Understanding the New Regulations for Financial Advisors: SEC’s Best Interest Rule and DOL’s Fiduciary Rule

Summary: Learn about the new SEC rule and DOL interpretation of ERISA that affect financial advisors and fiduciaries. Find out what it means for you. Call Tim Hayes for a free consultation

After the introduction of a new rule from the Securities and Exchange Commission (SEC), with a new interpretation from the Department of Labor (DOL) of an old law, the Employee Retirement Income Security Act (ERISA), there is not much difference in the duties and responsibilities that financial advisors, financial professionals, ERISA fiduciaries, and financial planners owe to their clients.

Boston Financial Advisor

Having been a financial advisor and financial planner for over thirty years, I have witnessed many financial advisors’ changing compensation structure. For example, according to a review of their financial situations, most personal financial advisors were paid commissions from selling a financial product or investment when I started.

Fee Based Advice

About midway through my career, the compensation in the marketplace began changing. More and more advisors began moving to a fee-based or fee-only financial planning compensation arrangement. So, instead of charging commissions from the sale of an investment, life insurance, or some other financial product, the financial advisor usually charges an ongoing fee, a percentage of the client’s investment for financial planning services.

The hope is that by disconnecting the compensation from the product or services, the client would receive better advice. However, another concern was that the planners were less inclined to provide ongoing advice and services when compensated from an initial product sale.

Regulation of Financial Advisors

Three federal acts regulate financial advisors: The first is the Securities Exchange Act of 1934, the second is the Investment Advisers Act of 1940, and the third is the 1974 retirement protection law called ERISA. The 1934 act regulates broker-dealers, the 1940 act regulates investment advisers, and ERISA governs retirement plans. (State laws also regulate them, and most insurance products are regulated at the state level.)

A broker-dealer (B/D) is a firm that buys and sells securities, operating as both a broker and a dealer, depending on the transaction. Fidelity, Charles Schwab, and TD Ameritrade are the three largest B/Ds. In addition, many regional and independent B/Ds exist, such as LPL Financial, Ameriprise, Cambridge Investment Research (my broker-dealer), and Raymond James. 

Their advisors are called registered representatives, who are usually paid a commission for selling financial products. They are not fiduciaries, but they are required to sell their clients a suitable product. 

Investment advisers are an alternative to broker-dealers. Moreover, investment advisers are fiduciaries. They have a different business model regulated under the 40 Act than that of B/Ds. They are usually paid fees as compensation, as opposed to commissions.  

Regulation Best Interest

The Dodd-Frank law emerged from the 2008 financial crisis. Its main objective was to shore up the banking system so we wouldn’t have another situation like in 2008 when the failing banking system put the world economy at risk.

Dodd-Frank, however, also tasked the SEC with studying whether changes needed to be made to the rules regulating financial advisors. The goal was to ensure the public was benefiting from having two silos’ commissions and fees and if it behooved brokers to become more like investment advisors (fiduciaries).

After much discussion, the SEC promulgated a new rule, Regulation Best Interest, primarily impacting B/Ds. The rule requires them to reduce and disclose conflicts of interest while working in the best interests of their clients. It, however, does not require that they become fiduciaries but moves them very close to that responsibility.

Remember, financial advisors are either registered representatives affiliated with B/Ds or investment advisor representatives working for investment advisors. I am dual-registered—that is, I am a registered representative of a B/D and an investment advisor representative of an investment advisor.

The New Rule from the SEC

Beginning June 30, 2020, B/Ds began operating under that new Regulation Best Interest standard. This requires them to better align their product recommendations and services with their clients’ best interests by eliminating conflicts of interest, such as proprietary product requirements, sales quotas, or sales contests.

Registered representatives will now be called financial professionals. Any advisors who are fiduciaries can continue calling themselves financial advisors. Some critics complain that the new standard does not meet the uniform standard’s original intent.

New Fiduciary Rule

Finally, however, to many people’s surprise, President Trump’s Department of Labor, run by Eugene Scalia, Supreme Court Justice Antonin Scalia’s son, implemented the Fiduciary Rule.

They removed some of the more demanding requirements and possible legal challenges provided to clients. Still, they kept the core tenant that financial advisors advising retirement plans and participants are fiduciaries. Most advisors, when recommending a client roll over their retirement account to an IRA, are also fiduciaries.

Remember, the Rule applies only to private-sector retirement plans, such as 401(k)s, SEPs, SIMPLEs, and 403(b) plans under ERISA. The 403(b) plans of public employees, such as teachers, are not covered by ERISA, so they are not subject to the new law. It only applies to them if they decide to roll over their 403(b) to an IRA. Roths, traditional, and rollover IRAs fall under the new rules.

