DOL Conflict of Interest Rule (Fiduciary Standard) - Can you Teach an Old Dog New Tricks?

Written By Ethan S. Braid, CFA on March 22nd, 2016

Over the last five years the Department of Labor has been hard at work crafting a proposed rule to address rampant conflicts of interest that currently exist in the market for retirement advice to retirement plans and IRA owners.  Overall the thrust of the proposal is in the right direction and will ultimately benefit the American consumer.  However, the rule is far too complicated and provides too many exemptions to the same business practices it seeks to ban.  There will be unintended consequences of this proposed rule.  In this article I will highlight what is good about the proposed rule, what is bad about the proposed rule, the opposition to the rule and what the unintended consequences of the rule will be.


The Good.


The DOL correctly identified that a significant problem exists in the marketplace for retirement advice:  conflicts of interest.  According to the DOL, research suggests that consumers who receive conflicted investment advice can expect their investments to underperform by an average of 100 basis points per year over the next 20 years.[1]  For many investors, this could result in underperformance that amounts to over $100,000 of foregone investment gains.  The DOL specifically states, “Non-fiduciaries may give imprudent and disloyal advice; steer plans and IRA owners to investments based on their own, rather than their customers’ financial interests; and act on conflicts of interest in ways that would be prohibited if the same persons were fiduciaries.”[2]  “Advisers commonly have direct and substantial conflicts of interest, which encourage investment recommendations that generate higher fees for the advisers at the expense of their customers and often result in lower returns for customers even before fees.”[3]


Translation = your so-called “financial adviser” can take advantage of you, legally, if they are not a fiduciary.


In the proposal, the DOL acknowledges what HighPass has been saying for years:  investors do not understand the difference between brokers and investment advisers.  Specifically, the DOL states, “consumers often do not read the legal documents and do not understand the difference between brokers and registered investment advisers particularly when brokers adopt such titles as “financial adviser” and “financial manager.””[4]    


Translation = consumers don’t understand the products they are being sold, how their adviser is getting paid or what legal standard (suitability vs. fiduciary standard) the adviser is following.


Way to go DOL!  In my sixteen+ years of experience as a financial adviser I have met with hundreds of investors.  My personal experience has been that even the most sophisticated investors can fall victim to conflicts of interest and hidden fees.  No investor I have met, in my entire career, has ever been able to properly identify the non-transparent commission as well as ongoing fees that they were paying for the numerous variable annuities I have reviewed.  As the DOL points out on page 21932 of their proposal, the variety and complexity of financial products has increased which in turn has widened the information gap between advisers and their clients.  With brokers and dual-registrants (a financial adviser registered as a both a broker and an investment adviser) referring to themselves as “financial advisers” it is easy to see why the consumer is so confused.  Consumers often do not realize that their financial adviser is just a product salesman in disguise.


I commend the DOL for properly identifying a major problem that consumers are up against and attempting to take action to solve the problem.  If put in place, I do believe that consumers will certainly benefit.  A great number of financial advisers who, for years, have been ripping off their clients, would no longer be able receive massive hidden fees when investing a client’s money in an IRA. However, it appears that the rule may not be as effective as one would hope…


The Bad. 


The bad can be summed up in one word:  lobbyists.  In reading the proposal, it becomes readily apparent that lobbyists had a heavy influence on the individuals at the DOL who developed the proposed rule.  The proof is in the numerous exemptions and exceptions to the proposed rule.  Some of these exemptions will allow financial adviser sales and compensation practices, that would otherwise be prohibited for a fiduciary, to continue.  For example, brokers often receive revenue sharing, 12b-1 fees, and other compensation from the parties whose investment products they recommend.  If these brokers were treated as fiduciaries, the receipt of such fees could violate the code’s prohibited transaction rules.[5] The DOL is proposing to allow these compensation practices to continue by providing a Best Interest Contract Exemption.  According to the DOL, the exemption requires the firm and the adviser to contractually acknowledge fiduciary status, commit to adhere to basic standards of impartial conduct, warrant that they will comply with applicable federal and state laws governing advice and that they have adopted policies and procedures reasonably designed to mitigate any harmful impact of conflicts of interest, and disclose basic information on their conflicts of interest and on the cost of their advice.[6]


So on one hand, the DOL states that consumers don’t read legal documents given to them by brokers and don’t understand the important differences between registered investment advisers and brokers.  The DOL has gone so far as to state that, “disclosure alone has proven ineffective to mitigate conflicts in advice and that most consumers generally cannot distinguish good advice, or even good investment results, from bad.”[7]  Then on the other hand the DOL is providing brokers with the ability to engage in prohibited transactions that a fiduciary could not engage in by simply having the client sign a form that contractually acknowledges fiduciary status!


Translation = DOL thinks investors are dumb.  But wait a minute DOL, you said that investors don’t read or understand legal documents and yet you are going to allow the same behavior you want to eliminate (prohibited transactions), to continue, so long as brokers provide disclosure documents to clients and both the broker and client sign a form contractually acknowledging fiduciary status.



The Opposition.


