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Tackling compliance with the new fiduciary rule

Wealth management firms find themselves at different stages of readiness as they work to comply with Department of Labor’s (DoL) new fiduciary rule announced in April 2016. All financial services firms that manage retirement assets are facing a significant challenge as they develop and execute plans to bring their business operations in line with the new rule by January 2018 – with some provisions requiring compliance by April 2017. 

The new rule expands the definition of who is a fiduciary under the Employee Retirement Income Security Act (ERISA) of 1974. First proposed in 2010, the new fiduciary rule was revised in April 2015 and finalized April 6, 2016. Importantly, it designates investment representatives who work at broker dealers, banks and other financial firms as fiduciaries when their advice involves retirement money. Previously, the role of fiduciary was limited to trust departments, registered investment advisors (RIAs) and people and firms advising and managing employer-sponsored retirement plans.

“This is one of the most significant changes that we’ve had in our industry since ERISA was passed nearly 42 years ago,” says JoAnn Schaub, manager of institutional wealth management at BOK Financial Corp. of Tulsa, Okla., which has $71.9 billion in investment assets under administration.

BAI has seen the banks we interact with take various approaches to the new regulation. Many have been preparing for quite some time, while others have been monitoring the process and taking a wait-and-see approach. It is certainly clear that the higher standard of care in the new rule will change how banks interact with investors who have retirement assets and, perhaps, result in changes to the advisor who deals with that portion of an investor’s overall portfolio. Amid this uncertainty, BAI’s Investment Benchmarking program has seen increased interest as banks find it more important than ever to compare themselves to their peers and the industry when it comes to investment management.

Client First

The rule redefines who is an investment advice fiduciary. It also expands situations where communications can be deemed investment advice, bringing in more people who will be seen as providing investment advice even if that was not the intention of the advisor, according to an analysis by Shearman & Sterling LLP, a Washington, D.C. law firm.

Under the new fiduciary standard, the advisor must put the client’s best interest first. The fiduciary is expected to act with prudence, avoid misleading the client, and provide full and fair disclosure of all pertinent information, according to the 401khelpcenter.com. In addition, the rule states the fiduciary should avoid conflicts of interest and fully disclose and fairly manage unavoidable conflicts in the client’s favor.

The new rule “has accelerated the importance of implementing a client-centric operating standard that aligns organizational processes and regulatory requirements with the individual client focus and attention investors expect,” says Mary Schlafly, vice president/general manager with Irving, Tex. based Epsilon Data Management, LLC. “Financial services companies that break down internal barriers to deliver client experiences that drive satisfaction as they map a post-fiduciary rule change future will retain current assets and attract new investors, now and during the record generational wealth transfer that will occur over the next 20 years.”   

The impact of the rule falls across nearly all lines of business at many banks. Changes will impact the trust department, wealth management, broker-dealer operations, the registered investment advisor (RIAs) business, the sale of annuities, employee plan advisory business, and any bank employees involved with Individual Retirement Accounts (IRAs), including front line employees at local branches.

Banks are undergoing an intensive effort to first determine the changes they need to make and then put together a plan to implement those changes across the organization. “The challenge is going to be to change the way we do business and the way we interact with customers,” says Rhomes Aur, executive vice president for wealth management service at First Tennessee Bank in Memphis.

“You’ve got to retrain your sales force. You’ve got to change your processes. You’ve got to change your account applications. And, you’ve got to change your documentation,” Aur adds.

Banks do have a leg up over some other distribution channels that provide investment advice because “they have an institutional knowledge about how to do this fiduciary business” from their long experience running trust departments, says Betty Moon, principal at Moon Consulting Group, Charlotte, N.C. “It would seem to be a fairly natural progression to extend that expertise across the organization.”

Banks that have established a registered investment advisor (RIA) business will also be well positioned to incorporate the new rule into the way they do business, according to Aur.

Bringing the broker dealer business into compliance will be the biggest challenge for banks because it potentially involves changing the culture and the compensation of registered representatives, according to Conway Dodge, managing director, Promontory Financial Group, Washington, D.C. “Within the broker dealer, you typically have a group of financial professionals subject only to the suitability standard historically, where their compensation is largely driven by commissions,” Dodge says.

