Credit: Individual investors won some but not all of what was hoped from a sweeping new rule that tightens conflict-of-interest standards for brokers. Those brokers manage trillions of dollars in retirement accounts such as 401(k)s and IRAs, creating compliance headaches and liability issues for the financial industry.
Still, the new rules are more lenient than the financial industry had feared they would be. And that leniency led investors to bid up stocks on Wednesday of many asset managers, brokers and insurers.
Life insurer Primerica ( PRI ) soared nearly 7%. Broker and financial adviser Ameriprise Financial ( AMP ) rose 1.5%. T. Rowe Price ( TROW ) rose 1.4%. "Several of these stocks are trading up today," said Morningstar analyst Greggory Warren. "The rule impact is being seen as not as onerous as feared."
Despite industry relief, overall the rule is seen as a victory for individual investors.
The final Labor Department ( DOL ) fiduciary rule, which follows months of public and industry views on its proposal, requires brokers to act in the best interests of clients when providing retirement advice. The Obama administration claims that will lower costs and boost returns for investors.
"Today's rule ensures that putting clients first is no longer a marketing slogan," Labor Secretary Thomas Perez said in a conference with reporters. "It is the law."
The fiduciary standard of behavior creates new grounds for complaints by investors who feel they have been short-changed by their broker. At the outset of a brokerage relationship, a broker can still require a client to agree to take any disputes to arbitration rather than to court. But now the broker has to meet a higher standard of professional behavior, says Andrew Stoltmann, a Chicago securities-fraud attorney.
"(The new rule) creates a strengthened cause of action for those suing their brokers," Stoltmann said. The new rule does not mean that DOL itself will become more active as a securities cop, Stoltmann added.
The government made some concessions in its final rule after months of criticism from the financial industry.
The Investment Company Institute, a group representing mutual funds, last summer called the proposal so complicated that it is unworkable. Brokerages charged that the requirement would add costs that make retirement advice unaffordable for many lower- and middle-income investors.
Some financial firms will probably benefit, while others are expected to be hurt.
Discount brokerages such as Charles Schwab ( SCHW ) and TD Ameritrade (AMTD) stand to be helped, Morningstar predicted. So are companies that sell a lot of index and exchange traded products, like State Street (STT), BlackRock (BLK) and Vanguard. And robo-advisors are also likely to gain business. Brokers would be compelled to use their low-cost products and services rather than high cost alternatives.
T. Rowe Price stock was up because its funds are relatively good performers, meaning they are more likely to be acceptable investment recommendations by brokers, Warren said. Also, the firm has been bolstering its sales staff in recent months, to boost its IRA business, he added.
In its new rule, the Labor Department addressed some industry concerns. The originally proposed eight-month deadline for compliance is gone, replaced by a longer, "phased" implementation timetable.
Also modified is a requirement for new clients to sign a contract in which any broker conflicts are disclosed. These would include the broker disclosing that high-commission products might be offered even though lower-cost alternatives are available. The final rule says the contract does not have to be signed until a client actually opens an account. The proposed rule called for the contract to be signed when the client first had contact with a broker.
Another item dropped from the final rule: a proposed list of acceptable assets that advisors can recommend instead of certain high-risk investments. And a widely expected prohibition of in-house investment products has been dropped.
"I'm a little disappointed the DOL has caved on the issue of whether firms can recommend proprietary products like annuities," Stoltmann said. "No real fiduciary could do this. I think the DOL caved on a very crucial issue."
What The New Rule Does
The new rule basically extends a fiduciary standard mainly to brokers when they provide investment advice for retirement accounts. A fiduciary standard requires brokers to act in the best interests of clients. Registered investment advisors (RIAs) are already subject to the fiduciary standard, but a stricter version than imposed by the new rule on brokers, said Stoltmann.
The new rule takes aim at IRAs -- particularly on money that is transferred or rolled over into IRAs from workplace retirement accounts such as 401(k)s, says Skip Schweiss, TD Ameritrade head of investor advocacy.
Under the old rule, brokers could recommend investments that were merely suitable for clients. The DOL says that the old standard allowed brokers to base recommendations on what would generate commissions for them, even if a better-performing, lower-cost investment was available.
The White House -- which supports the tighter standard -- said in February 2015 that investments made on the basis of conflicted advice under the old rule returned roughly 1 percentage point less a year on average than investments made on the advice of fiduciaries.
With an estimated $1.7 trillion of IRA assets invested in the type of products that generate conflicts of interest, the White House estimated that the aggregate annual cost of conflicted advice is about $17 billion.
"A retiree who receives conflicted advice when rolling over a 401(k) balance to an IRA at retirement will lose an estimated 12% of the value of his or her savings if drawn down over 30 years," read the White House report. "If a retiree receiving conflicted advice takes withdrawals at the rate possible absent conflicted advice, his or her savings would run out more than five years earlier."
With a $100,000 rollover for people age 55 to 64 in 2012, a 12% loss would cost the average investor $12,000.
Morningstar forecast a mixed impact for active asset managers, including AllianceBernstein (AB), Cohen & Steers (CNS), Eaton Vance (EV), Federated (FII), Janus Capital Group (JNS) and Legg Mason (LM). The same applies to full-service wealth managers, including Bank of America (BAC), Morgan Stanley (MS), Raymond James (RJF) and Wells Fargo (WFC).
These companies have product lineups that include both higher and lower cost products.
Asset Fees, Robo Boom?
And some impact could differ from what's expected. Many full-service brokerages could replace commission-based IRA fund sales with IRAs that generate fees on assets. "As fee-based accounts can have a revenue yield upwards of 60% higher than commission-based, this could translate to as much as an additional $13 billion of revenue for the industry," Morningstar reported.
Also, full-service wealth managers could stop serving clients with low IRA account balances. Those clients could take an estimated $250 billion to $600 billion in assets to robo-advisors. That could push a number of robo-advisors above the $16 billion to $40 billion asset base that Morningstar estimated they need to become profitable.
Even within groups that could be hurt by the new rule, like active asset managers and insurers, some companies could benefit. "(Firms) with moats will gain market share from their less competitively advantaged peers or ... will be able to adjust their business model to offset the negative financial effects of the rule," Morningstar reported.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
