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The DOL Rule: Lessons From the Ant and the Grasshopper

The Department of Labor’s conflict of interest rule, often referred to as the fiduciary rule, has arrived on the financial services scene. Its reception has been predictably divisive. The first few lawsuits in what will likely be a parade of litigation have been filed, aiming to stop, dismantle or delay the rule.

Now that the fiduciary rule’s hurdles are in place, the industry and consumers alike soon will know whether the rule has strong enough legs. Waiting for the outcome of a challenge before preparing for the rule’s implementation should remind us of the fable of the ant and the grasshopper. Let’s not find ourselves outside in the cold, shivering and unprepared, come next April’s deadline.

The new rule expands an existing fiduciary duty to include recommendations concerning retirement assets. This will target individual retirement account holders and rollovers as well as those who are acquiring, holding, exchanging or distributing retirement assets. This broad net definition covers just about every working or retired American, from a coffee-shop employee saving $50 weekly in a Roth IRA to a small-business owner opening her first 401(k) plan to a corporate officer facing retirement with a few million dollars in a profit-sharing plan. All of these are owed a fiduciary duty of care.


It’s About Relationship

A fiduciary duty can be illustrated as a relationship between two parties. Michael Jensen and William Meckling, in their paper “Theory of the Firm,” set up the discussion of principal and agent conflicts. A client (young employee, business owner, retiree) is viewed as the principal. The principal has an interest in retirement. That interest may be accumulating  capital, developing an income strategy, meeting bequest motives, developing an appropriate risk tolerance or a combination of motives. In financial planning, we refer to this interest as helping the client understand and meet specific goals.

The counterpart to a principal is an agent. The agent may be an insurance agent, investment advisor, broker, banker or other financial service professional. The agent also has a set of goals and motivations, such as profit, sustainability, growth and financial success.

The principal/agent model has natural conflicts. An agent has a set of best interests (success and profit) that may not lead to the best way for the principal to realize their goals and dreams. The model is often complicated by including the interests of the firm, which include the interest of the shareholders or the interest of the company’s policyowners. Multiple interests can be in conflict.

The conflict between agents, principals and firms can resolve itself in any number of ways. One party could win at the expense of the others; a natural market may develop that balances interests; or a regulatory policy may be imposed on a principal, agent and firm to ensure consumer interests are met. When we view the Department of Labor (DOL) fiduciary rule, we need to consider this framework.


DOL Takes Aim at ‘Vulnerability’

The Department of Labor stated that retirees and accumulators (principals) were vulnerable, and this vulnerability was leading to excess costs and fees. The excess costs and fees, coupled with increases in consumer longevity, contributed to underfunded or unsafe retirement strategies, according to the DOL.

Enforcing a fiduciary standard requires all parties (principals, agents and firms) to align their interests to that of the principal. Requiring a fiduciary standard puts profit and growth secondary to meeting the client’s financial planning goals, which is the first priority.

And this leads to the core of the rule. The DOL questions certain compensation structures that might lead to biased advice. Commissions, assets under management models, even hourly fees have the potential to create conflicts between principals and agents. Conflicted compensation is prohibited under the new rule, unless the agent works under a prohibited transaction exemption.

The DOL then can influence the principal/agent relationship by setting specific processes and rules regulating the allowable uses of prohibited transactions. The DOL is not trying to discredit the financial services industry with this rule. It is, instead, attempting to set specific parameters around the retirement advice provided to potentially vulnerable consumers. 

The ant prepares for the change in seasons, stores food and devises strategies for survival. Let’s not take the short-sighted perspective of the grasshopper when preparing for the future of financial planning. Take a lesson from the ant, and recognize the opportunities that exist today to create new models and procedures that will benefit not only the profession, but also the retirement security of the clients whose best interests we are pledged to serve. 

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