On April 14, the Department of Labor, at President Obama’s request, issued proposed new rules for advisers who provide advice on retirement accounts. The new rules create a quasi-fiduciary relationship between the client and the adviser, provided the investment recommendations concern distributions taken from or residing in a 401(k), Individual Retirement Account or pension plan. Should the proposed regulations make it past the public comment period unscathed, advisers will be — for the most part — required to make recommendations that are in the client’s best interest, else they may be subject to penalties and civil action.
The current framework permits financial advisers at brokerage firms to make recommendations based on the “suitability” standard, which is far less rigorous than the requirements faced by a fiduciary. Suitability permits brokers to recommend transactions that may generally fit the client’s financial situation, time horizon, risk tolerance and level of sophistication, even if they aren’t yet the lowest-cost or most-attractive alternatives available. In contrast, fiduciaries must put a client’s interest before their own and avoid conflicts of interest. The proposed rules do allow for commission-based retirement investing and for conflicts of interest to remain as long as they are prominently disclosed.
If adopted, the new rules will discourage some of more heinous abuses that can occur in 401(k) rollovers. But it’s important to note that products typically sold outside of retirement accounts, such as high-load mutual funds and frequently expensive insurance products, will not be covered by this new legislation. Clients need to be aware of their advisers’ motivations and their legal obligations. Registered investment advisers are typically considered fiduciaries. Professionals adhering to the CFA Institute Code of Ethics and Standards of Professional practice — specifically CFA charter holders — are held to a fiduciary standard regardless of where they work and on which account they offer advice.
Many brokers do routinely place their clients’ interests above their own regardless of their regulatory framework. Even so, for the sake of being informed, consider asking your financial advisers whether they are obligated to hold to a fiduciary standard or a suitability standard, and get it in writing.
Sam Levine, CFA, CMT is the founder of the investment community website Markets, Etc. and writes two columns for BetterInvesting Magazine. He is also on the board of directors of the Market Technicians Association and serves on their Ethics Committee.
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