Will the DoL fiduciary rule impact fund boards?

June 2, 2016

By C. Meyrick Payne and Jay Keeshan, Management Practice Inc.

There has been a lot of discussion about the Department of Labor’s fiduciary rule since it was released in early April after years in the making. In a nutshell, the DoL rule expands who is covered by the fiduciary standard rule and requires those who are covered to put clients' interests ahead of their own. It is not immediately clear how implementation will have a direct impact on how mutual fund directors perform their oversight duties, but independent directors should be familiar with the rule and understand that it might impact them. Boards should start discussions with knowledgeable counsel, and here are some talking points to get the conversation going.

This rule probably isn’t going away. True, it is being challenged in court by a group including the U.S. Chamber of Commerce and eight industry organizations, but the outcome is not clear. What is clear and deliberate is the intent on the part of the government for consumer protection, and there’s no putting the genie back in the bottle. The fiduciary rule has been six years in the making and is backed by the promise of a presidential veto if Congress votes to prevent it from going into effect. In this day of populist politics, it is hard to imagine defanging a rule intended to protect Main Street from Wall Street, even if it is burdensome and has some unintended consequences.


The rule applies to fund directors. If a pundit or lawyer tells you the rule doesn’t apply to you as fund directors or falls outside the scope of your responsibilities, think again. The rule specifies a loophole for “best interest contract exemption.” But from a business perspective, it seems that any existing practices may be exempted as long as the “best interests” of the investor are maintained. The exemption sounds circular. While some of the disclosure requirements are more directly the concern of the broker-dealer or distributor, at this stage of the rule’s implementation, fund directors should not imagine that they can pass the buck.

Annuities are a prime target, especially rollovers from low-cost 401(k) or other tax-deferred employer-sponsored plans to high-cost guaranteed benefit retirement plans. The irony is that many investors, particularly those approaching middle or retirement age, crave a guaranteed benefit plan to replace their no-longer-available pensions. This rule may preclude them from achieving their goal by destroying the ability of insurance companies or money managers to offer a viable alternative.


All aspects of investment management are affected. The clear intent of the rule is to ensure that the “best interests” of the investor are preserved. For example, 12b-1 fees may become untenable and front-end-load class A shares even more a thing of the past. Instead, low-level load funds or products with customer-based fees—not embedded in the financial product, but rather paid directly to the financial representative—will likely become the norm.

Disclosure will be a bear, especially at the point of sale. The focus of the rule seems to be ensuring that the customer knows precisely what he or she is buying. Annuities are typically complicated products where the advice of a trusted advisor is beneficial. Getting the disclosure correct and clear, not only at the time of purchase, but also in retrospect (especially if investment results have not turned out as desired), will be particularly difficult.


Compliance will be tough. DoL has added at least 100 inspectors and intends to enforce the disclosure provisions at the point of sale, which number in the hundreds of thousands. Of course, point of sale includes direct marketing, social media and a field distribution sales force.


Distribution will be affected, particularly for captive sales forces that up to now have had the responsibility of selling proprietary product. As long as the product was “suitable” for the customer, things were fine. But now the product has to be in the “best interests” of the client.


Advisers’ profitability will be affected. For many years, annuities have been very profitable (as long as there were not too many guarantees attached) and the fund assets derived from variable annuity sales have been “sticky” money with low redemption and a relatively high return for the fund manager. In some cases, the advisory fees attached to variable annuities have been higher than those for retail mutual funds. This differential surely would be called into question.

Get ready for lawsuits, especially if investment results are lower than anticipated. In that case, an investor may then have an arguable case that the product was not in his or her “best interests.” A difficulty with the rule is that it replaces the concept of “suitability,” which can be established at the time of sale, with “best interests,” which is subject to interpretation many years later.


Compensation plans for every level of mutual fund sales and annuities will likely change. The rule precludes preferential compensation for selling one product over another. The difficulty is that, historically, financial products have carried different levels of service. The rule seems to imply that these service level differences will have to be paid by the customer directly as opposed to being embedded in the product.


Despite these challenges, there is potential upside to implementation of the rule. For instance, there may be marketing opportunities for a money manager that has always employed the “best interests” philosophy. Regardless, the reputation of a firm will play an ever-more important role in determining winners and losers when—or perhaps, if—the new rule actually goes into force.

Meyrick Payne is the managing partner of Stamford, Conn.-based consulting firm Management Practice Inc. Jay Keeshan is a partner at the firm and focuses on fund trustee compensation, contract renewal/15(c), and profitability analysis.




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