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The way millions of Americans interact with Wall Street may soon face its most significant change in years.
A sweeping new rule, announced Tuesday by Labor Secretary Thomas Perez, will impose a tougher ethical standard on 300,000-plus financial advisers who work with retirement accounts like IRAs and 401(k)s, requiring them to act in the best interest of their clients.
After years of stop-and-start progress, the final regulation, known as the “fiduciary rule,” will go into effect by early 2018. Wall Street lobbying groups, which opposed previous draft versions of the new rule, didn’t immediately comment. But according to one report, at least one is already preparing a court challenge.
Many Americans who consult with a financial adviser for help picking stocks, bonds, and mutual funds assume that he or she is already required to give objective advice that’s uncompromised by conflicts of interest—much like other professionals such as lawyers or bank trust officers.
In fact, that is not necessarily the case. Many financial advisers—a professional designation that evolved out of the stock brokers of a previous generation—essentially act as salespeople, free to recommend investments that pay them the highest commissions, as long as they are broadly “suitable” based on factors like age and risk tolerance.
Such commissions often amount to 4% of an investor’s nest egg for a mutual fund sale and 6% or more on products like annuities—providing an powerful incentive for advisers to recommend them even when they carry higher investing costs, which can leave investors far worse off over time. The new rules, which technically apply only to retirement assets like 401(k)s and IRAs but are expected to influence practices industry-wide, are designed to prevent such conflicts of interest.
The stakes are high. As much as $3 trillion is currently overseen by advisers affected by the rule, according to a recent report by Morningstar (subscription required). Last year a report by the White House Council of Economic Advisers estimated the rule could save retirement investors $17 billion a year.
Consumer advocates, pointing to studies showing that investors assume all financial advisers are already fiduciaries, have been pushing for more than a decade to make the tougher ethical standard apply across the industry.
Advisers at many of Wall Street’s largest brokerage firms have already adopted a fiduciary standard to govern relationships with many of their clients, in part because those relationships provide a more stable and sometimes larger revenue source. So the greatest impact will be felt by financial advisers at smaller firms and those with ties to insurance companies, who specialize in investments like variable annuities. These advisers tend to cater to less wealthy clients, a fact that Wall Street trade groups used to campaign against the new rule, arguing that it would deprive millions of Main Street investors of financial guidance.
Federal legislators have been debating a fiduciary standard for years. The Dodd-Frank financial reform bill, passed in 2010, gave the Securities and Exchange Commission authority to impose a fiduciary standard across the wealth management industry. Then-SEC chairwoman Mary Schapiro vowed to make implementation a priority, but the effort stalled amid an intense lobbying campaign on Capitol Hill. Meanwhile, the Department of Labor began its own parallel effort, proposing then withdrawing its own version of the rule, before finally completing it Wednesday.
While the Labor Department technically claims jurisdiction over just 401(k)s and IRAs, those accounts are so popular among American investors that many experts believe the new rule will eventually change practices across the industry.
Some controversial details of the new rule remained unclear early Wednesday, including precisely how it will effect advisers ability to sell in-house investment products; the fate of adviser sales incentives like prizes; and the rule’s impact on the sale of costly commission-based investments like annuities. Shortly before the final rule was published, industry lawyers and trade groups were preparing to closely examine the final language on these and other important but technical points. And it may take years for courts to settle conflicts between what are likely to be conflicting interpretations of the rule.
Meanwhile, many Wall Street firms have already started preparing for the new legal regime. A recent report in the Wall Street Journal detailed how advisers at Bank of America’s Merrill Lynch were being urged to move clients from accounts in which clients paid for advice via commissions—historically giving advisers the freedom to act as salespeople—to ones which charge an annual fee, which already require compliance with the fiduciary standard.