Exclusive Interview with Knut Rostad: DOL’s Fiduciary Rule Grandfather Clause Does Not Protect Investors
Regular readers of FiduciaryNews.com have long admired the plain-spoken wisdom of Knut A. Rostad, the co-founder and president of the Institute for the Fiduciary Standard, a nonprofit formed in 2011 to advance the fiduciary standard. Rostad has advocated for fiduciary duties at the SEC and Department of Labor (DOL). Former SEC Chairman Arthur Levitt, Jr. recently stated, “I have supported the fiduciary standard, but I have not been as nearly as effective and as forceful as Knut has been in his efforts.”
Knut is also active in the industry. He is a frequent speaker on fiduciary duties at industry conferences, a columnist at Think Advisor and an oft-cited source in industry and financial news media. While compliance officer for Rembert Pendleton Jackson (2004-2015), he also served on the FPA Task Force on the 2007 CFP Board’s Codes of Conduct, actively engaged as a member of the Investment Advisor Association, and held the Accredited Investment Fiduciary (AIF®) designation with the Center for Fiduciary Studies, Pittsburgh.
Rostad is the editor of The Man in the Arena: Vanguard Founder John C. Bogle and His Lifelong Battle to Serve Investors First, by Wiley in 2013. In 2014, Rostad was one of the “IA 25,” Investment Advisers Magazine’s “list of 25 most influential people in and around the advisor industry.” In 2015, Rostad went to the semi-final round of WealthManagement’s “March Madness” tournament of finance leaders, where he was defeated (55% to 45%) by Federal Reserve Board Chair, Janet Yellen.
Here’s something you might not know about Knut. He worked in public affairs with diverse partners, including the Lillehammer Olympic Organizing Committee, Norwegian Ministry of Foreign Affairs and National Assoc. of Manufacturers. He also collaborated with Edwin Meese III, the 75th U.S. attorney general, on criminal justice reform. Rostad earned a BA in Political Science at the University of Vermont and an MBA from the Norwegian School of Management in Oslo.
FN: Knut, what’s new and happening on your end of things since we last interviewed you in September of 2014?
Rostad: The energy around the Institute for the Fiduciary Standard has grown. We have released our Best Practices for Financial Advisors and formed the Chairman’s Council, a group of larger RIAs who have come together to advise on and help advocate for Best Practices. Further, next month we will launch our ‘Campaign for Investors’ from the National Constitution Center in Philadelphia. .
FN: Before we get to your concerns, what the one thing you like most about the DOL’s new Conflict of Interest (a.k.a. “Fiduciary”) Rule?
Rostad: The investor educational impact of the DOL rule has been huge. The discussion around fiduciary duties and conflicts of interest, spearheaded by the President, has moved to center stage. Investor awareness of investing conflicts and costs has increased by a lot.
FN: You’re on the record as saying you agree with the Wall Street lobbyists about what the DOL did with the Rule regarding disclosure, the only difference being they like it and you don’t. Why do they like it and why don’t you like it?
Rostad: The comment was not directed to just disclosure. It was directed to a softening of the rule, generally. This softening is not good because the “problem” was not that the rule was too stringent. The problem was that many firms appeared to be unwilling to change and to adapt to a fiduciary culture.
There is an important distinction to make here between simplifying the rule (which is good) and softening the rule (which is not good). In a number of instances the requirements of the proposed rule were too complex and burdensome and needed to be simplified. One such requirement was providing performance projections for five or ten years. This requirement was burdensome and (in my view) of questionable value. It should have been and was removed.
Other revisions of the rule aimed to soften it. An interesting example concerns when the BICE agreement must be signed. The proposed rule said the BICE agreement must be signed very early on, before much or any advice or product recommendations are made. This requirement was highly criticized by the industry, generally, because it was asserted to be unreasonable to ask clients to sign an agreement before the broker or advisor rendered advice. The final rule seems to allow the BICE to be signed in conjunction with the first recommendation or transaction. Which requirement – the proposed or final version – best serves investors? Is this change simplifying or softening the rule?
That said, a couple of points about disclosure are particularly relevant. One, the DOL is correct in affirming that there is far too much reliance on disclosure, because as many academics affirm, disclosure is often ineffective and some disclosure is actually harmful. Two, the importance of disclosure of fees and expenses – in a reasonable and accessible manner – is an exception to this norm that disclosure is often ineffective. This is an exception because investors do care about and do focus on the bottom line. They want to know what they pay for investment expenses, just as they want to know what they pay for a new kitchen appliance or new home design and renovation. This very basic and common sense reality has been lost on the DOL rule discussion.
