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Capital Group Policy Spotlight

January 9, 2017

Moving Forward as a Fiduciary

A Guide to the U.S. Department of Labor's New Rule

There isn't a one-size-fits-all solution and the U.S. Department of Labor (DOL) did not outline steps that need to be taken to succeed in this new environment. Each practice and financial professional will need to determine what’s best for their clients. Although many will need to work closely with their home offices, this reference guide is designed to offer a greater understanding of the new rule. It also provides strategies to meet the new requirements and position your practice to succeed.


Introduction

The U.S. Department of Labor’s new conflict of interest rule significantly expands the definition of investment advice subject to a fiduciary standard. While the new rule tackles a simple principle that is widely shared, it alters the regulatory landscape in a way that will likely have broad and challenging consequences to your practice.

  • Under the rule, many financial professionals who have never been thought of as ERISA fiduciaries will now find themselves operating as such.
  • Beginning April 10, 2017, investment recommendations given to an IRA owner or to a retirement plan participant will be considered fiduciary advice.
  • As fiduciaries, financial professionals are legally required to put their clients’ needs before their own and give advice that is solely in the best interests of their clients.


In order to act in their clients’ best interests, financial professionals must:

  1. Act solely in a client’s interests and not take their own interests — economic or otherwise — into account at all. This is called the duty of loyalty.
  2. Make every effort to understand the clients’ needs and research the most appropriate options available to them. This is called the duty of prudence.


The new DOL rule has a grandfathering provision that maintains old rules with respect to investment advice and decisions made before April 10, 2017. The provision allows financial professionals to:

  • Accept ongoing commissions from mutual fund investments established before the rule goes into effect.
  • Receive commissions from new fund purchases that are part of an investment plan established prior to the rule’s effective date.
What is ERISA?

The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that sets minimum standards for retirement plans in private industry.


Among other things, ERISA requires accountability of plan fiduciaries. It generally defines a fiduciary as anyone who exercises discretionary authority or control over a plan’s management or assets, including anyone who provides investment advice to the plan.


Fiduciaries who don’t follow the principles of conduct may be held responsible for restoring losses to the plan. Additionally, the law gives participants the right to sue for benefits and breaches of fiduciary duty.


Understanding the Rule's Impacts

Beginning in April 2017, many financial professionals will be considered fiduciaries for the first time. As a fiduciary, financial professionals are legally required to put their clients’ needs before their own and give advice that is solely in the best interests of clients.


Being a fiduciary does not mean just changing your fees on existing services. Simply moving clients from a brokerage to a fee-based account does not resolve any complications from becoming a fiduciary. In fact, determining which type of account is in the best interest of the client is part of being a fiduciary.


In addition, to comply with the new DOL rule, financial professionals may not accept commissions for the sale of investment products without an exemption known as a Best Interest Contract.


Best Interest Contract (BIC)

The new rule significantly changes compensation for financial professionals. To receive a commission for the sale of a product, you have to cross a relatively high bar called the Best Interest Contract exemption. The regulation doesn’t require all firms to allow BICs to be utilized for clients; each practice will determine if it is comfortable employing the BIC and, if so, in what capacity.


For instance, there is a transaction-specific BIC as well as one that will be used for ongoing recommendations. Regardless of the type, the BIC ensures that compensation does not factor into investment decisions, but that some commissions are still permissible. Examples of actions that need to be covered by the BIC exemption include:

  • The new purchase of commissionable mutual funds shares, including Class A and Class C
  • The new purchase of commissionable variable annuity contracts
  • Rollovers recommendations
What You Need to Know

Here are examples of some actions that will be considered fiduciary advice under the new rule:

  • Most investment recommendation given to an IRA owner, a retirement plan participant or plan sponsor
  • The recommendation of an advisory account over a brokerage account
  • Any recommendation on a distribution, including a rollover from a 401(k) to an IRA

 


Pricing Your Services

Reviewing different types of advisory relationships and finding the best fit for each client is an important step in complying with the new DOL rule and making any necessary transitions in your practice.
 

Advisory relationships differ from client to client. There is no one-size-fits-all approach that can be taken as a fiduciary. Determining the relationship that is in the best interests of your clients requires having a strong understanding of their needs and goals, and clearly defining the services they want you to provide.
 

