As the Department of Labor mulls over reams of industry comments on its proposed fiduciary rule, banks are grappling with an important question if the rule goes through: Should or shouldn't they take the Best Interest Contract exemption?
The exemption will allow banks to continue charging commissions for advice on retirement accounts provided they comply with rigorous disclosure requirements that analysts say could potentially increase costs significantly.
While it's difficult to make a decision not knowing what the final rule will look like, or even if it will pass, many banks are busy doing analysis to determine if the exemption is a viable option for them, says Grace Vogel, a managing director at PwC and a former executive vice president for member regulation at FINRA.
Indeed, bank broker-dealers may be more likely than wirehouses to take the exemption because they're more reliant on commissions. In a survey conducted last year, research firm Aite Group found that more than 50% of the revenue that the average advisor with a bank broker-dealer generated came from commissions. "If [bank] brokerage firms feel they can no longer service clients in a commission model, that's a big disruption," said Sophie Schmitt, a senior analyst with Aite Group's wealth management team.
No doubt the decision to use the exemption will hinge on costs. The exemption calls for potentially costly point of sale disclosures, requiring banks to disclose to retirement investors the total cost of each new investment over holding periods of one, five and 10 years, prior to the execution of the transaction.
"Do More, Monitor More"
The point of sale and other disclosure requirements will require banks to "do more, monitor more and keep up with things more," meaning they will likely need more people, computer software and supervision, said Bryan Kucholtz, a managing partner at Stathis Kucholtz Partners.
The bigger banks will have greater flexibility as they have the scale to absorb any additional costs, according to analysts. "Any decision they make can be offset or aided by another line of business," said Kucholtz. "They might be able to afford to make a decision that will afford them less revenue in one area but have the ability to make it up in another."
Unfortunately, smaller banks won't have that option. Their business is going to be affected substantially more than Chase, Bank of America or Wells Fargo because they can't offset increased costs, explained Kucholtz.
As a result, smaller institutions will need to decide whether to absorb the ultimate cost of the added disclosures, thereby cutting into their margins, or pass the cost along to clients. "I just don't see all those banks absorbing that cost," said Kucholtz. "At some point in time some clients are going to absorb some of that cost."
Client Fees, Advisor Compensation
Kucholtz sees most banks opting to increase client fees, despite growing competition from robo advisors. Yes, banks may lose some business to the new challengers, but he doesn’t anticipate a big wave of defectors due to fee increases. "Cost is only a factor in the absence of value," said Kucholtz. "Every individual investor is going to have to determine, 'is the increased cost that I'm going to pay worth the value that I'm going to receive from the advisor?'"
Banks may also opt to lower advisor compensation to make up for any rise in costs or even exit the business, an option that Kucholtz doesn’t anticipate many banks taking as it creates bad publicity.
"The majority will find a way to be compliant, offset the cost and take care of the client, but that's not going to be an easy balance," Kucholtz said.
Other analysts noted there are too many variables in play to speculate whether banks will change advisor compensation, but one thing at least is certain, said Vogel. The new rule will do away with "differentiated compensation," meaning advisors would be paid the same for selling the same types of products. Today brokers are paid different commissions for similar funds, creating incentives for advisors to sell funds that will provide them with greater income.
"That's going to change under the DoL fiduciary standard," Vogel said. "They will have to get paid the same for every fund that they sell."
Analysts agreed that it was too early to predict which banks or how many would take advantage of the exemption as the rule is not yet final. Banks are waiting to get more clarity from the Department of Labor to understand the full implications of the rule before making any decisions.
In the meantime, banks are gearing up for possible changes. They're checking their systems to determine whether the information needed to provide the required disclosures is available or can be made available.
But banks aren't about to show their hand. "They don't want to play their cards right now," said Kucholtz. "They will wait to the last minute because I don't think they want the competition to know what they'll be doing."