On April 6th, the US Department of Labor (DOL) issued new regulations requiring financial advisors and brokers handling individual retirement (IRA) and 401(k) accounts to act as “fiduciaries,” or in the financial best interest of their clients.
Cornerstone Capital heartily welcomes this change. We consider fiduciary duty to be fundamental to the advisor-client relationship, and the DOL’s explicit recognition of this fact reinforces Cornerstone’s philosophy and values. These new regulatory changes establish a standard consistent with Cornerstone’s existing advisory business practices, and we hope they will accelerate a trend towards refreshed examination of the sustainability of financial services industry incentives, governance and regulation.
Despite the “customer comes first” marketing broadcast by many financial services firms, the DOL’s new regulation significantly shifts the legal requirements for an industry whose advisors have until now been obligated to recommend only “suitable” investments to clients, a lower legal standard of care. Put simply, the “suitability” standard has for many advisors come to permit the recommendation of expensive (and higher commission paying) funds – even when an otherwise similar, cheaper fund could offer an equal or better alternative for clients.
The Obama administration, citing extensive academic research, has estimated that misalignment of incentives embedded in the financial services industry, and permitted by the “suitable” clause, cost Americans $17 billion a year and depresses aggregate annual investment returns by about 100 basis points.
Under the new rules, any advisors or brokers who handle retirement assets must act explicitly in clients’ financial best interest, even if doing so will cost the advisor or broker some potential income. The change extends an existing law, commonly referred to as ERISA, which compels “fiduciary duty” on the part of investment advisors, to include non-employer-sponsored retirement assets, such as IRAs and Roth IRAs, in addition to the 401(k) accounts and SEC-regulated advisors already covered. There is significant money at stake: According to the Investment Company Institute, 401(k) type plans held $6.7 trillion at the end of 2015; IRA-type accounts had $7.3 trillion.
Wednesday’s pivotal regulatory change does not come without public review; the DOL has received roughly 400,000 comments, held numerous meetings, and modified preliminary regulation details to reflect industry feedback. The rule comes after years of opposition from many well-known wealth management firms, who argue it will drive up costs, curb commissions and ultimately harm customers as firms abandon clients with smaller, less lucrative accounts. However, backed by a large body of academic research, supporters of the rule, including consumer groups, retiree advocates, and indeed many other wealth managers, believe that the change will promote transparency and protect investors from being sold expensive and unnecessary financial products.
The new Fiduciary Standard rule will go into effect in spring of 2017.
John K.S. Wilson is the Head of Corporate Governance, Engagement & Research at Cornerstone Capital Group. John has close to 20 years of experience in socially responsible investing and corporate governance.
Caleb Ballou, CFA is an Associate at Cornerstone Capital Group. He is currently pursuing a dual MBA and MA in international affairs at Columbia University.