Regulators in other industries have tried a different approach to consumer protection – one that, if applied to the financial services industry, could also protect advisory firms as well as retail investors. (Photo: Shutterstock)

Retirement advisors and plan sponsors can look forward to two provisions of the Department of Labor’s fiduciary rule becoming applicable on June 9.

One provision would create a broader definition of who is a fiduciary when working with retirement accounts, and the other would establish impartial conduct standards by which fiduciary retirement advisors must provide such advice in the best interests of their clients.

The rest of the rule, originally set to take effect April 10, will be delayed until January 1.

A central provision of the fiduciary rule, the Best Interest Contract Exemption (BICE), will not be fully implemented until 2018, but it raises the possibility of even more lawsuits against financial services firms, their advisors and insurance brokers, because investors will have the right to bring class-action lawsuits against financial firms.

Under BICE, financial advisors can earn variable compensation on products sold, as long as the advisors meet certain conditions. BICE rules state that the fiduciary advisor must sign a “Best Interest Contract, or “BIC,” with the client saying he or she will provide advice in the client’s best interests.

Under the BIC, the advisor can engage in so-called “prohibited transactions,” such as encouraging the client to shift from a lower-cost 401(k) or IRA to one with a higher fee, as long as the advisor follows the BIC requirements.

Also, to meet BICE requirements, advisory firms must disclose all material conflicts of interest and take steps to prevent those conflicts from violating the impartial conduct standards. They must also appoint a person to be responsible for leading and monitoring the process. If the fiduciary process fails in any way, firms could be subject to class-action litigation.

The DOL estimates that $1 trillion of retirement savings will be subject to rollover in the next five years, and statistics from the Social Security Administration show approximately 10,000 people retiring each day.

For this reason, the DOL rules have targeted rollovers from 401(k) plans into IRAs or other investments, such as annuities. Since the fee structures for 401(k) investments are generally lower than IRAs or annuities, advisors must justify that their advice to roll over 401(k) funds are in the best interests of the investor.

Advisors must also be able to show that investors have received education on the options available to them, such as how the investor will derive additional value from rolling the assets into a different type of investment or group of funds, what fees are associated with the new arrangement, and a description of other benefits (for example, more personalized guidance) from the advisor.

In addition, advisors need to make investors aware of risks. In the case of an IRA rollover, it would likely be relevant to disclose that 401(k) plans are protected from creditors and IRAs are not.

401(k) plans are a key benefit provided by many employers. The fair handling of employee investments is important, because in some cases, it may be in the best interest of the investor/retiree to keep funds in the company 401(k) plan, even if it means paying higher distribution fees than would be charged in an IRA.

Evidence of comprehension could hedge against risk


ERISA lawsuits certainly are not new, but in light of the fiduciary rule, the threat of legal action weighs heavily on the minds of firms and their client-facing employees, and simply following compliance rules may not provide enough protection from class-action suits.

While regulators have traditionally turned to disclosure as a tool to protect consumers, even they are often quick to admit that disclosure has its limits.

The Securities and Exchange Commission’s investor advocate, Rick Fleming, recently told the Wall Street Journal that the SEC is looking to do a better job of making disclosure more useful to the average person.

That assumes, however, that the average investor actually reads and understands disclosures. A study conducted by NYU Law Professor Florencia Marotta-Wurgler found that only one or two people in 1,000 read agreements for software purchases, for example, and that those who did only read a small portion.

Additional research has shown that consumers can only pay attention to a limited amount of information at any given time. With the volume of financial reports and prospectuses an investor would need to read for all investments, reading disclosures could become a full-time job!

Regulators in other industries have tried a different approach to consumer protection – one that, if applied to the financial services industry, could also protect advisory firms as well as retail investors.

The key is shifting the paradigm of disclosure to one of comprehension.

In the telecom industry, for example, regulators enacted new rules in 1996 to prevent “slamming and cramming,” in which operators could illegally switch a consumer’s phone service, or add charges for services without a consumer’s permission.

As part of the Telecommunications Act of 1996, the Federal Trade Commission (FTC) and Federal Communications Commission (FCC), began requiring all providers of wired voice communication to obtain reliable proof that a consumer requested a change of service or ordered a new service.

At the time, acquiring this type of proof was difficult, because most change-of-service requests occurred (and still do) via telephone. The FTC and FCC decided to approve phone verifications as legally binding in these situations, as long as recordings were captured by a disinterested third party, available for audit for a minimum of 24 months, and that the identity of the consumer be verifiable through a Social Security number, driver’s license number, date of birth or other means.

The rules spawned a new industry called Third-Party Verification (TPV). Service providers using TPV are now able to track and confirm whether a customer understands or has approved charges for a new service, and can supply “evidence of comprehension” should a complaint arise.

If TPV were embraced by the financial services industry, it’s possible that, in addition to providing simplified disclosures, advisors could confirm – through a TPV – whether a client understood an investment or investment type, a recommendation as part of a creating a financial plan, or the terms of an annuity.

TPV providers now have the ability to confirm a client’s comprehension or understanding through a variety of methods that include a live agent, interactive voice response, email or text.

In each case, the client could be asked a series of questions to confirm his or her understanding of the rationale, terms and fees associated with a transaction. If clients provided incorrect answers, or expressed a misunderstanding, they would be redirected to the advisor or another party for further explanation.

Firms could also use TPV to identify communication weaknesses among their advisors or insurance agents.

For example, if a national firm received frequent notices of misunderstanding by clients of a particular office, reporting from TPV could be used to trigger additional staff training or other activities to improve scores.

Another advantage of TPV is that it can also produce a record that can be stored long-term and retrieved easily in the event of a lawsuit, enabling a firm to meet record retention requirements under the Fiduciary Rule.

The third-party reporting could help compliance officers monitor client feedback and solve problems before they reach the stage of litigation.

TPV as a differentiator


Although providing evidence of comprehension is not a requirement under the fiduciary rule, those who wish to differentiate their practices could find the use of TPV an additional trust builder.

As more and more advisors become fiduciaries, the commitment to place clients’ interests first becomes less of a unique qualifier and more of a threshold requirement.

Consumer awareness of the concept of “fiduciary” has increased since the introduction of the DOL fiduciary rule, and many predict that market demand for fiduciary advisors will increase, regardless of whether the fiduciary rule takes effect

TPV could enable some fiduciary advisors to better serve clients by enabling them to improve their communication skills, keep better records, and look out for their clients’ best interests, by ensuring clients understand what they’re getting.

Related: See more fiduciary rule coverage from BenefitsPRO