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7 Questions--and Answers--About the Fiduciary Rule

Where we are today, where we're going, and what it means for investors.

This analyst blog is part of our coverage of the 2017 Morningstar Investment Conference. 

There's been no hotter topic in the financial services industry than the on-again, off-again and now delayed Department of Labor fiduciary rule.

At the 2017 Morningstar Investment Conference in Chicago, director of personal finance Christine Benz got answers to some of the biggest questions related to the fiduciary rule from a trio of in-house experts.

How did the fiduciary rule come about?
Aron Szapiro, director of policy research for Morningstar, explained that retirement accounts are governed by regulation dating to 1975. That regulation includes a very narrow definition of what a fiduciary is, and wasn't designed for an era where 401(k) and other individual retirement accounts usurped pensions as the main form of retirement savings.

"The DOL looked at this and said that we need to do something," said Szapiro. "The rule they came up with is complex and expands the definition of fiduciary and introduced the Best Interest Contract as an enforcement mechanism, allowing class actions."

Implementation of the rule has been delayed. For how long?
Two aspects of the fiduciary rule have been delayed until June 9. On that day, the definition of a fiduciary will change, and the impartial conduct standards (stating that fiduciaries will act in the best interest of clients) will go into effect.

"On June 9, people will be fiduciaries," said Szapiro. "The question is what the enforcement mechanism will look like."

That's because the Best Interest Contract won't take effect until Jan. 1, 2018. This longer delay will give the DOL more time to collect comments and review the rule in light of those comments.

"There's some uncertainty of what will happen between now and Jan. 1," said Szapiro.

Did Morningstar provide comment on the rule?
Morningstar, along with other financial services firms, provided comment on the rule.

Morningstar's comment letter said the fiduciary rule would lead to three positive outcomes. The first: Advisors would be less likely to employ commission-based products and more likely to employ fee-based compensation arrangements, thereby increasing transparency on fees for consumers.

"When you remove some of the incentives to sell one security over another, that's a positive," said Paul Ellenbogen, director of global regulatory solutions for Morningstar.

In addition, Morningstar's comment letter said the rule will accelerate the trend of dollars going into low-cost products, and should spur innovation in the realm of financial advice.

What are T shares, and what do they have to do with the fiduciary rule?
T shares--or transactional shares--divorce the transaction from the security. With T shares, an advisor's compensation is no longer tied to a particular security; rather, the compensation is instead tied to some other action and/or service, such as asset allocation, transactions, etc. T shares are the result of the move toward fee-based compensation--a move the rule only accelerates.

"T shares level fees and make the investment decision more about the quality of the investment rather than the compensation that comes with purchasing the investment," said Ellenbogen.

Under the rule, how should investors be thinking about advisory services?
Morningstar Investment Management's head of retirement research, David Blanchett, said the planning industry has evolved away from focusing on investment advice and toward a more holistic approach.

"Twenty years ago, the value proposition for an advisor was picking great stocks or funds," said Blanchett. "Today, it's about helping investors reach goals."

"Holistic planning is more valuable overall," said Ellenbogen. The question for investors now is: What is that advice worth?

Will the fiduciary rule lead to the death of active management?
It's very possible that many fiduciaries will go with what they perceive to be "safe" solutions for themselves: low-cost index funds.

"Can you really lose with a low-cost solution?" said Ellenbogen. That said, he sees where active management can add something to a portfolio--notably as specific role players. Moreover, active funds still offer the opportunity to add incremental alpha or take away some beta.

Are there any unintended consequences from the fiduciary rule?
Some have argued the rule will spur a flurry of class-action lawsuits.

"This was the main thing that President Trump focused on when he asked for the rule to be reviewed," said Szapiro. Morningstar expects the number of lawsuits to be high during the first couple of years and to come down over time. (Specifically, Morningstar estimates a long-term annual range for the industry from class-action settlements of $70 million to $150 million, with higher figures in the rule's early years.)

Another unintended consequence may be, according to some, less advice available to investors with smaller account balances. Szapiro doesn't see any evidence of this happening--at least not yet. Robo-advisors and target-date funds (with their built-in advice) are two ways that even smaller investors can still get advice. Ellenbogen noted that many investors still want a personal touch, though; he expects new innovations in advice for smaller investors that may blend robo and traditional advisors.