Keeping Up with the Fiduciary Ruling

On February 3rd, President Trump issued an executive memorandum requiring review of the previously instated Department of Labor fiduciary ruling. In the memorandum, President Trump tasked the Department of Labor to fully review the ruling to assess if it would ‘negatively affect’ investors ability to access retirement information, offerings, product structures, or related financial advice. The issuance did not stipulate a time frame for the review to take place, leaving many financial institutions and investors in limbo on how to appropriately respond given the prior April 1st deadline.

Background on the Fiduciary Rule

Nearly a year ago, under the Obama administration, the Department of Labor issued the fiduciary directive. The ruling raised the bar for the financial services industry by requiring all agents to act in the best interest of their clients. While many firms were already doing this, brokers primarily acted under the lesser requirement of suitability standards.

The difference, while it may sound subtle, is quite stark. A fiduciary is required by law to suggest the best possible funds and investment opportunities available in the market, even if those options are not within the advisor’s offerings and even if the advisor will earn less from the advice. Suitability standards in comparison are used to pitch products to clients where advisors earn commissions off the sale of the product. The 2008 financial crisis relating to the housing market can be tied back to lack of proper regulation of the financial industry and suitability standards.

The argument against the DOL rule, and in favor of keeping minimum suitability standards, stems from concerns that fiduciary compliance could cost millions and force smaller to mid-level firms to either fold or merge with larger corporations. There’s concern brokerage jobs will be lost and that the rule could result in client’s with smaller portfolios being left behind.

On the other hand, the Department of Labor argues consumers erroneously pay $17 billion in investment fees for products that aren’t in consumer’s best interest. As recently as last week, a federal court judge in Texas ruled in favor of the DOL fiduciary ruling, dismissing a case brought against it by the U.S. Chamber of Commerce, by emphasizing the importance of the ruling for the protection of investors.

How Compensation Structure is Involved

For firms that run under fiduciary standards, fee structures are primarily set out in one of three ways: an hourly fee, fees based on gains in the investments they manage on a client’s behalf, or a combination of fees and commissions. Alternatively, firms that meet minimum suitability requirements earn commissions off the sale of certain investment services and products. The latter incentivizes advisors like a typical salesperson; the more sales the higher the commission.

To illustrate the difference, consider the example of an investor nearing retirement and deciding how to allocate $50,000 in discretionary income. Both types of advisers, fiduciary and suitability, might first evaluate the current assets, investments, and retirement vehicles in the investor portfolio.

The fiduciary advisor might advise the investor to take a conservative approach since the investor is nearing retirement. The advice might be to use the funds in a retirement vehicle comprised of 75% bonds and 25% stock equities, even though the advisor might generate higher earnings with a more equally balanced distribution based on market performance.

A suitability advisor, who earns money off commissions, might instead suggest a specific structured product or mutual fund, that while suitable for the client, does not necessarily serve the client’s best interests. Regardless, the suitability advisor will earn a commission on the sale and thus push the client towards that specific offering. Most customers, being unaware of the significant differences in suitability and fiduciary requirements, will go ahead with the plan.

This example illustrates how investors may get “burned” in suitability situations, and emphasizes how the DOL finds consumers are at risk. Investors are more appropriately protected under healthy fee structures found in fiduciary standards than in suitability situations, which is why TrueNorth serves clients as fiduciaries.

Moving forward

At TrueNorth Wealth, we remain committed to putting our clients first by meeting fiduciary standards in investment offerings, internal practices, and in client relationships. As the industry continues to define best practices and emerging trends, TrueNorth Wealth remains committed to business and sales models that meet the highest standards.

TrueNorth Wealth is a fee-only financial advisor firm specializing in personalized wealth management guidance to individuals and businesses. For a free financial consultation get in touch today.