Scenario 4: The Department of Labor enacts its long-debated fiduciary rule, including the proposed best interest contract exemption. How does this change the way you charge and disclose fees? Which clients are most affected? How seriously does it affect your business?
Eric Schwartz, Cambridge Investment Research, Division IV: I just looked at the three outcomes; one would be the severe case that goes through more or less like originally proposed, and with all the paraphernalia, it could have a pretty major impact on our business. It may be that 10%, 20%, 30% of the business we now do couldn't be done, or we don't even know. It's open.
Green: Is that because it wouldn't make economic sense to do that business?
Schwartz: It's all a question of how things are interpreted. They write these things, and then you have to have interpretations of what it means if you have one of these contracts. It may become standard operating procedure — no one ever said that Cshares are illegal or Bshares are illegal, but they wiped them out by basically saying you can only do them in certain circumstances in certain ways, which eliminated 90% of the current uses of them.
Depending on how they word it and then what the regulators choose to do with it once it's worded, that could be extremely draconian.
The other extreme is it that it gets watered down and basically we have another 20 pages of paperwork to fill out, but it doesn't have a really meaningful effect on our business. Maybe it eliminates the relatively small amount of business in alternative investments like REITs and IRAs. Some business is done but at most brokerdealers, it's probably not more than 1%, 2% of their business.
Variable annuities is another wild card. It could squeeze back variable annuities in retirement accounts but not a lot of other things. That's sort of a middle category. Maybe variable annuities and REITs can't go into IRAs anymore de facto, even if not the law of it. That may be 5% or 10% of our business, but advisors have adopted that.
I believe [Phyllis Borzi's] original position two years ago was, 'If we can just get brokers and advisors completely out of that business and have everybody on S&P index funds or whatever, that would be a good outcome.'
Ralph DeVito, The Investment Center, Division II: Right, we're going to probably somehow come up with a standard for our reps on the fee, whatever commission they can charge, by product maybe. Where fees are going to come into play, I don't know.
Lon Dolber, American Portfolios, Division III: Just have them charge a retainer, all those that deal with that.
DeVito: Probably not.
Dolber: Not the way I see it. I could just say, "For any business that you do regarding these plans, you'll charge a retainer based on X." The rule doesn't deal with retainers. It's almost like you're lacking an overlay manager in that case.
You're not charging a fee against assets. You're not charging a commission. You're simply saying, "One of the particulars, one of the things on my list of things I do, is I can advise you on your retirement account here. I'll charge you $2,500 a year for that."
DeVito: I think that would be tough because they're not used to that.
Green: Tough for the advisors? Tough for the clients?
DeVito: Probably both, but mostly the advisor.
Dolber: Eric, do you think the world deals with that, the retainer side?
Schwartz: I don't know that answer. I wasn't thinking about that, so I have not specifically asked. I'm sure our people have looked at it, but I can't comment.
DeVito: The one thing we know for sure is there's going to be more paperwork.
Schwartz: Killing trees is definitely not going out of style. As I say, there are workarounds a lot of times. There's been a huge amount of change since all of us have been in the industry. Things that we thought were really going to be draconian, they didn't really move the needle that much.
Dolber: It's very different. You're effectively giving a client an hourly fee. How can they argue against an hourly fee?
Schwartz: You didn't say hourly. You said $2,500. Basically, if it's a $500,000 account, it's $5,000.
Dolber: Maybe not. Maybe you're just going to charge a flat fee for the management of money, no matter where the accounts are at.
Schwartz: For where, yes. You can do that, but I'm saying you've got a $2 million client and a $100,000 client. You're going to charge them the same $1,000?
David Stringer, Prospera Financial, Division I: The issue, though, is you're still a fiduciary in that case. A fiduciary is 24/7. It's ongoing responsibility for a fee. I think the question that you asked about who's harmed. The very constituents they're trying to help are the ones harmed.
I was a participant on the FSI DOL task force. I think FSI submitted a 35page document of issues. There's a lot of ambiguity in how it's interpreted.
Everybody wants this single standard from which to operate, but I think the BICE in particular is really just unworkable — for all firms, but in particular smaller firms. I think they've underestimated the cost of compliance in order to come up with these websites that talk about every product you possibly sell plus project 3-, 5-, 10-year performance, which is in direct conflict with FINRA and SEC rules.
Dolber: It's like the mutual fund disclosure, the document that FINRA wanted. Where did that go? They wanted a detailed disclosure document, every single expense in a mutual fund.
Stringer: The principle I think they operate from is, "We want to put something in place that we can verify." That's where they come up with their mindset about all of these "gotchas" or ways to verify that we're operating with best standards in place.
This BICE, yeah, you can continue to do business the way you've always done it, but the paperwork and burden that we have to do to become compliant, to me it's unworkable.
Green: Just so I'm clear, the unworkability comes from underestimating, as you said, the cost of complying with this regulation?
Stringer: Plus, I'm concerned that we won't get it right on the front end. Then we have other regulatory entities that have their own standards. We've added complexity to it with another layer of oversight.
Schwartz: Certainly the SEC should be the one that's doing this, not the DOL because then whatever they did would apply to IRAs and regular accounts. You have [a client] come in. They have an IRA and a regular account. You're going to have two different standards and two different sets of paperwork to fill out. Talk about cumbersome.
DeVito: That opens up a whole other can of worms from a legal point of view. Why would you do it over here and not over there?
