Fiduciary rule change could mean compliance crush for B-Ds

Financial adviser training and compliance expenses could spike for broker-dealers of all sizes — and become especially burdensome to smaller firms — if the Labor Department applies its proposed fiduciary rule to individual retirement accounts, observers say.
The issue was front and center this week at hearings on a rule change that would expand the definition of fiduciary under the Employee Retirement Income Security Act of 1974.
The rule, as proposed, would designate as a fiduciary anyone who renders advice to a retirement plan or participant for a fee or who provides advice or recommendations on the management of securities. And because the Labor Department has rule-making powers over IRAs, any regulation change would apply to them, too.
That has broker-dealers anxious about compliance sticker shock.
“We’ve made enormous strides in addressing where we see ERISA going, so if we have to apply them to IRAs, so be it. But that doesn’t mean it won’t have a substantial impact,” said Paul Tolley, chief compliance officer at Commonwealth Financial Network.
Under the proposed rule, broker-dealer firms and their representatives wouldn’t be allowed to receive commissions on IRAs. Complying could require dually registered firms to shift their IRA business from the brokerage side of the business to the registered investment advisory side in order to allow firms to charge an asset-based fee on the accounts. If that happens, smaller accounts could be left out in the cold due to a shift to the higher-cost model.
“For small IRAs with limited trades, the asset-based account is going to cost more,” Kenneth E. Bentsen, executive vice president for public policy and advocacy for the Securities Industry and Financial Markets Association, said at the hearing.
Peter Schneider, executive vice president and general counsel at Primerica Inc., said that the firm would have to aim for a minimum account size of $25,000 if it had to switch to an advisory model.
Clients can now open an IRA with Primerica with as little as $250. By comparison, Commonwealth has a stated account minimum of $50,000.
“If you raise the advisory fee to cover [Primerica’s] costs it becomes so exorbitant that it doesn’t make sense to open an IRA,” Mr. Schneider said.
Then there are the logistics of shifting so many accounts, not to mention what Mr. Tolley expects to be a hefty price of training advisers in the new vernacular. How firms respond to increased responsibility over IRAs would depend on their resources.
Aside from notifying clients, firms would have to re-register their accounts at the custodial level as they convert IRA business held in brokerage to an advisory account, said Lisa Roth, president of Monahan and Roth LLC, a compliance consulting firm. She is also chairman of the Financial Industry Regulatory Authority Inc.’s small-firm advisory board.
“You’re not just giving the accounts a new title,” Ms. Roth said. “You have to manage and accomplish a significant amount of back-office tasks to make the transition from a broker-dealer platform to an investment advisory platform.”
The change also could come with increased supervision and licensing for advisers, plus higher costs for liability insurance, Ms. Roth said.
Broker-dealers may also change the way that they deal with referring clients to money managers.
These so-called solicitor programs allow advisers to collect a referral fee from money managersto which they refer clients. Large retail IRAs are in these programs, said Jason C. Roberts, chief executive of Pension Resource Institute LLC.
Because 12(b)-1 fees in IRAs wouldn’t be permitted under the proposed regulation, broker-dealers may also consider building platforms that would allow level compensation to the broker and the firm regardless of which mutual fund is chosen for an IRA, he said.
“[The IRA business] has been the elephant in the room, but it has taken a back seat to major changes in ERISA,” Mr. Roberts said. “You start changing the game with IRAs, and you are squeezing profit margins through compliance.”
The consequences could be especially dire for smaller independent broker-dealers, as tougher rules could strain budgets.
According to Ms. Roth, “12(b)-1 fees on IRAs support a good many small firms. They’re a revenue staple.”
Further, small firms that lack the resources to make the change might end up losing reps with IRA-heavy books of business to an outfit that can accommodate them, Ms. Roth said.
“The important thing is that the department understands how the rule affects the small investor, the starter IRA,” Mr. Schneider said. “If it’s a bludgeon approach, it’s going to impact the sustainability of companies like ours that service the small investor.”