Re-inventing retirement: DoL rules to redefine wealth management

No wealth manager wants to walk away from $7.2 trillion retirement assets with a predicted 9% CAGR, but the transformation to reach compliance is enormous

If the US wealth managers are not up at night worrying about what the Department of Labor (DOL) regulation is going to do to their businesses, they should be. The legislation that expands the definition of the Employee Retirement Income Security Act (ERISA) to include all advisors for Individual Retirement Accounts (IRAs) is redefining the current brokerage model.

The new rules push fiduciary responsibilities beyond historical ‘suitability’ requirements when recommending products. Moreover, they actually give IRA holders legal recourse to go after advisors that fail in any way to maintain clients’ best interest above their own.

This heightened liability means that the industry simply cannot operate IRA brokerage or advisory businesses the way they stand today. What will it take to comply with new DOL mandates? Will wealth managers re-create their businesses to stay in the game?


No small potatoes

The US retirement business is substantial. As of June 30, 2015, total US retirement assets reached $24 trillion, up 2.8% from six months earlier. $7.2 trillion (yes, TRILLION), is held in IRAs, the handling of which will be heavily impacted by the new regulation1.

With a predicted 9.1% Compounded Annual Growth Rate (CARG) from 2015 – 20202, this is an extremely big business for incumbent providers. Nobody wants to walk away from numbers like these, and yet the amount of business transformation that will need to take place to reach compliance is enormous.

This legislation, first proposed in 2010 and revamped in 2016, is a burning issue that the current US administration is intent on implementing expeditiously. The final rule, released in April 2016, will overhaul retirement investment businesses and is now a major imperative.


What happened? 

The US retirement landscape has shifted dramatically while regulation governing investment advisors in this space has largely remained the same.  Historically, companies, especially in the US earlier manufacturing economy, provided Defined Benefits Plans for their employees, i.e. pension for life. But the days of assured financial stability for retirement are no more.

First of all, people live longer. That means pensions would be significantly more expensive to provide. So, a shift toward Defined Contribution Plans, like 401-k and IRA, was only natural. Some would argue that retirement investing has benefitted from innovations in financial services options, but with freedom comes risk. The bottom line is that individuals are bearing the brunt of responsibility for their financial future, and they need the right regulation to protect them.

Quite unbelievably, the major ERISA tenets, which govern retirement investing, have gone almost untouched for the last 40 years. Regulation did not progress with the advent of individualized IRAs. As a consequence, a conundrum arose in which retirement advisors had the opportunity to give newly needed advice that could benefit them directly, rather than their clients. And many did. Conflicted advice costs US retirees a tremendous $17 billion per annum3. Enter the DOL.


What’s different this time?

The new DOL rules will prohibit certain types of transactions that they believe create an opportunity for conflicted advice. These dealings include, but are not limited to, commissioned transactions, revenue sharing (in which wealth managers get a share of revenue from mutual fund sponsors) and principal transactions (where brokers sell securities out of their own inventory). This language is common to the bill rejected in 2010. Where the DOL’s strategy deviates this time, however, is with its new provision for ‘exempted relief’, without which, the industry argues, the brokerage model as we know it could not survive.

Exemption requirements are, again, not unreasonable or difficult to understand. A major tenant is the Best Interest Contract (BIC). A BIC demands that the Financial Advisor (FA), as well as the wealth management firm, sign a contract with the client ‘legally acknowledging fiduciary status and agreeing to always act in the client’s best interest.’ 4 To comply with this promise, wealth businesses will have to disclose all fees and compensation arrangements, as well as create a process through which they can continuously prove they have upheld their legal obligation. Any financial services professional will immediately see the profound operational and legal risks inherent in the final DOL rule.


Business (NOT) as usual

As we know only too well in financial services, the most well-intentioned and exemplary efforts by regulators can wreak havoc on the operations of global institutions. To prove that IRA advisors are in fact on the right side of the law, day in and day out, is an incredible undertaking for businesses. Experts are predicting the cost of complying with the new regulations will be as much as $2.4 billion annually.5

Brokers and advisors who are not analyzing, strategizing and planning implementation now, will simply not have the processes in place to continue business safely after the compliance date of April 10, 2017. Reputational risks at stake are tremendous.