The Obama administration believed the Rule was needed because conflicts of interest caused 401(k) participants and IRA owners to pay higher financial advisor fees, resulting in smaller account balances.

What do I mean by ‘conflicts of interest’? For example, some firms paid their advisors bonuses and benefits if the financial advisors sold that firm’s proprietary products. This is no surprise, but it is surprising that these conflicts go on with retirement plans—given that ERISA forbids conflicts of interest.

But ERISA stipulated that the prohibition against conflicts applied only on five conditions:

  1. The financial advisor must render advice as to the value of securities or other property;
  2. The advisor must do so regularly;
  3. The advisor must do so under an agreement with the client;
  4. That advice will serve as a primary basis for the client’s investment decisions; and
  5. The advice is to be based on the particular needs of the investment or retirement plan.

The advice must be given regularly and must be the primary basis for the client’s investment decisions. The DOL believes it allowed financial advisors with conflicts of interest to provide advice without violating ERISA’s prohibition.

Plus, the DOL felt that the 1974 exemptions were put in place when there was no such thing as an IRA or a 401(k), and companies invested the retirement money for their employees. However, now that individuals are responsible for their own investment decisions, new rules are needed.

For example, the DOL believes people are rolling over their 401(k)s into IRAs when it would cost them less if they remained in the 401(k). Moreover, under the old rules, rollover advice never fell under ERISA guidelines because the rollover happened once.

So, the new fiduciary rule reinterprets the five-part test so that now more financial professionals fall under the ERISA standard of who is a fiduciary. It also removed a previous ruling that rollover advice was not fiduciary advice. Instead, it requires that any advisor falling under these standards work in your best interest, including when they recommend a rollover.

The Financial Services Industry is Adapting

More and more financial products, such as variable annuities and life insurance programs, can be fee-based. For example, an annuity can be part of a fee-based advisor’s assets to calculate your fee. As a result, the product is stripped of some of the costs associated with a commission-based product.

Firms are also removing conflicts of interest to align with the new Best Interest Standard. The DOL also now uses that standard in their interpretation of who is a fiduciary advisor under ERISA. When the investing public works with an advisor, they benefit from having a similar standard for conduct as Best Interest aligns closely with the fiduciary responsibilities in the 40 Act.

Why I Remain Duel Registered

I remain registered as an investment adviser representative and as a registered representative. Most of my business is as a fee-only investment advisor representative, where I charge a client a fee or an hourly rate for my advice. I like this arrangement because it is not product-based, and I can get paid to provide ongoing advice to my clients.

However, I keep my registered representative license because when I compare a commission product, it makes more sense for the client. For example, a new client who is 25 years old wants to purchase a Roth IRA with $6,000—I cannot imagine charging them a fee for the next 40 years.

Also, I like to use American Funds for some clients with big 401k or 403b accounts, if I recommend that they roll over their money. If their 401k account balance is over a million, they pay no sales charge. And American Funds has some of the lowest management fees for actively managed funds. They also offer excellent funds for customers interested in generating retirement income. But I need to have a registered representative licensed to provide this option.

What to Do Now

If you have an IRA and work with a financial advisor, now is an excellent time to review the financial planning arrangement, fee or commission, best interest, or fiduciary. Also, if you are thinking of rolling over a 401(k) or 403(b), ensure your decision is consistent with the new rule.

Suppose you happen to administer a retirement plan for an employer: Ensure that any advisor compensation is aligned with the new interpretation from the DOL and the new rule from the SEC.

These are the opinions of Financial Advisor Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only and should not be construed or acted upon as individualized investment advice. Content provided via links to third party sites should not be considered an endorsement of content, which we cannot verify completeness or accuracy of.

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Financial Advisor Tim Hayes

I’ve held an industry securities registration for 30+ years and am subject to SEC and FINRA oversight.

Most clients pay fee-only or an hourly rate. The size and complexity of the client’s wealth management and financial and retirement planning determine that fee.

Some clients pay a commission, mainly those with smaller accounts, i.e., Roth IRAs, some public-school teachers with 403b retirement accounts, or parents or grandparents who set up a 529 college savings plan.

The first introductory and fact-finding appointment can be in-person or by phone. The next meeting where I provide my recommendations should be in-person. (For the time being, telephone, Zoom, and email are replacing some in-person meetings.)

Subsequent meetings during which we monitor your progress and investments can be done in-person or by phone, email, Zoom, or Skype – or, more likely, a combination of these meeting types.

Contact Tim

Tim has offices in Boston and South Dartmouth, Massachusetts. He’s licensed to handle securities in 8 states: Massachusetts, Rhode Island, New Hampshire, New York, New Jersey, Connecticut, Maine, and Florida.

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