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The U.S. Department of Labor (DOL) has recently finalized regulations holding all financial advisors to the standards of conduct to which Registered Investment Advisors have historically been held, at least with regard to providing investment advice on retirement accounts. These new regulations, at long last, clearly define who is to be identified and held to the highest standards as a “fiduciary,” requiring designated advisors to put the interests of their clients ahead of their own. The result will be a whole new level of disclosure and transparency until now only seen in the context of an investment advisory relationship.
While Registered Investment Advisors such as Marc J. Lane Investment Management, Inc. are comfortable with this “fiduciary” classification, having historically been held to it, it is uncharted territory for many others who give financial advice. According to the DOL’s new definition of covered entities, any person (broker, financial advisor, insurance agent, etc.) paid to provide advice to a retirement plan sponsor, plan participant or individual retirement account (IRA) owner is now a fiduciary. The new regulations require advisers of retirement accounts to meet a fiduciary standard when recommending investment vehicles like stocks, bonds, mutual funds and variable annuities to their clients. Before the rule change, stock brokers and insurance agents were only held to the lower standard of “suitability” when making investment recommendations to clients, allowing them to put their own interests ahead of their clients if they so chose. These advisors now must fully disclose all of their various forms of compensation on the investments they recommend to clients for their retirement accounts.
Critics of these new regulations argue that the cost of advice is going to increase and that there will be fewer advisors willing to serve small investors saving for retirement. But the Department of Labor was left little choice in the matter: an industry that won’t police itself invites government regulation. It’s the financial industry’s failure to “self-regulate” that has resulted in this turn of events. The widespread practice by so many investment firms to charge exorbitant fees that are rarely noticed, understood, or fully disclosed to clients has forced the Labor Department’s hand.
The most blatant abuse may be the sale of variable annuities to retirees. These instruments carry hefty sales commissions, expense ratios in excess of 3% per year (mutual funds and managed accounts typically charge approximately 1%), and often substantial back-end fees if the investor wants his or her money back within the first 7 to 12 years of purchase. "Exit" fees for many of these variable annuities typically start at 7% to 12% of market value in the first year following purchase and decline by 1% to 2% per year, only allowing one to redeem an investment free of penalty after having held it, and paid upwards of a 3% annual charge, for 7 to 12 years.
While we applaud the Labor Department’s action, several questions immediately come to mind. Why did it take so long? Why stop at retirement accounts? Aren’t all investors—not just retirement account clients—entitled to the same high level of disclosure and transparency that benefit investment advisory clients? And while we’re at it, why not shine a light on what seems like an even greater and more far-reaching injustice, the practice of disguising the fees mutual funds charge as mere “expense ratios.” How surprised would the average investor be if he or she were shown the annual fees these funds charge? What possible rationale could there be for allowing mutual fund companies to disguise their fees instead of requiring them to post them to client statements for all to see?
We can’t speak for others in the financial services industry, but we welcome the Department of Labor’s action. Let’s pull back the veil of secrecy and let this rule change usher in a period of heightened self-regulation. Let’s ensure that all financial professionals always put the best interests of financial service's clients first.
To find out more about fiduciary standards and how engaging an investment manager who adheres to them is in your best interest, please contact Marc Lane in confidence at email@example.com or via telephone at 312/800-372-1040.
J. Brad Strom is a Senior Vice President and Portfolio Manager of Marc J. Lane Investment Management, Inc. Mr. Strom is a graduate of Illinois State University (B.S.) and DePaul University's Graduate School of Business (M.B.A.). Mr. Strom is a Chartered Financial Analyst (CFA).
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