The proposed fiduciary rule included a requirement that “total costs” be disclosed in a form that would be very useful to investors. The final rule is stripped of this requirement and replaced with a general fee disclosure found on the website. This is a significant change that I don’t think has gotten enough attention. It’s significant because making disclosure in a reasonable and accessible manner in finance – just as it is in most other sales transactions or advice relationships we experience – would do a world of good. It would bring market forces to bear in financial advice in a totally new way.
FN: Many say the Rule goes beyond mere disclosure because it requires the broker to act in the “best interests” of the client. Why do you see this as a distinction without a difference?
Rostad: There is no doubt the best interest standard, when applied appropriately, is important. I hear from fiduciary colleagues that an enforceable best interest standard is the anchor of the Rule and that the best interest standard is well established. These assessments are accurate as far as they go. The question, though, is how courts will define “best interest” as there is no single definition widely accepted by the industry and advisors today. The true definition based in common law has been rejected by the industry. The upshot is many fiduciary advocates are seriously concerned as to whether a true fiduciary standard will evolve in the courts.
FN: OK, let’s get to the nitty gritty of your apprehensions. First, the Rule groups together all forms of conflicts-of-interest with those most egregious ones that academic research shows can harm investor returns (e.g., self-dealing fees like commissions, 12b-1 fees, and revenue sharing). For an investing public that can’t comprehend the subtle difference between the fiduciary standard and the suitability standard, why is the DOL’s all-encompassing definition of “conflict-of-interest” going to cause greater confusion among investors?
Rostad: The potential for even greater confusion involves the sheer magnitude of claims of fiduciary fidelity that are sure to come from industry representatives who are advisors or brokers who also possess conflicts-of-interest that are both material and recurring and whose disclosure and mitigation of these conflicts is uncertain. Will a firm ensure an advisor will follow a careful step-by-step process for each and every separate conflicted transaction? Will the process be documented? Will it entail disclosure, mitigation, and client informed consent in writing? And will the transaction then be affirmed by the advisor as consistent with a true best interest standard? And then, will the same level of care be afforded to the same client’s non retirement clients? If not, how does that conversation between the broker and customer explaining the lower standard go?
FN: What is the practical difference between the self-dealing conflicts-of-interest and the “conflict-of-interest” alleged to exist when merely asking investors to hire you?
Rostad: Great question. The practical difference is night and day. We talk a lot about the “prudent man” rule. It’s a fiduciary bedrock. Yet, we hardly ever even mention a corollary rule – the common sense investor rule. That is, what would a ‘common-sense investor’ do or think? The point is that such an investor likely sees a world of difference between a professional pitching his own services at a price clearly stated as opposed to a sales rep then pitching a myriad of products with embedded fees and commissions that are not transparent.
FN: What are the drawbacks to honest service providers for them to “admit guilt” by when none necessarily exists? Why should it be considered to be a conflict-of-interest just because you get paid a reasonable fee? And what about instances where it is a conflict-of-interest NOT to recommend to an investor to hire you (because it is not in the investor’s best interests to remain at his current provider)?
Rostad: The drawbacks to advisors who are far, far less conflicted than are broker are huge. There is basic illogic in following the “logic” of the industry position that all RIAs and brokers are presumed to be equally “guilty” of conflicts. There is no distinction whatsoever between a fee-only advisor whose only material conflict (he has other conflicts) is negotiating his own fee and an advisor or broker heavily dependent on third party commissions, fees, and payments, This just doesn’t pass any test, much less the basic smell test.
FN: In order to preserve existing business models, the DOL has gone out of its way to both grandfather in current self-dealing fee arrangements, but also allow future self-dealing fee arrangements via disclosure. How does this violate the DOL’s stated objective of protecting retirement savers? Why would the DOL place the interests of preserving existing business models ahead of the interests of protecting retirement savers?
Rostad: I can well see that a tiered implementation timeline makes sense. I do not know how one justifies a broad-based and absolute grandfather clause to sustain the status quo which has been affirmed to be NOT protecting retirement savers.
FN: Where do you see us going from here? What will the future of the Fiduciary Rule be?
Rostad: The DOL Conflict-of-Interest Rule era is in its infancy, now just two weeks old. This will be an extraordinary era for retirement investors and fiduciary advisers. How the courts interpret “best interest” and “reasonable compensation will be important, no doubt. But an evolving court interpretation will not “happen” right away. Or next year or the year after. The near term future of fiduciary advice depends far more on market forces than it does on legal forces. Advisers today have a tremendous and unprecedented opportunity to literally steer the immediate future of fiduciary advice; To determine what fiduciary advice comes to mean over the next five or ten years. This is a huge opportunity and responsibility and should not be underestimated.
FN: Knut, as usual, you have hammered home the salient issues with the blunt force of Thor’s Hammer. It’s no wonder why our subscribers enjoyed reading what you have to say. Keep up the good fight. Perhaps, one day, we will all find the elusive fiduciary Valhalla.