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Last month, the United States Department of Labor (DOL) won a five-year battle with the financial industry to move forward on regulations designed to protect 401(k) and Individual Retirement Account investors by requiring all advisors to act in the best interest of retirees.
These new rules have been touted to be the biggest change for financial advisors and brokers since the stock-trading commissions were deregulated in 1975. And so, we would like to take a closer look at these new rules and what they mean.
What are the proposed rules?
The DOL’s new regulations require that anyone providing investment advice on a retirement account must become a fiduciary for the client — that is, one who must act in the client’s best interest. This would generally require advisors to sign a contract detailing fiduciary obligations, to provide extensive information about fees and expenses and to earn “no more than reasonable compensation, while implementing procedures to minimize conflicts of interest. If the advisor fails to meet these fiduciary duties, the client can sue.
Why are these changes being proposed?
The DOL received a memo (The Effects of Conflicted Investment Advice on Retirement Savings) from the White House citing academic research that indicates that financial advisors can become opportunistic at the expense of clients because of incentive opportunities from specific product providers, resulting in IRA investors paying excessive fees. The analysis estimated that investors incur losses of approximately 1% from conflicts of interest, and so the DOL is aiming to mitigate the impact of these conflicts in the retirement investment marketplace.
Why these changes matter
The proposed new rules from the DOL updates existing regulations that are almost 40 years old and increases the number of people who are subject to the fiduciary best interest standards. The new approach is a flexible and principle-based one that is designed to be able to adapt as business practices evolve.
By being required to acknowledge their fiduciary statue, advisors must enter a contract and explain each investment fee and cost clearly, ensuring the investor is fully aware of each step of the process. These new regulations are designed with the investor in mind to mitigate the harmful effects of conflicts of interest and retention of information regarding performance data and fees.
Fiduciary advisors working under contract may still receive common fees such as commissions, revenue sharing and 12b-1 fees; however those who do not enter into contracts may not recommend investments with conflicted compensation unless payment fall under an exemption.
The DOL’s comment period on this proposed rule was open until September 24. A public hearing will follow to ensure a thorough evaluation of processes occurs.