In an ironic twist in the strung-out saga behind the Labor Department’s fiduciary rule, a leading consumer group is calling on regulators to investigate the migration of retirement savers to fee-based advisory accounts.

The Consumer Federation of America, a prominent proponent of the fiduciary rule, has sent a letter to the Secretary of Labor, the Commissioner of the Securities and Exchange Commission, and the President of FINRA, alleging that some brokerage firms may be using the rule to shift customers to fee-based accounts even when it is not in investors’ best interests.

“We cannot dismiss out of hand the possibility that some firms are using the rule as an excuse to shift customers into fee accounts, even when that is not the best option for the investor, or charging them unreasonable fees as a result,” CFA’s letter says

Under the rule’s impartial conduct standards, which were implemented in June, brokers and advisors are required to give advice in investors’ best interests and can only charge reasonable compensation.

“The Department’s rule includes provisions specifically designed to protect against this sort of misconduct,” says the CFA.

The contentious fiduciary rule, promulgated under the Obama administration to address conflicts of interests on investments recommended to qualified retirement accounts, was designed to favor fee-based compensation models over commission-based recommendations.

The rule’s primary enforcement mechanism requires new warranties and disclosures on commission-based sales of investments. Those requirements have not yet been implemented; Labor has proposed delaying full compliance with the rule until July 2019.

CFA turns industry evidence against industry

For more than two years, industry has argued that full compliance with the fiduciary rule would force brokerage firms to move investors to fee-based accounts.

By charging a reoccurring level fee on assets instead of commissions on sales of individual investments, brokers can avoid the appearance of conflicted advice.

Brokers can also facilitate compliance with the rule by moving clients to fee-based accounts.

“Fee accounts qualify under the ‘level fee’ provision of the rule’s Best Interest Contract Exemption,” explained Louis Harvey, CEO of DALBAR, Inc., a Boston-based consultancy that provides compliance support for financial institutions.

“That dramatically reduces the compliance burden and cost,” Harvey told BenefitsPRO. “For example, there are 31 provisions that apply to 401(k) plans but with fee leveling this drops to eight. For IRAs, 32 provisions drop to eight.”

Industry has also long argued that the rule’s restrictions on commission-based sales would harm buy-and-hold investors and savers with modest account balances, who in some cases would pay more in annual fees over a lifetime of investing than they would on the one-time commission-based sale of investments.

In lobbying the Labor Department to delay full implementation of the rule, industry has generated data showing that investors are being moved en masse to fee-based accounts.

A Deloitte &Touche study of 21 brokerage firms, commissioned by the Securities Industry and Financial Markets Association, shows that 10.2 million accounts with $900 billion in assets have been moved from brokerage accounts to fee-based advisory accounts since the impartial conduct standards were implemented.

In a comment letter to the SEC, Fidelity Investments said the fiduciary rule is causing brokerage firms to move clients to fee-based accounts.

“Many investors are now required to pay an asset-based fee to receive exactly the same services that were previously provided to them for no additional fee under a transaction-based fee structure,” Fidelity’s letter said.

“The rule has thus made it harder and more expensive for retail investors, particularly investors with low balance accounts or investors who simply want to use their broker-dealer to execute a limited number of trades per year, to get the advice they need for their long-term savings goals,” the letter added.

In its letter to regulators, the CFA cites Fidelity’s letter as potential proof that some firms are using the rule to generate higher fee-based income.

“If true, (that would) offer strong evidence that some firms at least are flouting the rule’s requirements,” the CFA wrote.

Compliance motive or profit motive?

The CFA’s allegation that profit motive is driving the migration to fee-based accounts amounts to “political rhetoric” and “posturing,” according to Kent Mason, a partner at Davis & Harman. Mason testified to Congress before the rule was finalized that a migration to fee-based accounts would occur under the rule.

“There is clear data that Labor severely underestimated the effect of the fiduciary rule on the cost of advice,” Mason said in an email. “Commission-based accounts are risky and costly under the rule.”

Avoiding that risk and cost explains the migration to fee-based accounts, said Mason, not profit motive.

“Real facts--not rhetoric –show that because of these risks and costs, many financial institutions and advisors are either withdrawing from the commission-based market or are restricting access to commission-based accounts,” said Mason. “Just as the industry told Labor, this is happening solely because of the costs and risks imposed by the rule.”

The CFA says most firms have chosen to continue to offer commission accounts.

“If these firms are nonetheless encouraging their advisers to push retirement investors toward fee accounts when they would be better off in commission accounts, that would be a clear violation of both the rule’s requirement,” the CFA’s letter to regulators said.

In cases where buy-and-hold retirement savers are moved to fee-based accounts when they don’t need the gamut of advisory services, the fees on those accounts should be lowered, says CFA.

“The level of fee charged to these investors is entirely within the control of the firm,” the CFA argues. “They should not be allowed to act opportunistically to maximize their fee income, then point to their willingness to disadvantage customers in this way as evidence of the rule’s harmful impact.”

No enforcement, no sweat

The question of whether investors are being moved to fee-based accounts against their best interest underscores the need for a strong enforcement mechanism in the fiduciary rule, the CFA says.

The Labor Department has issued a temporary enforcement policy saying it will not regulate the impartial conduct standards, so long as firms are making a good-faith effort to comply with the rule.

Labor has also said it will not enforce the rule’s prohibition against class-action waivers in the BIC Exemption.

That provision of the rule would have allowed investors to bring class-action claims for breach of contract. Industry vigorously opposed the provision. Three federal courts have upheld Labor’s right to allow class actions as an enforcement mechanism for the rule.

DALBAR’s Louis Harvey says the CFA’s letter has called attention to the tip of an iceberg.

“Switching to fee accounts is just the first consequence of a no-enforcement regulatory policy,” Harvey said. “The fact is that the regulators do not have the budget and are very unlikely to ever get the budget to effectively investigate and prosecute such widespread and intricate violations.”

The fee-based accounts that the rule favors are far more expensive for investors over the long run, Harvey added.

Had the rule’s original enforcement mechanisms been implemented as scheduled, some migration to fee accounts would have been seen, but at a slower pace, according to Harvey.

The pace of migration has been expedited by Labor’s no-enforcement policy. Capturing more fee-revenue has also added incentive, said Harvey.

“There are only two practical options for enforcement -- lawsuits or independent audits,” he noted. “The declaration of ‘no-enforcement’ simply puts in writing that which is well understood in the industry. The longer all of this drags on, the less likely the rule will ever be enforced.”

The SEC declined to comment for this story. The Labor Department would only confirm that it has received CFA’s letter. FINRA did not respond to a request for comment.

A request for comment from Fidelity was not returned before going to press.

Instant Insights /

CFA calls on regulators to investigate shift to fee-based accounts

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