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The Labor Department’s New Fiduciary Rule: How It Can Affect You

November 20th, 2017

The Wall Street Journal recently reported on the Labor Department’s new fiduciary rule that protects retirement investors from conflicts of interest.  The new rule requires financial advisers and brokers to put the client’s best interest first.

Previously, the “suitability” standard required advisers to recommend investments that suited a client’s needs but were not necessarily in the client’s best interest.  The fiduciary rule also extends the fiduciary duty to brokers who advise clients about retirement accounts.

Level-fee fiduciaries are financial advisers who charge a set fee regardless of gains or losses on assets managed, as opposed to charging a commission on each purchase or sale of a security.  The fiduciary rule encourages advisers to choose a level-fee payment because it eliminates some compliance procedures that are required for a commission-based trades.  Advisers who continue to charge commissions must provide more disclosure to their clients to avoid conflicts of interest.  An example of advisors engaging in a conflict of interest is when they recommend investments that pay a higher commission when a lower commission option is available for the client.

The same disclosure applies to mutual funds with 12B-1 fees—a 0.25% to 1% charge used for advertising and to compensate brokers who sell that fund.  Advisers operating under the fiduciary rule are now more likely to recommend funds without 12B-1 fees.  This could save clients a considerable percentage over time.

 

The fiduciary rule will also lead to the introduction of new mutual fund share classes.  Investors who buy Class A shares usually pay a 2.25% to 5.75% sales charge.  But as fund companies start creating share classes with fewer extra fees and charges to compensate dealers, the Class A share will probably disappear.  In its place, some fund companies have introduced Class T shares.  T shares typically charges the same sales fee and 12B-1 fee across all fund categories regardless of price, eliminating the profit motive to sell a needlessly expensive fund.

Clean shares, another product of the fiduciary rule, charge only a management fee and no compensatory sales fee.  Investors who buy clean shares can expect to pay 60% to 70% less for a fund, but they will likely have to pay a broker separately for advice.

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