The rules governing how financial professionals handle the trillions of dollars they invest on behalf of Americans saving for retirement are about to get a lot tougher.
The Labor Department, after years of battling Wall Street and the insurance industry, issued new regulations last week that will require financial advisers and brokers handling individual retirement and 401(k) accounts to act in the best interests of their clients.
The government move is expected to encourage a shift of retirement funds into lower-cost investments – potentially saving billions of dollars for many ordinary investors – while setting off one of the biggest upheavals in the financial services industry in decades.
“The marketing material that I see from many firms is, ‘We put our customers first,’” said Thomas Perez, the secretary of labor. “This is no longer a marketing slogan. It’s the law.”
Never miss a local story.
The new regulations, which may be challenged in court, were proposed a year ago by the department – which oversees pensions and retirement accounts – and were modified after hearings and industry criticism. They are not expected to take effect until next spring at the earliest.
Many consumers assume the individuals and firms investing their money are operating under the same sort of ethical and legal standards as a family doctor – someone who is obliged to provide the very best advice.
But brokers are generally required only to recommend “suitable” investments, which means, for example, that they can push a more expensive mutual fund that pays a higher commission when an otherwise identical, cheaper fund would have been an equal or better alternative.
The Obama administration, relying on extensive academic research, estimated that conflicts of interest embedded in the way many investment professionals do business cost Americans about $17 billion a year, leading to annual returns that are about 1 percentage point lower.
“It has the potential to really change the way advice is delivered to retail investors,” said Barbara Roper, director of investor protection at the Consumer Federation of America. “It is a really big deal. Revolutionary, even.”
The so-called conflict of interest rule covers only tax-advantaged retirement accounts and does not apply to most other investments. But it could lead to more sweeping changes across the financial services industry, making it harder for some smaller firms to do business and perhaps encouraging a further consolidation into larger companies better able to handle the detailed rules of compliance.
It is also expected to promote a shift away from commissions for individual transactions toward a greater reliance on flat annual fees for managing accounts, a move that would not benefit all investors equally.
Critics of the rule in its earlier proposed form said they were still reviewing the specific details of the new regulations to determine its effect on investors.
Jules Gaudreau, president of the National Association of Insurance and Financial Advisors, whose members include insurance agents and brokers, said the organization was pleased that the Labor Department had incorporated some of the changes it suggested.
But he said his members still had reservations. “We remain concerned,” Gaudreau said, “that the costs to implement such a complex rule will result in higher costs and reduced access to advice, service and products for retirement savers.”
Generally speaking, the new rules – six years in the making – require a broader group of professionals to act as “fiduciaries,” the legal term for putting customers’ interests first. They cannot accept compensation or payments that would create a conflict unless they qualify for an exemption that ensures the customer is protected.
If brokers want to receive certain types of compensation that can pose a conflict, they will be required to offer an enforceable contract that promises to put the customer’s interests first.
The firms must also disclose any conflicts and direct consumers to a website that describes how they make money. Firms can charge only “reasonable compensation,” and they cannot offer advisers financial incentives to act in a way that would hurt investors.
In using the contract, brokers will still be permitted to charge commissions and engage in a practice known as revenue sharing, which allows a mutual fund company, for example, to share a slice of its revenue with the brokerage firm selling the fund. Companies that pay more, for example, may secure a spot on the firm’s list of recommended funds.
The rules also aim to protect investors when they roll over money from a 401(k) retirement plan to an IRA. Right now, because the recommendation provided is considered “one-time” advice, brokers do not necessarily have to act in the investor’s best interest.
The new rules also simplify disclosures. They also permit firms to sell proprietary products, which critics say weakened the rules.
There are also allowances for small 401(k) plans. Under the final rules, advisers who provide advice to small businesses that sponsor 401(k) plans, or plans with less than $50 million, as well as advice to participants, can qualify for an exemption from the strictest rules.
Consumer advocates and lawyers say that a fiduciary rule will help thwart more unscrupulous brokers, such as the one encountered by Russell Kazda, a retired mechanic, and his wife, Christine, a fourth-grade teacher in Illinois.
Their advisers took $172,000 of the Kazdas’ IRA savings and put it in illiquid real estate investment trusts and later invested money in an options strategy. They ended up losing about $125,000, which prompted them to sue the advisers.
“I could have had my fourth-graders do it and they would’ve done a better job,” Kazda said.