Unpacking the Quirks of DOL’s Fiduciary Rule

Last month I wrote about the then-brand-new Department of Labor (DOL) Fiduciary Rule, which would bring any broker or financial advisor who touches retirement accounts (read: everyone) under a common standard for how they interact with their clients.  In short, they’d all have to meet a “best interests” requirement, and likely go to very clean and simple compensation agreements. 

Related: Winners and Losers of Department of Labor's Fiduciary Rule

Since then, the industry has had a chance to process what the rules may and may not mean, and I’ll be sitting down with the good folks at Investment News next week to parse some of the nuances in the rule (hey, it’s free, why not tune in?).

Specifically, there are a few quirks in how the DOL rule may intersect with certain kinds of advisors, and certain kinds of products:

The “Level Fee” Concept

While much is made of the requirement that advisors sign contracts with their clients acknowledging their newfound status as fiduciaries, there’s an exemption in the rule, called the “Best Interest Contract Exemption.”  This wrinkle is a safe harbor for advisors who only receive a flat fee (generally as a percentage of assets) and nothing else.  It doesn’t let advisors out of various disclosure and transparency requirements, but streamlines the whole affair.  Since most ETF-based advisory firms essentially already comply with this rule (since most ETFs don’t even have 12-b-1 fees or loads to complicate matters), there is general consensus that the level fee model will now become the default for most advisory practices, and thus make ETF adoption even easier.  Check out Michael Kitces’ excellent rundown on this part of the rule. 

A Conflict of Interest for Robo Advisors?

On the surface, this level-fee exemption seems tailor made for the robo-advisor market.  Folks like Wealthfront and Betterment make all of their money from level fees charged to the investor, all clearly disclosed, and they have well documented processes for both how they give advice (albeit algorithmically) and how they select investment strategies and specific ETFs. But how will this interact with companies whose robo-platforms lean heavily on proprietary, in-house ETFs like Schwab and Vanguard? In the case of someone like Schwab, they explicitly don’t charge for their robo-advice platform because they use their own ETFs as the investment vehicles. That creates—maybe—a potential conflict of interest under the strictest interpretation of the new rules. 

Implementation: Start Now

The DOL rule automatically becomes the law of the land in mid-June. There has been a push in Congress to interrupt that process but without enough support to override a promised veto of the Senate efforts. This has led many advisory firms, broker-dealers, and wealth management shops to move from the “what’s happening?” phase of analysis to the “how do I comply?” phase. The good news is that there’s a one year window before the rules actually go into effect, specifically to give every advisor and firm a chance to put policies in place and talk to their clients. And that’s what’s going to have to happen. Every firm that interacts with retirement investors—even those who firmly comply with the safe harbor exemptions—will have to re-paper their clients and create documentation of their policies and procedures to ensure their investment process and compensation practices are up to snuff.This is just the tip of the iceberg on how the DOL Fiduciary rule is going to shake up the investment management business.  After all, the final rule is over 1,000 pages long. 

I hope you’ll join me and Investment News as we dig deeper behind the cover page on Tuesday, May 24.

Live Webcast: How the DOL Fiduciary Rule Could Reshape the ETF Game

Join Dave Nadig and Investment News on Tuesday, May 24 to learn:

• Why ETFs are well-suited in the wake of the new rule
• What advisers need to know
• How the new rule will impact exchange-traded funds
• How advisers should communicate these changes to their clients

Register, free, at Investment News.