NEW YORK--(BUSINESS WIRE)--Proposed regulations from the US Department of Labor aimed at reducing conflicts of interest between corporations providing investment/retirement products and selling agents could drive significant revamps of business practices for many registered investment advisors (RIA) and the financial advisors of broker dealers, says Fitch Ratings. As proposed, the new standards would greatly expand the universe of individuals and corporations covered under the 1974 Employee Retirement Income Security Act (ERISA).
The Labor department's April 21 fiduciary proposals promote new best-interest standards that provide protections to investors for retirement accounts and annuities. The proposed rules raise the risk of regulatory enforcement and or trial bar litigation, and will likely force RIAs to do more to prove that a client's product choices indeed meet the individual's best interests. The new proposals could curb the willingness of agents to promote complex and higher fee products. Asset managers and insurance companies would also bear responsibility for examining distribution policies and commission structures paid to independent and affiliated distributors that sell many of the investment products reaching retirement accounts.
Limitations on commission structures could have a disproportionate impact on the sale or fee structures of investment and retirement products sold in the middle market, which generally tends to have more fee sensitive customers. Effectively, the rules may encourage some brokers to adopt advice-for-fee models for their advisors as a means of compensating them for the compression (or elimination) of their commissions.
Annuity products, arguably viewed by some investors as costly relative to lower priced products, could see fees pressured and/or commissions reduced under greater scrutiny. Adding to the challenge is the complexity of annuities, with guarantees that are difficult to value. Obtaining affirmations from clients that all features of any complex product are understood could become more common, but also burden the sales process and hurt volumes.
ERISA rules were designed to ensure that trustees and plan sponsors were acting with prudence and not self-dealing. While investment advice to individuals planning for retirement has avoided being covered under ERISA, the proposals sweep general wealth and retail advisors under the rule in the interest of ensuring they are acting in client's best interest. Meanwhile, life insurance companies and asset managers would be contractually bound to enhance conflict risk management, publicly disclose fee practices and provide enhanced disclosures of compliance to regulators.
Under current fiduciary rules, a person responsible for serving in a fiduciary's best interests (such as a trustee) may not receive compensation for selling to the fiduciary and may not self-deal in the same investment scheme for which he or she oversees as a fiduciary. In an effort preserve commissions while retaining certain established sales structures, the Labor department has established multiple levels of exemptions that could keep many practices in place, provided that compliance with the principles of rules is met. The precise extent to which an advisor would be required to explain product solutions not offered in order to demonstrate serving a client's best interest is not yet entirely clear.
Overhauls over the past years to the UK, German and Australian retirement markets have included complete bans on commissions without resulting in significant curbs to dollar sales of the products, although there have been indications of the middle-market customer being less targeted. Higher end customers have been offered and generally accepted moving to fee-for-advice models.
In a sign of the political sensitivity of the issue, earlier in June, the House of Representatives' 2016 appropriation bill for the department included a provision that would block the agency from spending any of the annual funds on finalizing, implementing, administering or enforcing the proposed rules.
Full implementation is not envisioned until third-quarter 2016 at the earliest, giving all affected parties meaningful time to prepare for and respond to the changes. A comment period on the proposals closes on July 21.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.