The U.S. Department of Labor (“DOL”) recently issued a final rule that expands the “investment advice fiduciary” definition under the Employee Retirement Income Security Act (ERISA).[1] Under the rule, persons who provide investment advice or recommendations for a fee to retirement plans, plan fiduciaries, and individual retirement accounts (IRAs) will be required to abide by the ERISA’s fiduciary standard. That means investment advisers will be required to act in the sole interest of their client.
The new ERISA standard is a significant increase in the standard of care required under the current so-called “suitability” rule. The “suitability” rule, found in federal regulations and state laws like the Securities Act of Washington, requires only that broker-dealers, salespersons, and investment advisers “have reasonable grounds for believing that the [investment] recommendation is suitable for the customer.”[2]
The “suitability” rule has long been criticized as not preventing conflicts of interest between financial advisers and their clients. For example, under the rule, an adviser may recommend an investment because it provides a commission, even though cheaper and equally as strong investments are available. The investment adviser would not run afoul of the rule as long as the recommended investment meets the “suitability” requirements.
The DOL’s new fiduciary rule takes aim at these types of conflicts of interest, which the Obama administration estimates cost Americans $17 billion annually.[3] That’s roughly one percent lower investment returns each year, which significantly adds up over time.[4] If implemented, the fiduciary rule could mean significant gains for retirement investors; in just one market segment (for IRA investments in front-end-loaded mutual fund), the DOL expects gains to be between $33 billion and $36 billion over ten years, and double that over 20 years.[5]
Donald Trump’s victory casts doubt as to whether the fiduciary rule will be implemented. Several news outlets reported last month that Mr. Trump would repeal it if elected.[6] But even with Mr. Trump set to take office, investment firms and professionals would be wise to continue preparations for the transition from non-fiduciary to fiduciary status: the effective date, April 10, 2017, is fast-approaching.
–Michael Licata