While nearly half of all consumers believe that financial advisors are required to make investment recommendations which are in the best interests of the consumer, until now that has not been a strict rule. The U.S. Labor Department, after years of meetings with Wall Street, insurance companies and consumer groups, has put forth new “customer first” rules for retirement accounts. It is estimated that these rules could save consumers as much as $17 billion in fees and commissions.
On April 6, 2016, the U.S. Labor Department announced new “customer first” rules for retirement accounts which will require financial advisors and brokers to only recommend suitable investments with reasonable commission rates for the majority of individual retirement and 401(k) accounts. Advisors must now act in the best interests of their clients, rather than suggesting only those products which pay the highest commissions.
According to Thomas E. Perez, the Secretary of Labor, “The marketing material that I see from many firms is, ‘We put our customers first.’ This is no longer a marketing slogan. It’s the law.”
Barbara Roper, Director of Investor Protection at the Consumer Federation of America, said “It is a really big deal. Revolutionary, even.”
The changes are expected to save Americans as much as $17 billion in excess fees and commissions on their retirement accounts.
Many consumer advocates, including Suze Orman, are pleased by the new Labor Department rules.
What Will Change for the Typical Retirement Savings Plan?
First, it is important to note that the new regulations will probably not be fully implemented until next spring. However, most firms will begin to take steps to meet the requirements sooner than that.
Prior to the passage of these new regulations, financial advisors were only required to put their clients in “suitable” investments … which they did not have to interpret as ones with reasonable commissions, when two funds were otherwise similar. Now, the investments are required to have an appropriate level of risk, as well as a low commission.
In addition, firms may only charge “reasonable commissions” and they must provide consumers with access to a website which explains how the advisor makes money.
Brokers are still permitted to charge a commission, of course, and can engage in revenue sharing with mutual fund companies, although everything must be disclosed.
One significant change is that brokers will now be expected to act in the best interests of the client when money is rolled over from a 401 (k) into an IRA. Up until now, brokers could recommend high-commission investments that were not necessarily in the best interests of the clients.
In general, the new rules will protect people from having their retirement savings invested in generally unsuitable products that generate high incomes for brokers, such as non-traded REITs or variable annuities in an I.R.A. In addition, brokers are discouraged from “churning” or actively trading stocks and options in their clients’ retirement accounts.
There Are Exceptions to the New Customer First Rules
At times, the least expensive product may not be the best one for a specific client. For example, there are situations where a variable annuity with a higher commission rate might be more appropriate for some clients than other types of retirement products.
In addition, firms which give advice to small companies with a 401(k), or that have plans with less than $50 million, can qualify for exemptions from some of the stricter provisions in the rules.
The regulations only apply to tax advantaged retirement accounts. Individual investors will not initially be impacted by the changes. However, it could eventually cause changes across the financial services industry.
What Are the Objections to the New Rules for Retirement Accounts?
It has taken years of battling Wall Street and insurance firms in order for the Labor Department to come up with these new regulations. Officials believe that they may still face court challenges from those institutions that object to the stricter rules.
One of the objections is that investors will be placed in lower risk investments, which also have a lower rate of return, because brokers will not want to be sued if the value of the portfolio goes down.
Some firms are concerned that the new regulations will be enforced by the courts, via frequent lawsuits, which could result in expensive legal fees.
The cost of complying with the regulations could also make it more difficult for smaller firms to compete. As a result, many of them could end up being consolidated into larger firms. This could be one reason why Merrill Lynch released a statement in favor of the new regulations:
Another objection that has been expressed by some is that the new rules could result in more reliance on consumers paying a flat fee to someone who manages their account for them. This might save money for larger investors, but could cost more for others, especially those starting out with very small accounts.
On the other hand, despite the fact that the new rules are much stricter now, some consumer advocates do not believe they go far enough.
Overall, however, the praise for the new customer first fiduciary regulations has outweighed the criticism, particularly in mainstream and social media.
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