What is at Stake in the Battle over the Fiduciary Duty Rule?

By ·February 8, 2017
Brandeis University

The Issue:

In February, President Trump signed a memorandum directing the Secretary of Labor to examine the Fiduciary Duty Rule, which was scheduled to become applicable on April 10, 2017. On May 23, Secretary of Labor Alexander Acosta stated that the Department of Labor has “found no principled legal basis" to further delay the implementation of the rule – parts of which will now enter in effect on June 9 – even as his department continues to review the rule. The rule would mandate that financial advisers follow a fiduciary standard, which essentially means that they have a duty to put the client’s interests first when giving advice regarding assets invested through retirement plans such as IRAs and 401(k)s. This is higher and stricter than the suitability standard which currently applies to many investment advisers. The President’s memorandum directs the Department of Labor to determine, among other things, whether the Fiduciary Duty Rule would prevent savers from accessing advice or threaten financial firms with a greater susceptibility to lawsuits, arguments made by the financial service industry. (This version updated May 25, 2017 to reflect policy developments.)

The rule would mandate that financial advisers follow a fiduciary standard – which means that they have a duty to put the client’s interests first  – when giving advice regarding assets invested through retirement plans such as IRAs and 401(k)s.

The Facts:

  • Pension and retirement accounts are extremely important components of household financial portfolios. Individual Retirement Accounts, also known as IRAs, had $7.5 trillion in assets as of the second quarter of 2016. Other defined contribution retirement accounts, such as 401(k)s and 403(b)s, held another $6.8 Trillion, according to the Investment Company Institute. The United States Department of Labor oversees some aspects of the regulation of pension and retirement accounts.
  • At the moment, financial professionals who serve investors with retirement accounts are frequently not held to a fiduciary standard that puts the client’s best interests first. Rather, many must meet the less stringent suitability standard that requires that recommendations must be appropriate for a client’s investment profile taking into account the client’s age, income, net worth, and other factors. For example, the recommendations of broker dealers who make trades in exchange for fees or commissions are currently subject to the suitability standard but not the fiduciary standard.  Registered Investment Advisers (RIAs), on the other hand, are currently held to the higher fiduciary standard.
  • The fiduciary standard is meant to limit the damage that can be caused due to conflicts of interest between investors and financial advisers. Many situations can create conflicts of interest. One example is when investors pay front-end or back-end sales charges to brokers. These charges can create an incentive for brokers to direct investors toward investments that pay them higher fees, even if these are not the best choices for the investors.
  • There is growing evidence on the cost of conflicts of interest between investors and potentially conflicted brokers. In my own research, my co-authors and I found that broker-sold domestic equity and bond mutual funds underperformed by between 14 and 90 basis points per year relative to investment funds that investors purchase independently, without the advice of a broker. This underperformance was calculated before subtracting the brokers’ fees; underperformance after subtracting their fees would be even larger. Over time, this underperformance can have a large effect on household wealth accumulation.  If benchmark returns are 6 percent per year, 50 basis points of underperformance amounts to an almost 10 percent difference in household assets after 20 years. (A “basis point” is a hundredth of a percent so “90 basis points” means 0.90 percentage points.)
  • The proposal of the rule by the Obama administration sparked fierce opposition from the brokerage industry, which argues that the rule would raise the cost of investment advice and potentially put that service beyond the reach of the middle class. However, even before the implementation of the rule, a number of financial services firms, such as Merrill Lynch, were already moving toward a fiduciary standard for their retirement financial advisors.  This suggests that the imposition or adoption of a fiduciary standard for retirement financial advice is not a barrier to profitability.

What this Means:

Trump’s recent memorandum to the Department of Labor, if it stalls or prevents the implementation of the fiduciary standard for retirement financial advice, would be a step backward for the protection of investors. Conflicted financial advice has imposed a significant burden on American households. A rule requiring financial advisors to put their client’s interest first – as do doctors, lawyers, and other professional service providers – is a reasonable step toward ameliorating this burden.


Financial Regulation
Written by The EconoFact Network. To contact with any questions or comments, please email [email protected].