The new fiduciary rules from the Department of Labor stand to impact a huge number of banks, as more employees will fall under “fiduciary” standards that will change the way they do business. Boards should be asking questions now about how the revised rules will affect their banks, especially if they have wealth management or trust departments or subsidiaries, which are likely to see the greatest impact.
The Department of Labor, which has rule-making authority for ERISA, the Employee Retirement Income Security Act of 1974, last week expanded the definition of fiduciary to include a wider variety of people who give advice on retirement accounts. The rules don’t apply to non-retirement accounts. Although some employees may already be fiduciaries and familiar with the rules, others may be encountering them for the first time. There also could be an impact on certain fee-generating products such as the sale of proprietary funds and variable annuities, and boards should ask questions of the bank’s senior management to assess the effect on their bank. “Over the next several months, we will find out what the impact is,” says Andrew Strimaitis, a partner at the law firm Barack Ferrazzano in Chicago.
The rules go into effect a year from now, April 2017, with some requirements delayed until January, 2018.
Saying outdated rules didn’t protect Americans as their retirement savings increasingly move away from employer-provided pensions and into self-directed individual retirement accounts (IRAs) and 401(k)s, the labor department said Americans were too often exposed to conflicted advice that moves them into high-fee products that benefit advisors more than clients. The labor department estimated Americans would save $40 billion over 10 years under the new rules. “While many investment advisers acted in their customers’ best interest, not everyone was legally obligated to do so,’’ the labor department said. “Instead, the broken regulatory system had allowed misaligned incentives to steer customers into investments that have higher fees or lower returns—costing some middle-class families tens of thousands of dollars of their retirement savings.”
Any investment advisor who handles retirement accounts becomes a fiduciary and has to comply with ERISA standards, which means providing impartial advice and not accepting payments that represent a conflict of interest, according to the department of labor. The industry has been concerned that the new rules would eliminate the possibility of brokers making commissions on trades or fees for selling insurance, or prohibit certain products such as a bank’s proprietary funds, or even variable rate annuities. But none of those products were ruled out, and neither are commissions. Instead, there is a “best interest contract exemption” that allows brokers and other advisors to continue their compensation practices and to sell products such as proprietary funds as long as they promise to put their clients’ best interest first, pay “reasonable” compensation to advisors and disclose all conflicts and fees.
What’s the Impact?
There will be new compliance costs associated with the rule. Analysts at the investment bank Keefe, Bruyette & Woods estimated that Morgan Stanley, as an example, could face a two-year implementation cost of $2,500 per financial advisor, plus about $600 yearly per advisor after that for on-going compliance, based on calculations from the trade group SIFMA, the Securities Industry and Financial Markets Association. The costs could potentially push some banks with marginally profitable asset managers to sell or outsource their compliance, and many of them already do the latter. Some think the rule could have far-reaching effects in terms of changing the types of products advisors are willing to sell, because of the uncertain liability. “It is fundamentally changing the way a bank will interact with the typical IRA client,’’ says Richard Arenburg, a partner at the law firm Bryan Cave LLP in Atlanta. Customers can sue advisors who don’t represent their best interests. Recommending products that benefit the advisor when lower-cost or more appropriate products are available could be a bad idea. “To continue to recommend funds where it is questionable whether they are in the best interest of consumers, you will have a tougher road to hoe to avoid liability,’’ Arenburg says. Some banks may react by limiting the number of advisors who handle retirement accounts such as IRAs. “I think you’re going to see consolidation definitely,’’ says Strimaitis. “People are going to have larger operations to make the compliance costs worth it.”
Boards should review the impact on the bank periodically, says Nancy Reich, an executive director with accounting and advisory firm Ernst & Young LLP. What’s the impact on the business model? What changes to its policies and procedures is the firm considering to address the impact?