There has been plenty of sound and fury around the introduction of the new requirement that all financial advisors to Individual Retirement Accounts [IRAs] be held to an ERISA fiduciary standard (summarized here: Fact Sheet). While these new regulations are indeed significant, their actual practical impact in day to day advisory and money management practice hardly justifies the alarmist reactions.
The new standard will loom large in litigation, where the seemingly nebulous distinction between the suitability and best interest standards will require lawyering and judicial review in the context of claims by unhappy clients or regulatory audits. As a result, clients engaged in providing financial services are strongly encouraged to be pro-active in not only acting in clients’ best interests – which is typically already the case notwithstanding the newly imposed legal standard – but also to document that they have done so. While it is too early to say how the courts will interpret the new regulations, and rest assured that they will, it is much better to avoid entanglement than to be a guinea pig in court interpretations.
Among other things, it is essential that boards of directors and where applicable, supervisory persons, provide clear written direction as to what changes in practice are required. The suggestions below are likely to be a useful starting point in this process. We advise a practice similar to the now familiar written investment policy statements by employee benefit plan fiduciaries.
Time should be taken to identify actual and potential conflicts of interest and ensure that they are appropriately addressed under the new regulations. The new rules also make essential clear and conspicuous disclosure in investor agreements of all fees – both fixed and contingent – payable by an investor. Consideration should also be given to the use of newly introduced ‘best interest contract exemption’ [BICE] waivers to permit transactions that would otherwise be prohibited as a conflict of interest (e.g., contingent, transaction-based compensation or commissions). However, it is still too soon to fully grasp how such waivers will be construed by the Department of Labor and the courts.
We firmly believe that apart from legal characterizations, the vast majority of IRA advisors have generally already been acting in clients’ best interests, and not relying on the use of investments that are in the seemingly-academic netherworld between ‘suitable’ and ‘best interest.’ Such conduct has for some time already been required of Certified Financial Planners and Registered Investment Advisors.
However, one potential exception to current practice that must be promptly revisited is the heavy or even exclusive reliance on proprietary investments offered by asset managers. No investment is suitable for every investor or every situation, which means that no fund family or class always works. As a result, advisors must be open to the use of all fund alternatives based upon individual needs. If a small cap value fund appears warranted in light of an investor’s objectives and circumstances, then the advisor must consider the full range of such funds, including applicable fees and costs, as opposed to automatically pulling the in-house alternative ‘off the shelf.’ The new regulations require advisors to address these conflicts of interests and change the practice. Again, proper, documented management direction on this topic is essential.
There will undoubtedly be more impassioned commentary on this topic in coming months. Before accepting that either the new standard is of little significance to you, or that the rules really do strike at industry fundamentals, we suggest consultation with one of our corporate, regulatory, or employee benefits partners to discuss specific ramifications for your situation.
In the meantime, all participants in the wealth management field are encouraged to:
- Take a deep breath;
- Put in writing what most of you were probably already doing; namely, putting your clients’ interests first [and consider whether there is any marketing mileage to be had from publicizing that this is what you have been doing all along];
- Make sure that the advice is codified at the Board level;
- Review investor agreement forms to ensure that there is adequate disclosure of fees and conflicts;
- Address all conflicts of interest with a change in practice or a ‘best interest contract exemption’ (but understand that the courts have not put any ‘gloss’ on the application of the BICE); and
- Identify alternatives to in-house offerings in each fund class.