual adviser can result in a stain on the adviser's U-4. Additionally, firms have an economic incentive to settle complaints that are small, or that are unlikely to prevail, for small amounts, even though the adviser's reputation might be ruined, and the adviser would prefer that the complaint proceed through arbitration.

Second, under the DOL's rules, the individual adviser must not receive differential compensation, but the firm can. Given such, some firms will continue to insist that products which provide differential compensation to the firm be sold. Even though the adviser knows, intellectually, that higher compensation to the firm results from higher-fee products which, on average, result in lower returns to the client. This development marks a further divergence of the interests of the firm, from those of the adviser.

Third, the cost structures of many broker-dealer firms, and dual registrant firms, in terms of the amount of support staff they possess at their headquarters (and other locations) to support the sales force in the field, simply cannot support the reduced level of compensation likely to result from the fiduciary standard of conduct. In contrast, fee-only firms are "lean and mean." Unlike what many individual advisers have been told, the compliance costs from acting as a bona fide fiduciary - in which conflicts of interest are avoided (not just disclosed) - and in which proper (and extensive) due diligence is undertaken on investment strategies and investment products - are quite low compared to those of broker-dealers. And the liability insurance costs are lower, as well, for those who avoid conflicts of interest.

Fourth, senior partners of the firm, and/or senior executives, don't make tens of millions of dollars in most fiduciary firms. They may receive millions (7-digit) compensation, but rarely (if ever) do they receive the 8-digit compensation seen in many of the larger broker-dealer firms. Professional services firms simply don't support such high levels of executive compensation.

Fifth, broker-dealer firms with associated investment banking operations - i.e., those firms that engage in securities underwriting, use the retail sales force to support the distribution of stock and IPOs and newly issued bond and other securities. Yet, academic research demonstrates that, during most periods, returns for IPO stocks underperform the broader market over the first few years. (Some speculate that this is due to mispricing, resulting from overhyping the stock, or other reasons.)

Also, witness the manufacture and sale of mortgage-backed securities containing subprime loans, or the sales of alternative investments in recent years that have "blown up" in the face of the firm and the adviser. Other examples include the sale of non-publicly traded REITs that have blown up in the face of some firms and their individual advisers (see, e.g., the Apple REIT litigation), oil and gas limited partnerships, and other products that pay high commissions (often 10%, plus marketing support dollars often equal to another 2% or more) to the firm.

The result of this dynamic is that many broker-dealer firms make a lot of money selling sub-par investments. And, to protect their own reputations, I have long advised RRs / dual registrant advisers in these firms to undertake their own extensive due diligence on the investment strategies they choose to employ, and on the specific investment products they recommend, prior to the sale of the products to any clients. The level of fiduciary due diligence required is large. Yet, due to pressures on the top line and/or the bottom line, many BD's firms due diligence processes are insufficient to protect them from claims, and to protect the advisers in those firms. For many firms, getting "caught" (whether in the context of private litigation/arbitration, or by regulators) just results in a "cost of doing business" - for they have made substantial sums from their sales of products and the underwriting of them. But the consequences for individual advisers are huge.

Individual advisers in BD and dual registrant firms need to undertake their own due diligence, if they are at all concerned over their own reputational risks, to protect themselves.

BUT ... not all firms are reckless. Indeed, some large BD firms are beginning to transition to bona fide fiduciary (and near conflict-free) platforms in which the firm receives an AUM fee (and the adviser receives a portion of same), and in the accounts are held only low-cost ETFs (with no revenue sharing present). In some situations 12b-1 fees and other revenue sharing fees, if received by the brokerage firm, are offset against the advisory fees charged. These moves are to be applauded, and such platforms should be embraced by the advisers in those firms.

Q.9. I'm Uncomfortable with the "Sales Culture" of My BD/Dual Registant Firm / Insurance Firm. What Should I Do?

If you are uncomfortable with your BD firm's approach to supporting your adherence to your fiduciary obligations, I would suggest you consider speaking with your superiors in the firm. Chances are that the firm will be rolling out platforms for the delivery of fiduciary advice, in the near future.

