The DOL fiduciary rule: heralding the end of commissions

Once the Department of Labor fiduciary rule starts to take effect in April of 2017, it's a fair bet that industry costs will go up significantly, and not just in terms of compliance: Embedded into the rule is a provision that leaves advisors and insurers vulnerable to a class action lawsuit.

That legal exposure could prompt the industry to shift en masse to other options for complying with the rule. The safest and least costly of them — charging a no-conflict, level annual fee for investment advice — is likely what the Labor Department is expecting most advisors will adopt over time.

This shift would realize an unstated objective of the department: killing commissions as a viable method of compensation for most producers offering retirement advice involving variable or equity-based products.

That's the conclusion I draw from a Tuesday focus session of the 2016 annual meeting of the Million Dollar Round Table, held in Vancouver, British Columbia, June 12-15. The session's presenter, Valmark Securities President and CEO Larry Rybka highlighted several dangers that advisors ignore at their own peril.

Including those who think they're beyond the rule's reach. As Rybka noted, the 1,000-plus pages of the Labor Department's regulations covers investment advice offered on a wide range of transactions governed by the Employee Retirement Income Security Act. Among them: the selection of investments for employer-sponsored qualified plans; 401(k)-to-IRA rollovers, variable annuities inside an IRA, and other investment products managed within fee-based accounts.

One unintended consequence of the rule will be a decline in the flow of assets from one managed account to another. Simply by moving retirement assets from a broker-dealer to a registered investment advisor (known as an RIA), or vise-versa, could invoke the rule. "Grandfathering" of existing accounts (as understood in the conventional sense of the term) will not be allowed.

Another unintended consequence: New business that today easily gets past compliance will not be consummated because of questions as to whether a product or plan recommendation meet's the rule's requirements respecting disclosure, charging "reasonable compensation" or the mitigation of conflicts of interest.

Under the proposed Department of Labor fiduciary rule, advisors have "four doors" they can choose among, according to Valmark Securities President and CEO Larry Rybka. (Photo: iStock)

The four doors

"In the future, someone at the broker-dealer or RIA or insurer will have to ask, 'Is this transaction in the client's best interest?" said Rybka. "Because that's not well defined, way more business is going to get kicked back. That's a big change."

As are options for producers to weigh when deciding how they're to be compensated. Available under the new regulations are, as Rybka labeled them, four "doors" that advisors can choose among. The first of these (door No. 1) is effectively a "safe harbor" for bypassing the rule's draconian requirements: charging a flat, annual fee not dependent on any transaction connected with advice given.

The advisor could, alternatively, elect door No. 2: a level compensation Best Interest Contract Exemption (often labeled "BICE light"). In exchange for making necessary disclosures, a flat fee or commission may be charged on transactions. The catch: compensation must be uniform, irrespective of the product recommendation.

It's door No. 3 — the full-blown BICE — that's the biggest concern for producers looking to retain commissions. To satisfy this option the advisor must, apart from fulfilling additional Labor Department disclosure requirements, have the client sign a pre-advice contract.

But even if they surmount all of the regulatory hurdles, there's this to worry about: the inability to add provisions to the contract limiting the advisor's liability (e.g., to the fees or commissions charged).

Worse, trial lawyers could pursue a class action lawsuit against an advisor or broker-dealer, making a party to suit all other clients who received the same product recommendation. As Rybka noted, this is truly a scary prospect — and one that most insurance and financial professionals will want to stay well clear of.

That brings me back to Department of Labor's unstated intent: ending commissions on variable products. If the department gets its way — as surely will happen if the rule remains as is — consumers unable to afford advisory fees will be the ultimate victims of the regulatory overreach. Given the woeful lack of retirement planning in the United States, that would be an unfortunate outcome.

How the final DOL fiduciary rule will impact advisors

5 things to know about selling annuities under the DOL fiduciary rule

Let's continue the conversation on Facebook!