Breaking Down the Fiduciary Rule, part V: What is the Potential Impact to Other Aspects of the Financial Services Industry?

This article is part five of a five part series, originally published May 25, 2016 on
by Ryan W. Smith
Last month, the Department of Labor released its final rule regarding an amended definition of a fiduciary on retirement accounts under the Employee Retirement Income Security Act of 1974 (ERISA). This proposal, often called the “Conflict of Interest Rule” was initially proposed in 2010, but was withdrawn for further analysis after numerous industry groups and members of Congress from both political parties objected.
On April 14, 2015, President Obama asked the Department of Labor to re-examine the proposal. Over 3500 comment letters were examined by the Department before the final rule was sent to the Office of Management of Budget (OMB) in January 2016, with the final rule being published on April 6, 2016. Full compliance with the rule is expected by the Labor Department within eight months, with full implementation of the rules in one year.
Reaction to the rules changes, perhaps the most significant change to ERISA since its initial passing, have been mixed, but the Labor Department has been assuring the financial services community that it carefully considered the comment letters it received in order to address the concerns from its original 2010 proposal.

After the Department of Labor’s initial 2010 proposal, many in the financial services industry lamented that only fee-based compensation practices would be allowed under the new regime. The Labor Department tried to specifically address these concerns to make sure that firms were able to continue their current compensation practices under the Best Interest Contract Exemption (BICE) provided they follow the fiduciary standard and openly disclose any conflicts of interest. Firms will still be able to use common forms of compensation like commissions and revenue sharing for employer-sponsored retirement plans even if the compensation is paid for by a third-party, as in a mutual fund for example.
While the rules regarding employer-based retirement accounts are now more clear-cut, it is not so clear regarding certain securities. For example, annuities need to be handled completely differently after the rules changes, many in the industry say. They contend that the Labor Department is suggesting that all variable annuities will be subject to the BICE exemption and not the traditional insurance exemption, while fixed annuities will still fall under the insurance exemption. It is potentially significant, they contend, because the BICE could raise barriers of use since many annuities are created by investment companies, leading to a potentially substantial increase in conflict of interest situations.
While some of the amended BICE rules have met with some resistance, many in the industry do like way the Labor Department addressed direct conflicts. These conflicts, under the original proposed rule, would have prohibited a representative from recommending the lowest fee security within a product class if the security also met other conflict criteria. This “low-fee exemption” removes the requirement for representatives to make projections about future performance of assets, enabling disclosures to be more streamlined in order to be more realistic on what can, should and could be disclosed. If a product is the lowest-fee, even if otherwise conflicted, a representative will still be able to recommend that security to a client. The fiduciary standard is now the primary standard in all situations involving employer-based retirement accounts, according to the Department of Labor’s Fact Sheet.
There is one final change, at the firm level, that many in the industry are unhappy with. The amended Labor Department rule has a threshold test regarding the distinction between a large plan and a small plan, potentially putting small companies in a difficult position. The original 2010 proposal had a cutoff between a large and small fund if there were more than 100 participants or $100 million in assets.
The amended rule, however, has reduced the amount to $50 million and 100 participants in a fund. Many in the industry complain that this change goes the opposite direction it should have as there are many plans with well over 1,000 participants that are also under $50 million in assets. This change is potentially noteworthy because smaller companies and funds will not necessarily have access to, or be able to provide, the same services as large companies. This could lead to higher expenses for smaller companies and a disadvantage in the marketplace. It is unclear at this time what services will be directly impacted, though many say it will be “significant.”
Many in the industry also view the final fiduciary rule issued by the Department of Labor as one that will raise expenses unnecessarily, even for larger funds and firms, while leaving small businesses at a competitive disadvantage. They also fret that clients will be confused, especially anyone rolling over an employer-sponsored 401(k) retirement plan or anyone interested in annuities.
The Labor Department has explicitly noted that additional amendments will be necessary and are keeping an open dialogue with industry players as well as members of Congress in order to make sure they are attempting to address and correct as many issues as possible going forward.