Schwartz: It may be that the DOL, whatever they do may automatically apply to all accounts before it's all done because that one came first so everything else has to be paralleled. Otherwise you have to defend why. You weren't allowed to sell [clients] this product over here, so you sold it over here instead. That's some odd stuff.
Stringer: When you enter that agreement with a client, you now have legal responsibility that's outside the arbitration process. It puts a new layer of liability to the organization. I just think that their intent is good.
Dolber: This is the problem. The government [goes] to war without thinking about what they'll have to do after the war is over to sustain the region.
They should first create a data standard because there's no data standard. There's no product description standard. Think about it: You can create a rule or a law, but you have to monitor it. You have to know you're getting compliance to it. You have to know you're getting adoption.
You'll never get adoption with this if you don't have a data standard. Take all the manufacturers of product; if you want to be able to compare products across manufacturers, this is not really a question of how you charge. It's really a question of how you see the transactions.
We have a high-definition TV standard in the United States. We don't have four different standards.
The way Nationwide does its data is different from the way Jackson National does its data. There's no standard. CARDS might be the closest thing. Guess what? You want to do what they're talking about with the Department of Labor? You better have a way to monitor it, and you better have a way for the firms to comply with it, or you'll never get adoption.
Schwartz: They seem to like to regulate us as the retail distributors of products in their vision, but they don't try to regulate the producers of the product, the manufacturers.
DeVito: We've been saying that for years. If you're going to yell at us or try to regulate us over B shares, which at the time they were wrong anyway and wanted to change, or C shares, why allow it? Why not, like you said, come up with a standard?
Dolber: Take the clearing firms. If you look at all the clearing firms and you look at all the DST and DAZL, they don't even describe conversions, exchanges and switches the same way. Try and determine what's a switch, what's a conversion, what's an exchange. You have to do programming. There's no other way.
There's no common way to describe a conversion from a C share to an A share. That could look like a switch. It won't if you programically say, 'Okay, it's the same fund. It's just a different share class.' There's no symbol that tells you [it's the same] because they don't have the willpower. FINRA has not gone to the SEC. The SEC is not going to the government. The Department of Labor is thrashing about with a rule but no way to enforce it, no way for us to adopt to it, no way for us to manage it. Data is the answer in my mind, but I've been talking about that for years.
Green: It sounds like you're a little skeptical that that data would be forthcoming.
Dolber: Let me ask you, how far did the regulators get pushing insurance companies to declare that index annuities were a security? When it comes to pushing back against the insurance industry, they don't see very great success, so they push back against us.
Eric, what you just said: It seems like they don't really go to the vendors or manufacturers of product because how much pull do they have with them? They're not members of FINRA.
Schwartz: You came right down to it. Even if [insurers] have a brokerdealer, it's for distribution. The rules on manufacturers are smaller, so they have apparently no legal grounds to stop them from manufacturing a product they think is bad. They only have an ability to punish you when you sell that product.
Stringer: President Obama has said this is a cornerstone of his middleclass economics. He's endorsed it. I think they got bad data. I think they've said, based on their studies, that the investing public is overcharged.
I don't think they fully understand there are a lot of investors sitting in mutual funds that are paying their fee. They're going to be orphaned, small accounts. My hope is that they'll take their time and really listen to the comments because they're going on with hearings right now. They're getting an earful about how they need to change this, but they'll be thoughtful about making these draconian changes. I think it could be pretty impactful in a negative way. I think they'll hurt the people they're trying to help.
Dolber: How come FSI never took up the data standard argument with the government? Why has it never been something they've been passionate about when it would solve so many issues for smaller firms, for mediumsized firms and for this issue?
Schwartz: I've been out [of the FSI board] for quite a while. I don't know if you've been in any discussions where that's been brought up. I have never heard that discussion.
Stringer: I can tell you that it seems like you have to fight the fire that's in front of you. While [a data standard] is probably important, it doesn't seem urgent. We have urgent issues. As long as I've been [on the FSI board], there's always been an urgent issue that needs advocacy. There's a limited budget. They're fighting states. They're fighting a lot of activity. It was CARDS before this. Now it's the DOL. When you have a limited budget, you've got to pick your battles.
Green: Is part of the issue that it's the DOL doing this and not the SEC?
Schwartz: That's the bizarre part of it in the first place. The SEC is still going to have to address it at some point. I know why the SEC has backed away, because they had some Democrats and Republicans on there that couldn't agree on anything. They should really have led the charge. This is their turf. Then it would at least be uniform.
Stringer: The DOL has the authority. They don't have to go get legislative approval. They have the backing of the president. We're going to deal with this in some form. The DOL doesn't have any authority over any of the data standards.
They do have some authority over retirement accounts. They're expanding their authority. It's with the president's backing, so we're going to face something. I don't think we're going to get away with a pass.
Schwartz: No, we're not going to get away with a pass.
Stringer: It's going to have an impact. We just don't know at this point. It's very fluid.
Dolber: We're going to have to manually handle thousands of transactions and make comparisons using paper because there's no electronic way to do it easily.
Schwartz: If we actually have to do that, that is sort of unfathomable. As you said, you're making forecasts of what you think the return is going to be and then what it would be and wouldn't be under different scenarios. That's really strange.
The regulators have never been successful at going after the really big insurance companies to get them to change. They have a pass. The reality is both the insurance companies and the large mutual fund complexes have a lot more money than we do.
Dolber: We can thank them for one thing. They've made the independent contractor status, even though the government, at times, has tried to change that. The insurance industry comes right at them because their agents are independent agents.
