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

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

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

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Under the rule’s impartial conduct standards, which wereimplemented in June, brokers and advisors are required to giveadvice in investors’ best interests and can only charge reasonablecompensation.

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

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The contentious fiduciary rule, promulgated under the Obamaadministration to address conflicts of interests on investmentsrecommended to qualified retirement accounts, was designed to favorfee-based compensation models over commission-basedrecommendations.

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The rule’s primary enforcement mechanism requires new warrantiesand disclosures on commission-based sales of investments. Thoserequirements have not yet been implemented; Labor has proposeddelaying full compliance with the rule until July 2019.

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CFA turns industry evidence against industry

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

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

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

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

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

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

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

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A Deloitte &Touche study of 21 brokerage firms, commissionedby the Securities Industry and Financial Markets Association, showsthat 10.2 million accounts with $900 billion in assets have beenmoved from brokerage accounts to fee-based advisory accounts sincethe impartial conduct standards were implemented.

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

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

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

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

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

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Compliance motive or profit motive?

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The CFA’s allegation that profit motive is driving the migrationto 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 finalizedthat a migration to fee-based accounts would occur under therule.

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

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

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“Real facts--not rhetoric –show that because of these risks andcosts, many financial institutions and advisors are eitherwithdrawing from the commission-based market or are restrictingaccess to commission-based accounts,” said Mason. “Just as theindustry told Labor, this is happening solely because of the costsand risks imposed by the rule.”

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The CFA says most firms have chosen to continue to offercommission accounts.

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“If these firms are nonetheless encouraging their advisers topush retirement investors toward fee accounts when they would bebetter off in commission accounts, that would be a clear violationof both the rule’s requirement,” the CFA’s letter to regulatorssaid.

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In cases where buy-and-hold retirement savers are moved tofee-based accounts when they don’t need the gamut of advisoryservices, the fees on those accounts should be lowered, saysCFA.

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“The level of fee charged to these investors is entirely withinthe control of the firm,” the CFA argues. “They should not beallowed to act opportunistically to maximize their fee income, thenpoint to their willingness to disadvantage customers in this way asevidence of the rule’s harmful impact.”

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No enforcement, no sweat

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The question of whether investors are being moved to fee-basedaccounts against their best interest underscores the need for astrong enforcement mechanism in the fiduciary rule, the CFAsays.

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The Labor Department has issued a temporary enforcement policysaying it will not regulate the impartial conduct standards, solong as firms are making a good-faith effort to comply with therule.

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

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That provision of the rule would have allowed investors to bringclass-action claims for breach of contract. Industry vigorouslyopposed the provision. Three federal courts have upheld Labor’sright to allow class actions as an enforcement mechanism for therule.

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

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“Switching to fee accounts is just the first consequence of ano-enforcement regulatory policy,” Harvey said. “The fact is thatthe regulators do not have the budget and are very unlikely to everget the budget to effectively investigate and prosecute suchwidespread and intricate violations.”

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

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

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The pace of migration has been expedited by Labor’sno-enforcement policy. Capturing more fee-revenue has also addedincentive, said Harvey.

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“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 wellunderstood in the industry. The longer all of this drags on, theless likely the rule will ever be enforced.”

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The SEC declined to comment for this story. The Labor Departmentwould only confirm that it has received CFA’s letter. FINRA did notrespond to a request for comment.

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

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Nick Thornton

Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.