The Department of Labor’s proposed conflict of interest rule is not the “appropriate way” to create a uniform standard of care for advisors to retirement investors, according to Robert Ketchum, CEO of the Financial Industry Regulatory Authority.
The DOL’s proposal, which would establish a fiduciary standard of care for anyone advising a 401(k) plan or IRA account via so-called Best Interest Contract Exemptions, is well intended, said Ketchum in an address at FINRA’s annual conference.
But those very contracts are wrought with “practical” concerns, namely that enforcement of the DOL’s rule would be left to class action claims and arbitration hearings.
Ketchum, who said he has supported a “best interests of the customer” standard for some time, thinks the upshot of the DOL’s rule would be courts and arbitration panels prohibiting investments with higher costs, even if those more expensive investments are right for clients.
“I suspect a judicial arbiter might draw a sharp line prohibiting most products with higher financial incentives no matter how sound the recommendation might be,” Ketchum said.
He also said that the “subjective language” in the DOL’s prohibited transaction exemptions leaves brokers with “insufficient workable guidance” to determine if the advice they are giving is conflicted. That uncertainty could force brokers to a fee-based compensation model on IRA accounts, and that, Ketchum thinks, ultimately could drive providers from the IRA market.
“It is not that Labor’s conflict concerns don’t have validity,” Ketchum explained. “It’s that I fear that the uncertainties stemming from contractual analysis and the shortage of useful guidance will lead many firms to close their IRA business entirely or substantially constrain the clients that they will serve.”
The DOL’s focus on disclosing conflicts of interests in advice on 401(k) and IRA assets are “aimed at exactly the right areas,” Ketchum said.
But he thinks the rule would apply a different standard to those assets, compared to the rest of investor assets.
“A great many investors simply do not plan for their retirement by segregating tax-advantaged vehicles from their other investment strategies. An effective regulatory environment would apply a consistent best interest standard across, at least, all securities investments and have the examination and enforcement mechanisms to oversee compliance with the standard,” he said.
The Securities and Exchange Commission is the right agency to craft a new best interest standard, Ketchum thinks.
“The best interest standard should make clear that customer interests come first and that any remaining conflicts must be knowingly consented to by the customer,” he said.
Though similar sounding to the spirit of the DOL’s proposal, Ketchum said no new standard should come without the clear guidelines he thinks are absent in the DOL’s proposal.
Also, firms should be required to design internal compliance structures to manage potential conflicts of interest.
And a new rule should bring better client disclosure requirements that include “plain English descriptions of the conflicts they may have and an explanation of all product and administrative fees,” he said.
He also suggested a new rule incorporating the growing best practice of creating “fee neutrality” across products broker-dealers sell, which would minimize incentives for reps to favor one investment over another.