In the interim, seek out the most conflict-free platform that the BD firm provides, and serve your clients that way. If, however, conflicts of interest persist, and no appropriate platforms are provided, you will have the tough decision as to whether to remain in that environment over the long term. A myriad of factors come into play, of course. An adviser, prior to making any decision to leave a firm, would be served to consult with a securities attorney who specializes in advising departing advisers. The adviser would also need to spend extensive time investigating "where to go to" - perhaps aided by education from NAPFA (the largest fee-only financial adviser organization), Garrett Planning Network, XY Planning Network, Alliance of Comprehensive Planners, various independent dual registrant firms that possess a fiduciary culture, various "roll-up" firms that acquire larger practices, and independent RIA firms.

If you work for an insurance company, and its affiliate BD, expect a harder path to the fiduciary standard. I have not seen any large insurance company adopt a platform in its BD affiliate that enables a conflict-free fiduciary practice methodology.

Q.10. I'm an Executive at an Independent, Regional Broker-Dealer Firm. What is the Best Way to Begin to Comply with the DOL's Rules, and the Expansion of Fiduciary Standards Generally?

As the question suggests, fiduciary obligations don't just flow from the DOL's proposed rule. They are also imposed under the Investment Advisers Act of 1940, as well as state common law (when either de facto discretion exists, or a relationship of trust and confidence exists between the broker and the client). And fiduciary obligations can result from adherence to certain professional organizational standards.

If you are asking this question, you have a great deal of work ahead of you, in a small period of time. You need to act fast, before change passes you by and the revenues and cash flow you need to effect change disappear. Alternatively, if you don't possess cash flow sufficient to implement the changes required, consider a merger with another firm.

I would suggest that you begin to look at the most important job ahead of you - transitioning the firm away from a "sales culture" to a "fiduciary culture." Changes in culture require time, and effort. And they are never successful unless they flow, correctly and in a well-planned manner, from the top down.

Understanding why fiduciary obligations are imposed, and what is required under a bona fide fiduciary standard, is part of your initial homework assignment. The fiduciary standard is a very strict standard; it is far more than serving up "good products."

But, if you truly understand the fiduciary standard's many requirements, you will find that it is easy to comply with. And your advisers will discover new happiness in coming to work, as they serve the best interests of their clients.

If you have asset management affiliates, consider divestiture of them.

If you engage in underwriting stocks and bonds, consider the culture of underwriting that existed among top firms 20 years ago, and how to return to that culture. 

Start with the proper goals in mind. You desire to be the best firm - able to attract and retain the best talent, and able to provide the best value-added services to your clients.

Lastly, promote your firm's new fiduciary culture to the public, once you are ready. It's a significant marketing advantage, if you explain it correctly - to both your current clients and to prospective clients. You don't have to use the word "fiduciary" - find other words that impart that your firm is the steward of your clients' hopes and dreams, not just their wealth. Be deserving of your client's trust.

I hope that the blog posts I've previously posted, this month and in prior years, can assist you in this process and journey.
Q.11. I work in an asset management firm (i.e., a mutual fund / ETF complex) that sells through intermediaries. What should we be doing?

Your firm should be speaking to its customers (brokers, investment advisers, etc.). Your customer's needs are changing, and you need to change with them.

If you wait too long, your current revenues will decline as the competition races ahead. Lacking profits and cash to fuel change, you will be forced to merge with other firms.

Design new compensation structures, within your products, that will better meet the fiduciary requirements of the DOL rule.

For example, establish share classes that provide negotiable sales loads, regardless of whether breakpoint discount levels are achieved. Provide other share classes with no sales loads of any kind.

For all new share classes, eliminate 12b-1 fees (a controversial move, to be certain, but one that will pay off in the long run). Eliminate payment for shelf space. Reduce investment adviser (management) and administration expenses. Don't pay soft dollars anymore. Sell your products on the basis of their high quality, rather than the extra compensation they provide to the intermediary firm (since such differential compensation will be problematic, in the future).

Build better investment strategies. Hire finance professors who are well-versed in the many "factors" emerging from academia (i.e., the "factor zoo), but who are also pragmatic enough to ensure that any factors applied in a fund possess a very high probability of adding value over the long term. Don't pay fund managers exorbitant fees, however.