When you threaten to alter the way an industry charges consumers, even if the change is for the better, there will be a fight.  In this case, broker dealers, insurance companies, mutual fund companies and financial advisers have all fought back against the DOL.  These industry participants argue that by enforcing fiduciary status on all brokers and advisers who counsel IRA investors, there will be significant disruptions to both advice and service.  They claim that forcing advisers to always do what is in the best interest of the client will result in:  less investment advice, higher up-front fees, and a reduced level of assistance to investors, particularly to investors with smaller accounts.[8]  Under the current system, they argue, brokers will service smaller investors because they can give these investors a free financial plan when the investor buys a product like a variable annuity.  In other words, so long as investors pay 7% hidden loads with ongoing high fees and trailer commissions, brokers and financial advisers will be willing to service these clients.  But take away the ability to sell products with massive hidden commissions and require brokers and financial advisers to work for a transparent fee and be required to always put client interests first and all of a sudden they don’t want to do the work anymore.  Great!  Maybe all of these bad apples will quit!  What is wrong with putting your clients’ interest ahead of your own, at all times?  Here is what I have to say to the people at the insurance companies, broker dealers, etc. who are making that argument:  take a good long look at yourself in the mirror, if you don’t feel ashamed, something is wrong with you.


The Unintended Consequences.


A problem that the DOL correctly identified is going to metastasize and grow into something larger, uglier and more problematic.  The DOL in their proposal noted that the typical investor does not know the difference between a broker and a registered investment adviser.  The DOL accurately mentioned that brokers use titles such as “financial adviser” implying significant investor confusion. In the late 1990s brokers began to hijack the title financial adviser.  Now, nearly two decades later, consumers don’t know the differences between brokers, registered investment advisers and the more common dual-registrant (a financial adviser who is registered as a stockbroker and an investment adviser).  As a result of this consumer confusion, investors are often completely oblivious to hidden fees, products sales and conflicts of interest because they mistakenly think that their financial adviser is looking out for them.


Much like the issues that have developed from dual-registration and brokers using titles like “financial adviser,” allowing every broker who manages IRA accounts to tell clients they are “fiduciaries” is going to create even more confusion.  This will result in advisers who work for insurance companies or broker dealers telling clients they are fiduciaries and selling the benefits of working with a fiduciary.  I promise you however, that many of those advisers will not tell their clients that they are not acting as a fiduciary when they sell the client a variable annuity in the client’s trust account or a maybe a life insurance policy for the ever elusive and unicorn-like “tax-free” growth of the client’s money.  The end result is going to be a lot of very confused investors.  Can you teach an old dog (100s of thousands of financial advisers who have been brokers their whole career) new tricks?  I am doubtful.


HighPass Opinion & Suggestion.


The general direction of the proposed rule is very good.  In some ways however, I think it goes too far.  Not all IRA accounts should be subject to the fiduciary standard nor should all brokers or financial advisers who provide guidance to IRA accounts.  The proposed rule attempts to provide exemptions and exceptions but the end result will be confusion.  In my opinion, the DOL should simplify this overly complicated proposed rule.  My suggestion is as follows:


No-one can call themselves a “financial adviser” unless they are a fee-only fiduciary, have no conflicts of interest and thus do not sell any products, including insurance.


Everyone else (which will be over 80% of existing financial advisers) will use the old title of stockbroker or call themselves a dual-registrant.  All clients who work with a stockbroker or dual-registrant must sign a one-page form that boldly and explicitly states that their financial adviser is not required to act in their best interest and that the investor’s portfolio may underperform due to higher fees and conflicts of interest.


Let the investor decide what is best for them.


Ethan S. Braid, CFA


HighPass Asset Management

800 – 672 - 7916        


About the author of this article.

Ethan S. Braid, CFA is the founder of HighPass Asset Management – an independent, fee-only, registered investment advisory firm with a fiduciary duty to the clients it serves.  Mr. Braid has been passionate about managing client investment portfolios and providing customized financial planning advice since he started working in the investment industry over 16 years ago. Mr. Braid earned a BS in finance from Robert Morris University, an MBA from Cleveland State University and he is also a CFA charterholder.  The CFA program is a graduate level, globally recognized, multi-year program with a focus on investment knowledge.  Candidates for the program commit an average of 900+ hours of cumulative study time to complete all three levels.

Mr. Braid is devoted to being an expert in the field of wealth management for high net worth individuals and families and for many years, has read one book per month on subject areas such as:  estate planning, retirement planning, investment analysis, mergers & acquisitions, business history and behavioural finance.  Mr. Braid has a passion for business history with a focus on the late 19th & early 20th centuries.  To date, Mr. Braid has read 70 books on the subject areas above.

When Mr. Braid is not helping clients, he enjoys: cooking, wine, exercise, his yellow Labrador retriever, fly fishing, hiking, travel, playing guitar, snowboarding and duck hunting.  Mr. Braid is a committee member of the Denver Chapter of Ducks Unlimited.

This article is provided by HighPass Asset Management for informational purposes only.  No portion of this commentary is to be construed as a solicitation to buy or sell a security or the provision of personalized investment or legal advice.

[1] Federal Register/Vol. 80, NO. 75/Monday, April 20, 2015/Proposed Rules, page 21930

[2] Federal Register/Vol. 80, NO. 75/Monday, April 20, 2015/Proposed Rules, page 21928

[3] Federal Register/Vol. 80, NO. 75/Monday, April 20, 2015/Proposed Rules, page 21930

[4] Federal Register/Vol. 80, NO. 75/Monday, April 20, 2015/Proposed Rules, page 21934

[5] Federal Register/Vol. 80, NO. 75/Monday, April 20, 2015/Proposed Rules, page 21946

[6] Federal Register/Vol. 80, NO. 75/Monday, April 20, 2015/Proposed Rules, page 21948

[7] Federal Register/Vol. 80, NO. 75/Monday, April 20, 2015/Proposed Rules, page 21952

[8] Federal Register/Vol. 80, NO. 75/Monday, April 20, 2015/Proposed Rules, page 21946