April 11, 2016 Practice Points

New Regulations Impose Fiduciary Standard on Retirement Fund Brokers

The actual impact of the new rules is not yet clear.

By Lance C. McCardle

On April 6, 2016, after years of discussions with the brokerage and insurance industry as well as investor advocacy groups, the Department of Labor released new regulations imposing a “fiduciary” standard on brokers that manage assets in retirement accounts, including individual retirement accounts (IRA). The new regulations require financial advisors handling IRAs and 401(k)s to act in the “best interests” of their clients and remain free of conflicts of interest. As President Obama described it in a speech to the AARP last year, “It’s a very simple principle: You want to give financial advice, you’ve got to put your client’s interests first. You can’t have a conflict of interest.” And Labor Secretary Thomas Perez was quoted as saying, “Today’s rule ensures putting the clients first is no longer a marketing slogan. It’s now the law.”

The new regulations will protect, among others, those investors rolling their retirement funds from a 401(k) plan into an IRA. This is incredibly significant as funds rolled over from 401(k)s are overwhelmingly the largest source of funds in IRA accounts. Many investors have always assumed that brokers managing their retirement funds were obligated to act in their best interests, but that has not necessarily been the case. Investments in 401(k)s have been protected by the Employee Retirement Income Security Act, which generally requires that investment advisors act as fiduciaries to plan participants and choose investments that are in an investor’s best interests. IRAs, however, were handled differently prior to the new regulations. Aside from duties imposed under state law, IRAs were governed by the Financial Industry Regulatory Authority’s “suitability” standard, which requires only that brokers recommend that their investor-clients buy, sell, or hold investments that are suitable for the investor, based on the investor’s objectives, needs, and circumstances. While the “best interests” and “suitability” standards may sound similar, they can differ significantly in practice.

For example, one operating as a “fiduciary” or under the “best interests” standard could not generally recommend an investment with a higher cost structure over another otherwise identical investment, but one subject only to the “suitability” standard may be free to recommend a higher cost investment so long as that investment otherwise meets the customer’s risk profile. While a fiduciary cannot engage in a transaction with a conflict of interest, a broker working only under the “suitability” standard may be able to recommend products promoted by companies that offer the broker higher commissions or non-cash benefits. The Department of Labor (DOL) estimates that conflicted advice causes the returns in retirement accounts to be about 1 percentage point lower annually, costing investors $17 billion every year.

Some in the brokerage industry have embraced the new regulations, explaining that they have always acted in the best interests of their clients and hoping that the new rules will level the playing field across the industry. Others complain that the new rule will require them to turn away customers with relatively small IRA accounts because of the increased costs associated with operating under a fiduciary standard and because of the increased risk of arbitrations or lawsuits.

The actual impact of the new rules is not yet clear. While the DOL made some concessions at the request the brokerage industry (including continuing to allow firms to sell proprietary products and private placements and delaying the period of time for compliance) prior to the release of the final version, the rule still may be subject to future legal challenges.

Lance C. McCardle, Fishman Haygood, L.L.P., New Orleans, LA


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Lance C. McCardle – April 11, 2016