A number of factors play a role in determining what type of account is best for clients, including the investable assets they have under management and the active management needed for their investments. Regardless of the account type, the financial professional will be a fiduciary for his or her clients. The main difference in account relationship types is the manner in which the financial professional will be compensated.

What You Need to Know
  • To comply with the new DOL rule, determine which advisory relationship is in the best interest of each of your clients.
  • Consider their planning needs, investable assets, and how much active management is needed.
  • No matter what, you will be considered a fiduciary, which affects how you are compensated.


Getting Ready

The DOL’s new fiduciary rule will have a major impact on the financial industry. However, with the appropriate preparation, you will be able to optimize your practice, transition your current business successfully and position yourself for future growth.
 

If you are planning to transition to an advisory business model, you may find it difficult to manage the same number of households as you did previously. If you are in that position, there are several ways to successfully streamline your business, including using select objective-based managed portfolios.


Scaling Your Practice

With more demands on your time, having conversations with your clients and prospects will be critical to determine the account type that is in their best interests and to construct comprehensive investment plans aligned with their specific goals. It also will provide you with the information you need to add scale to your practice so you can focus more time on clients and growing your business.

Here are some questions you can ask your clients to help determine which account will be the best fit for them:

  1. What are your short- and long-term financial goals?
  2. Do you have a working budget? If not, would you like me to work with you to create one?
  3. Do you have taxable and non-taxable (retirement) savings?
  4. Where do you hold your different savings? Multiple locations?
  5. Would you like support working with other professionals, such as accountants, tax attorneys, etc.?
What You Need to Know
  • Make sure you prepare your practice if you are planning to transition to an advisory business model.
  • One way you can add scale to your business is by using select objective-based managed portfolios.
  • Ask your clients questions to determine the best account for them and allow you to grow your business.


Conducting Client Conversations

As in any profession, clarifying the value you provide is important during times of change. You must not only provide real value to your clients but you also must make sure that you communicate that value to your clients. Below is a suggested outline to guide your client communications.

Defining Your Value Proposition

Clearly defining, differentiating and communicating your value to clients on a regular basis is a key building block to a business that will be successful over the long term. To assist you, we’ve developed an online tool designed to help you create your own customized value proposition statement.

Here are some questions to ask yourself:

  1. What is the most important thing that I do for my clients?
  2. Why is the role that I play valuable to my clients?
  3. Do my clients understand the value of my knowing their current and future plans?
  4. Are the clients’ Investment Policy Statements current and do they understand the importance of those statements?
  5. Do they understand the investment process and the due diligence I undertake before recommending an investment?
Outline for Client Communication

Provide background and a general overview

  • The DOL issued a new fiduciary rule concerning retirement investment advice that goes into effect April 2017. 
  • As such, financial professionals have a legal obligation to act in their client’s best interest when giving investment advice.

Explain what this means for the client

  • It is important to understand that I have worked in your best interest since the beginning of our relationship. 
  • While this new rule may require us to change some aspects of our relationship, the rule should not impact the general nature of our relationship.

Discuss adapting the compensation model

  • The rule requires that the structure and compensation of some accounts must change. I had been compensated via the investments chosen for your account.
  • Discuss the differences between a commission-based model under a BIC framework and a fee-based compensation model, which may be more streamlined.

Reaffirm your commitment

  • This regulatory change in no way alters my longtime commitment to your financial health and investment success.
  • Whatever is in your best interest is my primary focus.
  • If you have any other questions regarding this change or about anything in general, don’t hesitate to call me.


Developing and Documenting a Plan

This regulatory change will have a major impact on the entire financial industry. Taking steps to prepare will be a key factor in a smooth transition for both you and your clients prior to the April 10, 2017, implementation date.

Ensure that you and the members of your team are educated on the new rule. In addition to the resources your firm offers, our Policy Spotlight section provides up-to-date information and a number of resources that can help you learn more about the new DOL rule.

Below are three steps you can take to help make your fiduciary practice run smoothly and position yourself to succeed in today’s fiduciary world.