Find ways to transform your trading desk. Manage cash inflows/outflows better. Reduce transaction costs wherever possible. If you fund is highly diversified, and other circumstances dictate, consider whether securities lending revenue can be secured for your fund shareholders.

Consider designing broad market funds, with factors, that result in little need for trading within the fund.

There will come a time when every fiduciary adviser will seek out tax-efficient funds for taxable accounts. Always possess mutual fund or ETF offerings designed for investing in taxable accounts. Mutual funds may be called tax-aware, tax-efficient, or tax-managed. establish methodologies to eliminate short-term capital gain distributions, to limit long-term capital gain distributions, and to seek qualified dividend treatment where available. Especially pay close attention to international stock funds in this area, in order to pass through tax credits.

Consider the use of the ETF structure (and its unit creation and unit disposition methods) to achieve even greater tax efficiencies (but watch out for IRS regulations or rulings in this area, that may in the future negate such advantages). However, ETF transparency can increase market impact costs.

If using index funds, consider the choice of a better index, to limit portfolio turnover. Also, the more funds that track an index, generally the more market impact costs. Perhaps the better solution is to possess low-cost funds in which you create your own index, but don't publicize it. Why let everyone know, in advance, your trades?

If you advise on IRA rollovers, realize that your sales force will need better training in connection with many factors present in the IRA rollover process. Expect some guidance from the DOL on this, in their final rule, but be prepared if the DOL does not provide more substantive guidance.

For those in the variable annuity business, massive changes are likely needed. See my prior blog post on variable annuities, and cost/benefit analyses for VAs. There are emerging several VAs that are attractive to fiduciary advisers; find a way to have products that are even more attractive by stripping bare many of the guarantees. (Just because a guarantee is potentially costly to your company, because of the potential risks - including tail risks - assumed, does not mean that the guarantee is just as valuable to your customer. There are other alternatives to manage risk.) Focus on gaining market share, while others resist change.

For those who issue equity indexed annuities (EIAs) (or insurance companies considering same), consider building a fully transparent, no-load (and/or reduced load) product that delivers more returns to investors. It is possible to have EIA structures that pose very little risk to the insurance company, in terms of the necessity of setting aside monies for guarantees. Provide a "stripped-down" product. See my prior post on EIAs.

Again, get ahead of the curve, and gain huge market share. Because, in a future era of lower fees, only those who possess huge market share will be able to leverage economies of scale and remain highly profitable.

A shake-out is coming in the asset management industry, and you don’t want to be the one shaken out.

CHANGE IS COMING. Don't dawdle ... "Who Moved My Cheese?"

Ron A. Rhoades, JD, CFP® is the Program Director for the Financial Planning Program and an Asst. Professor of Finance at Western Kentucky University, at its beautiful main campus in Bowling Green, KY. He is a CFP certificant, a regional board member of NAPFA, a consultant to the Garrett Planning Network, and a member of the Steering Group for The Committee for the Fiduciary Standard. Ron previously served as Reporter for the Financial Planning Standards of Conduct Task Force and Fiduciary Task Force, and as a consultant to a major financial services firm on a project involving IRA rollovers.

An estate planning and tax attorney (Florida), and a fee-only investment adviser, Ron provides instruction to highly motivated students at Western Kentucky University in courses such as the Personal Financial Planning Capstone, Applied Investments, Estate Planning, and Retirement Planning. He has previously taught courses (at another college) in Insurance and Risk Management, Advanced Investments, Employee Benefits Planning, Business Law I and II, and Money & Banking.

This blog represents Ron's personal views and is not necessarily indicative of the views of any institution, organization or firm with whom he may be associated.

Ron is scheduled to provide two presentations in early 2016 on the DOL's rules and the general impact of the fiduciary standard on the financial services industry:
·       Feb. 24-25, 2016: FPA of Oregon and S.W. Washington Midwinter Conference 2016, where Ron will discuss: "The DOL's Transformational Conflict of Interest Rule"
·       Feb. 26, 2016: FPA of Puget Sound's 2016 Annual Symposium, where Ron will discuss: "Reducing Your Risks in the New Fiduciary Era"
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