There’s just no easy way around it. The transformation needed to comply with this type of regulation is serious and significant. This regulation will reach deep into every crevice of the business. Any hope of compliance means highly organized, strategic and tactical planning, beginning now.


Leading the way for bigger changes 

The good news is that the change being duly forced by regulators may actually be just what the retirement industry needed to prepare for its next chapter. The industry is moving further and further away from old models where commission-based earnings ruled. It is likely that, fuelled by regulation, the historically hefty, up-front commission charges will move to fee-based models. This could mean an initial 20% to 30% hit for wealth management firms dealing in the IRA space. Handled correctly over the long-term, however, the trajectory put in motion by industry regulations could benefit IRA businesses, with some fee-based, larger asset accounts having revenue yields of 60% over historical commission-based models. In addition to the demise of the commission, the DoL rules and their complications might also see wealth management trend toward lower-cost passive investment products and the rise of robo-advisors.


Will robos save the day?

Some industry insiders feel that the DoL is touting robo-advisors as a low cost solution for retirement investors, posing minimal risks of conflicted advice. It is important, however, for individual investors to understand the full robo picture before initiating investments using these tools. Crucially, robo agreements require that the client, and not the robo-advisor, is responsible for ensuring decisions are in the client’s best interest. This is a large departure from regulated provider relationships.

In most robo cases, advice is generated from cursory questionnaires that do not elicit all relevant information and may exclude clients’ key financial facts. According to industry experts, robo-advisors are affected by many conflicts of interest, such as self-dealing transactions, payments for order flow and investing client assets in proprietary products. Investors willing to enter the robo territory must consent to these conflicts as a ‘condition of use’.6 Additionally, robo-advisors do not monitor client investments on an on-going basis, so for the potentially unsuspecting customer the robo solution comes with “know what you’re buying” stipulations.


Next steps

The new DoL rules bring a change that creates opportunity and are not just a case of mere compliance. It’s also a ‘comply, adapt or exit’ game, and businesses first have to decide what’s best for their particular organization. Next they need to understand their customers’ behavioral profiles and create segmentation models to illustrate the best future structure for their business. A comprehensive analysis of emerging technologies is necessary at this stage, as they will be key to responding to the demands of individual customer segments. Of particular interest are:

  • Solutions incorporating Artificial Intelligence (AI) to help with suitability and fiduciary decisioning,
  • Regulatory gamification to augment training and education,
  • Calculation tools to lower the risk of manual processing procedures.

Wealth managers need to answer important questions such as such as ‘Is robo-advise a good fit for my business?’ and ‘If yes, how will it operate?’

The impending DoL regulation will alter the DNA of the retirement business. For professionals in the retirement advisory business – it’s game on, with less than a year to get ready.








About the Authors

kapin vora

As Partner for the North American Wealth Management practice at Capco, Kapin is responsible for the market offerings with a keen focus on the development of digital initiatives that will enhance the capabilities of today’s progressive Wealth Managers.

A recognized thought-leader and expert in the Wealth Management sector, Kapin has obtained over 15 years’ experience while delivering large-scale, transformation initiatives for a variety of institutions. Whether working with boutique Wealth Managers, leading Investment Banks or Asset Management firms, he has led the implementation of clearing transformations and the adoption of digital innovations. With a particular expertise in operational strategy and planning, Kapin has been instrumental in helping these organizations successfully review and address their technology and outsourcing requirements.

matthew berkowitz

Matthew Berkowitz is a Principle Consultant within Capco’s Wealth and Investment Management practice. He is a recognized thought leader in wealth management and has over 14 years of industry experience working in cooperation with senior management of major wealth management practices, banking institutions, and global diversified financial services firms. He is specialized in leading portfolio advisory teams in the development of customized wealth management strategies, analysis, and advice including capital market ideas, trust & estate strategies, risk management, and other client specific asset allocation and portfolio construction issues for high and ultra-high net worth clients. Matthew’s deep industry expertise has enabled him to provide innovative solutions in an effort to transform and help major financial institutions navigate the complexities of a dynamic financial services landscape. Matthew holds an MBA from Cornell University - S.C. Johnson Graduate School of Management and is a holder of the right to use the Chartered Alternative Investment Analyst designation.


The content and opinions posted on this blog and any corresponding comments are the personal opinions of the original authors, not those of Capco.