Experiential Wealth, Inc.
Experiential Wealth, Inc.
Experiential Wealth, Inc.

Best Interest Contract: “I’m From the Government, and I’m Here to Help”

May 4, 2016 | Individuals, Institutions, Opinions, Plan Sponsors

Since the publication of the final DOL rule to redefine the term fiduciary last month along with the Best Interest Contract (“BIC”) Exemption (“BICE”), many in and out of the retirement industry continue to debate its impact and if the rule, when implemented, will improve on “protecting the public interest in the integrity of retirement and other important benefits”. I suggest the new rule is like an earthquake which disrupts the status quo without meaningfully improving consumer protection by legitimizing conflicts. It adds confusion and makes fiduciary status a check-the-box exercise.

  1. Fiduciaries are All the Same – legitimizes conflicted broker advisers as fiduciaries by exempting blatant conflicts from being prohibitive;
  2. Rule Based Standard is Easier to Regulate but also Easier to Skirt – applies FINRA rule-based like approach to BICE, the new fiduciary rule is bleeding into the suitability standard, which is inferior;
  3. A Shell Game – disintermediates a group of non-retirement plan centric broker advisers and their broker-dealers by shifting business opportunities from the many to the few;
  4. Bigger is Better – raises the likelihood of mergers, consolidations, and exits where the winners have scale and size; and
  5. Deeper is Even Better – binds the deeper pockets of institutions through the BIC to future retail clients is evidence that the DOL accepts the ineffectiveness in regulating individuals and is now holding organizations responsible and liable for fiduciary breaches, malfeasants and wrongdoing.

At the end, there are huge disturbances within the industry yet most retail clients remain unaware and confused, and all in the name of protecting them and their retirement assets. The following parody should be instructive about how much the DOL has fallen short in its mission and how confusing the new BICE would be to implement and understood by the intended audience.

The “Honesty Standard” has been in place when selling investment products since the 1970s when the SEC and subsequently DOL created regulations (for the protection of all welfare and retirement plans) to set the framework by which honesty is imposed in securities transactions. Any violation would be subject to severe fines and penalties. The basic premise is that investment brokers or salespersons must be honest with their retail customers when completing a securities transaction (buy or sell). Fast forward to today, the DOL found that brokers and salespersons find cleaver ways to get around the Honesty Standard. What the DOL found was that brokers were working in teams where one broker recommends securities in an untruthful way but does not actually complete the transactions while the second broker from the same firm contacts the customer subsequently to complete the transactions the first broker recommended. Another common practice is that a broker does not complete “a” transaction but dishonestly recommends and implements “solutions” in the guise of portfolio construction for retail clients. These practices are blatantly designed to skirt the application of the Honesty Standard in order to sell risky, unsuitable and high commission products to the public. The DOL, working closely with the SEC, issued proposed regulation to redefine the application of the Honesty Standard six years ago. There was significant lobbying and push back by the brokerage industry stating that the proposed Honesty Standard regulation would 1) cost the industry a lot of money to comply and 2) would hurt the retail customers whom DOL wants to protect since brokers and salespeople would simply not serve the retail market any more. Sensing that the proposed regulation would not pass the political smell test, the DOL retracted and this year issued final regulation with significant support by the lame duck White House containing the Tell The Truth Contract (T3 Contract”) Exemption. The new regulation tightened the Honesty Standard by imposing honesty in any transaction to include a single transaction and portfolio solution recommendations (before the transaction) and ongoing servicing (after the transaction). In an effort to accommodate misrepresentation, distortion, exaggeration, ignorance and self-interest, a T3 Contract can be used. This is a disclosure based approach that binds not the brokers or salespeople but their institutions (with deep pockets) to retail clients. The T3 Contract allows brokers and salespersons to be exempted from the Honesty Standard as long as they clearly state how they can be dishonest and agree to fair dealing. Customers can subsequently bring suits against the institutions for harm arisen from dishonesty however. The bottom line is that all brokers and salespersons are now deemed honest and meeting the Honesty Standard literally or via exemption through the application of the T3 Contract. The true winners of this new regulation are securities and compliance lawyers and web developers (creating more robust online disclosures across America), and the true loser is the forest where more trees have to be cut to generate the paper for the T3 Contract.

Retail investors can now all sleep soundly under the protective blanket of the T3 Contract. There are no more liars!