Over the past year, there has been increasing buzz in the financial industry surrounding new regulation from the Department of Labor (DOL). The “Conflict of Interest Rule” proposed by the DOL seeks to apply a “fiduciary standard” to any financial advisor who makes recommendations about clients’ retirement accounts. The ruling is expected to reshape the financial industry and drastically change the commission system that provides compensation for many advisors.
What is Fiduciary?
fi·du·ci·ar·y /fəˈdo͞oSHēˌerē,-SHərē/: An individual that is required to act in a client’s best interest.
Background
The DOL originally proposed the Conflict of Interest Rule back in 2010; however, opposition to the rule was strong enough that it was defeated in 2011. In early 2015, the DOL and President Obama proposed the rule once again. After its initial proposal, the DOL accepted 3,000 external comments on the rule, using them to fine-tune the regulation and add necessary exceptions. On April 6, 2016, the rule was finalized and went to Congress for review; the financial industry has until January 1, 2018 to be in full compliance.
What the Rule Does
The Conflict of Interest Rule places a fiduciary standard on financial advisors receiving compensation for recommendations on a client’s IRA or 401(k) (as well as some other tax-deferred accounts).
For advisors that earn commission for recommendations for retirement accounts (i.e. not paid directly by clients), the rule requires the use of the “Best Interest Contract Exemption” (BICE). The BICE guarantees an advisor will work in a client’s best interest, disclose any conflicts of interest and provide compensation structures for the financial products they recommend.
Why the Rule was Created
The motivation behind the rule was to update the Employee Retirement Income Security Act of 1974 (ERISA), which guaranteed pension managers would act in the best interest of pensioned employees. Now that 401(k)s and IRAs have replaced pensions as the standard methods of funding retirement, the DOL wants to expand ERISA so that these new accounts receive the same fiduciary protection.
The DOL believes that the previous standards allowed for conflicts of interest among advisors who personally benefit from account recommendations. By holding these advisors to a fiduciary standard, the DOL aims to stop any unethical management of clients’ retirement accounts and guarantee the quality of all retirement investment advice.
Reactions
The Conflict of Interest Rule has received both praise and criticism from politicians, financial institutions and the general public. Opponents of the rule say it is unnecessary and wrongfully implies that commission-based advisors weren’t already serving clients’ interests; others have welcomed the proposal, saying it will help protect clients while officially giving advisors the credibility they deserve.
Several groups are seeking retraction or modification of the rule, which could mean it will undergo changes the future. While it’s unknown what alterations will be made, the DOL clearly intends to shape a law that is focused on clients’ best interests.
Fingerlakes Wealth Management does not provide tax or legal advice. You are encouraged to consult with your tax advisor or attorney regarding specific tax issues. This article was written by Advicent Solutions, an entity unrelated to Fingerlakes Wealth Management. The information contained in this article is not intended to be tax, investment, or legal advice, and it may not be relied on for the purpose of avoiding any tax penalties. © 2016 Advicent Solutions. All rights reserved.
