When the U.S. Department of Labor recently changed the rules of the financial advisory game, you would have thought the sky was falling based on the knee-jerk reactions from many in the business. Personally, I jumped for joy, just as many other investors did.

It’s not as though the new rules came out of the blue; and although this new regulatory framework includes seven documents and 1,023 pages, it really boils down to one issue: Advisors must put their clients’ interests first, specifically in retirement assets such as IRAs and 401ks, or face stiff penalties.

The practice of recommending high-commissioned products like annuities or load mutual funds solely to pad the pockets of a broker, advisor or fund family first—and fulfill the needs of investors second—has long been criticized by the government, Securities Exchange Commission (SEC) and Average Joe advocates.

Designed specifically to shield investors’ from such shenanigans is causing angst among the financial community. What some consider a moral issue will become a legal one come April 10, 2017—the deadline to comply.

This change seems like a long overdue no-brainer to me. Over the past decade, I’ve worked for many financial advisors whose sole purpose was to empower individual investors with knowledge to either make smart self-directed decisions or know the right questions to ask of advisors. That meant stern warnings against buying high-fee mutual funds, insurance products and anything that seemed suspiciously too good to be true.

For example, an A-load fund requires that investors pay a transaction fee when you buy it. So, if someone invests $100,000 in one with a 5 percent front-end load, $5,000 goes to pay the commission and $95,000 is invested. A B-load fund, on the other hand, penalizes investors if they sell it within a certain period. A C-fund neither imposes a back- or front-end load but adds a sales charge into the expense ratio that is much higher than most no-load funds.

Mind you that the new DOL rule doesn’t forbid commissioned products, but advisors will have to prove that it is in the best interest of their clients—something they may be hard-pressed to do.

With nearly 7,500 no-load mutual funds making up the investment landscape that mirror the performance of their more expensive counterparts, there’s simply no reason for an advisor to recommend the load variety to a client other than to pocket a profit from the transaction.

To add insult to injury, load or no-load, all mutual funds charge ongoing management fees, also referred to as 12b-1 fees. They cover an advisor’s cost to manage the fund’s portfolio, and operating expenses such as marketing or distribution. In general, expense ratios between 0.5 percent and 2 percent are deemed “acceptable.” The industry average through December 2015, according to Lipper, is 1.01 percent. Anything above 2 percent is considered excessive; something the mutual fund industry has been guilty of all too often. The U.S. government estimates that investors waste $70 billion a year paying exorbitant fees.

Annuities, however, might be the worst offenders. They carry commissions up to 10 percent and deliver stiff penalties for early withdrawal of funds. Nearly two-thirds or $34 billion in assets from indexed annuity sales last year in the U.S. were funded through IRAs or rollovers from qualified retirement accounts, according to Connecticut-based research firm Limra.

That said, the new rule is likely to weed out the few bad apples that rely solely on steep commissions, high fees and immoral practices to make a living. Squeezing them out of business should leave a healthier industry—and wealthier investors—in their wake.

It’s Not All Doom and Gloom

Here are some companies that may benefit from the changing landscape:

  • Discount brokers such as Charles Schwab (NYSE:SCHW), TD Ameritrade (NYSE:AMTD) and E-Trade Financial (NYSE:ETFC) stand to gain customers as smaller accounts are migrated to self-directed IRAs or robo-advisors.
  • And, Goldman Sachs brought up an interesting point with respect to IRA rollovers: Because transferring assets from a retiree’s 401k to an IRA will be subject to the fiduciary rule, brokers may advise clients to leave their assets in the 401k. If that happens, those with the biggest share of 401k accounts such as BlackRock (NYSE:BLK), State Street (NYSE:STT), Prudential Financial (NYSE:PRU), Northern Trust (NASDAQ:NTRS), Principal Financial Group (NYSE:PFG) and Bank of New York Mellon (NYSE:BK) should see an increase in assets, or at least a stabilization.
  • Finally, ETF-related companies should continue to see assets mount. The parent managers of iShares and PowerShares: BlackRock and Invesco (NYSE:IVZ), respectively, plus State Street and WisdomTree Investments (NYSE:WETF) should also come out unscathed.

The DOL’s new rule is already disrupting the annuity industry as sellers of the insurance product scurry to move to fixed-fee models. After a 10-year surge in assets, sales are projected to decline 30 to 35 percent next year.

It may also serve to weed out a few small fish. It’s likely that firms with manage accounts holding less than $25,000 will be saddled with unaffordable costs to comply and simply go out of business, leaving small investors to fend for themselves. Meanwhile, the survivors would be subjected to shrinking profitability, raising costs across the board for investors. Goldman Sachs predicts that the costs associated with revising procedures and retraining staff to comply with the rule will be more than $13 billion in upfront costs and more than $7 billion in annual costs.

The new rule affects about $7.3 trillion in IRAs and $4.7 trillion in 401ks held in these accounts at the end of last year, according to the Investment Company Institute—and billions of dollars of revenue generated from them.

The imminent shift out of expensive, actively managed funds into passive index funds has already dealt an additional blow to the industry. In May, an estimated $18.7 billion flowed out of actively managed funds while inflows totaled $8.1 billion for passive/index funds, according to Morningstar. Investors are also putting assets into lower-fee ETFs, which Goldman Sachs says could reach $7 trillion globally by 2020 from today’s $2.8 trillion.

This continuing shift into cheaper asset classes by shareholders and the new fiduciary rule are clearly causing disruptions. For those firms that have always strived to put clients’ interests first, the new fiduciary rule should require minor adjustments. Offenders, on the other hand, are being urged to tackle the slew of necessary changes before it’s too late.

Stayed tuned for part two of this series. I will address how the financial industry is coping as it tries to comply with the new rule and what role technology is playing.

Karen Riccio

Karen Riccio

Financial Writer at Kurtosys
Karen Riccio has had a 20-year long career in journalism covering the financial and technology industries. She is currently a member of the Financial Braintrust Alliance for Newsmax and writes a weekly blog. Her clients have included Moneynews.com, InvestorPlace.com, ChangeWave, Business Financial Publishers, ETFtrends.com, Global Trends, and Wall Street Daily. Karen graduated from Cal Poly Technical University in San Luis Obispo, Calif., with a BS in Journalism and lives in Orange County, Calif.
Karen Riccio

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