Three Steps to a Fiduciary Practice

This regulatory change will have a major impact on the entire financial industry. Preparing early will ensure you and your clients have a smooth transition when the rule goes into effect. Educating your team, defining roles and responsibilities and identifying third-party partners is a good way to start getting organized.

Clear communication and documentation of each step of your relationship and investment process is even more important when acting as a fiduciary. It will be important to do the following: formalize your investment process, document your clients’ Investment Policy Statements and establish your portfolio construction process.

Three Main Approaches to Managing a Client’s Investments

Financial Professional Constructs Model

Makes trades for clients if acting as portfolio manager; if not, the financial professional must obtain client approval before making trades.

Firm Constructs Model

Home office sets asset allocation models, which the financial professional can then select and adapt to meet clients’ specific needs.

Investment Manager Constructs Model

Managed portfolios offered with different objectives that financial professionals can use as complete or core portfolios, or tailor for clients’ needs.

Providing well-informed advice that supports the best interests of your clients is what you are paid to do as a financial professional. Taking clear steps to determine your recommendations will enhance your ability to deliver consistently over the years and meet the requirements of being a fiduciary.


Selecting an Investment Manager

When finding the best investment manager for clients, focusing on consistency and persistency of results is key. Here are the steps you can take as a fiduciary to best deliver for your clients:

  • Establish a strong, documented selection process to identify managers who are in line with the client’s Investment Policy Statement and fill the specific role needed within the asset allocation model.
  • Question — Once you have identified managers who meet your investment criteria, ask the three questions below to evaluate several key qualitative and quantitative data points.
  • Document the due diligence process you used and the factors you evaluated that led you to make your investment manager selection.
  • Monitor the results of the managers within your client’s portfolio and remove them if they are no longer meeting the client’s needs compared to the appropriate benchmark and their peer group.
Three Questions to Consider When Choosing an Investment Manager

What Are Their Results?

Eliminate any manager with below-average investment results over meaningful periods. Be sure to review a manager’s results and a variety of market and economic cycles. Then you can determine who generated the strongest results at a low cost for your client. Expenses should be reasonable based on industry averages.

What is Their Process?

Learn about the investment manager’s process and determine what factors drove their results. Are they reliant on one person for investment results or do they employ a committee approach? What is the experience of the manager(s)? Do the managers conduct their own research or do they outsource it?

Are They Repeatable?

Who were the key players who drove the manager’s past results? Are the same people still managing the fund? You want to ensure the investment manager’s track record is strong and repeatable. Also ask how many funds they’re managing. Will they be focused on the fund you’re interested in for your client?


How We Can Help

At Capital Group and American Funds, we understand the challenges of transitioning your practice and are committed to supporting you and your clients during this time. As you prepare for the new regulatory environment, we encourage you to learn more about the resources we have to offer.

Capital Group’s American Funds team can help you…
  • Provide high-quality, low-cost investment options for your clients
    As you continue to refine your due diligence process to comply with the new DOL rule, American Funds can help facilitate and support your investment manager selection process. We can also assist you with your research and documentation requirements. We remain committed to providing strong investment options for you and your clients while helping mitigate risk in this new environment.
  • Strengthen and streamline your practice with managed portfolios
    Scaling your investment process and policy can help improve client outcomes and increase your practice’s efficiency. Using select objective-based managed portfolios is a low-cost way to meet your clients’ active management needs in a fee-compressed environment. American Funds offers a wide variety of low-cost managed portfolios. By employing the correct managed portfolio based on each client’s objectives, you can harness the strength of active management while keeping fees in line with the best interests of your clients.
  • Define and communicate your value to prospects and clients
    American Funds understands the importance of clearly articulating the value of your advice and services to prospects and clients. To assist you, we’ve developed an online tool designed to help you create your own customized value proposition statement.
  • Learn more about the new regulations
    Guidance from our sales force and online resources can help you navigate the new environment. For up-to-date information about the new regulations, visit our Policy Spotlight section.

As always, call your American Funds wholesaler if you have specific questions or concerns.

 

 

Financial professionals affiliated with firms should make sure to refer to and follow their firm’s policies and guidelines as they relate to the U.S. Department of Labor’s new fiduciary rule.


Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

This material is intended for use by financial professionals or in conjunction with the advice of a financial professional.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.