Banks must decide among a set of options where each choice has its own downside. “The big question is: are you going to continue to offer commission-based products in retirement accounts? I think that’s what every institution is trying to figure out,” says Aur. “And if you are not, then are you going to go fee-based only?”

If a broker dealer operation decides it does not want to move to a fee-based model and wishes to continue with at least some commission based products for investment advice, it will have to comply with the rules under the best interest contract (BIC) exemption. Banks that wish to operate under the BIC exemption have until January 1, 2018, to comply with the terms of that exemption.

First Tennessee is currently trying to assess the BIC exemption option. “So what we’ve got to do is figure out what that encompasses,” says Aur. “What are the risks associated with that? How do we solve for the risk? And how do we implement that into our existing programs?”

It will not be an easy task to conform operations and compensation to the BIC exemption, which is complex, burdensome and costly to implement. Moon suggests moving larger clients into the RIA solution. “Then, move the smaller, less profitable, less complex accounts with fewer assets, and with less hand holding into a robo solution. That solves the problem,” she says. 

Robo or digital investment advice recommends to retirement investors how to invest the money in their retirement accounts and how to periodically adjust the allocations among investment options. “If you don’t have a robo solution and you don’t have an RIA solution and you don’t have some other places to serve customers, you are going to have to fix compensation,” says Moon. “To do that is going to be difficult. It’s going to have a direct impact on advisors.”

Given the higher average age of registered representatives in the broker dealer business and the fact that many are close to retirement, some may choose to retire rather than stay in the business, according to Moon. This could adversely affect the ability of consumers to obtain advice from an investment professional by reducing the supply of investment advisors, she adds.

Scott Cooley, director of policy research at Morningstar in Chicago, says broker dealers he has talked with have indicated they are likely to shed lower balance IRA accounts or serve fewer new low balance accounts. “Some of that money may end in the banks and it may end up getting advised by a robo advisor that has a lower cost structure,” Cooley says.

He also expects that more employees will leave money in their 401(k) plan when they leave a company rather than roll it over to an IRA. “One reason people roll money out now is that they are often targeted pretty aggressively by various service providers to roll over the money into an IRA, even if the fees in the IRA are higher than they were in the 401(k) plan,” Cooley says. “It will be much harder for people to justify giving that advice to clients in the future.”

Broker Dealer Focus

To address these issues, BOK Financial formed a steering committee in April 2015, created a charter and set up working groups by line of business to develop impact plans for all the parts of the bank that would be affected by the fiduciary rule. The effort was launched at the behest of Scott Grauer, executive vice president for wealth management and chief executive officer of the company’s broker dealer.

The task force convened every two weeks over the past year to work through a number of issues. Not surprisingly, the broker dealer business was a key focus. BOK Financial, in its deliberations, concluded that “there will be places where commission-based products will be appropriate and we’ll continue to offer those,” says Schaub. This includes offering managed accounts, which have a minimum of $10,000, so would be available to a broad range of clients. A managed account is a personalized investment portfolio tailored to the needs of an individual account holder; it is a fee-based account in which the fees are level.

At the same time, BOK Financial has decided to also offer a robo solution for some of its customers. “Some clients just want to do things on the web. They want to go direct. They don’t want to go through an intermediary,” and robo advice suits those clients, says Schaub.

The new fiduciary rule creates another peril for banks communicating to customers who ask about rolling over a lump sum from a 401(k) into an IRA. In response to a customer query, at what point does a communication from anyone at the bank, including a front line branch employee, such as a teller, cross the line into fiduciary investment advice? “If it doesn’t fall under the education exemption, then it’s a very blurry line between when I am wearing my fiduciary hat and not wearing my fiduciary hat and that blends into sales practice issues,” Dodge says.

“The smartest banks will educate the workforce to assume that they are always wearing fiduciary hats and document exactly what it is they have recommended, how they have advised a client, and demonstrate they have acted in the best interest of the client,” says Dodge.

There may be a silver lining in the challenge posed by the new DoL rule – it may finally help banking organizations succeed in forging more cooperation between their many departments that now operate as silos, says Moon. “The DoL rule is going to be the impetus to force us to talk to one another about what it means to be a fiduciary and what it means to act in the best interest of the client and to do that so the customer truly is at the center of everything we do.”

Mr. Kowalczyk is managing director, Business Development, for BAI. He can be reached at [email protected]