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Morningstar | We Forecast a Muted Financial Impact From Regulation Best Interest on Wealth Managers

We don't anticipate making material changes to our fair value estimates for wealth management firms after the U.S. Securities and Exchange Commission voted to adopt Regulation Best Interest, Form CRS relationship summary, and interpretations regarding duties of investment advisors and the limited, "solely incidental" advice that brokers may provide. This set of regulations from the SEC has been in the works for over a year, and while there were some modifications from the initial proposal, the stock prices of wealth management firms were largely unchanged after the regulatory release, signaling that the market either doesn't believe the regulation will have a material effect on the profits of the firms or that the anticipated effects had already been baked into the stock prices. Our initial impression of Regulation Best Interest is that it shares quite a bit of similarity to existing Financial Industry Regulatory Authority rules, but certain provisions clarify higher standards that should spur changes in the industry, such as those regarding retirement account rollovers, elimination of product sales contests, and consideration of product fees when making an investment recommendation.

The overarching move toward best-interest, or fiduciary, standards and how they may change the financial-services industry is far from over. The U.S. Department of Labor, which has jurisdiction over retirement accounts, is creating another fiduciary rule. Multiple states in the U.S. have gone forward with their own fiduciary regulations, and it will be interesting to see what the interplay between state and federal regulation will be. We are also eagerly looking forward to commentary from the management teams of financial-services firms, especially since they've hardly discussed the SEC’s best-interest regulation compared with the former DOL fiduciary rule that was often a focus of discussions.

There have been several changes and elements in the final regulation that we found interesting. Regulation Best Interest applies not only to investment recommendations, but also to account recommendations, such as an IRA rollover and choosing between a brokerage or an advisory account. Retirement account rollovers can be one of the most important financial decisions an investor makes, so enforcing a best-interest standard at this critical juncture is necessary. The move to advisory or fee-based accounts has been an industry trend, and some wealth management firms have increased their percentage of fee-based assets around 20 percentage points over the past decade, so safeguarding the choice of brokerage or fee-based advisory and ensuring consumers make a well-informed choice can improve investor outcomes. Looking at the implicit recommendation to "hold" an investment and that a broker/dealer considers the cost of product recommendations also expands what advisors need to pay attention to.

We don't currently anticipate incremental costs related to this regulation that will materially affect our fair value estimates. Much of the industry had ramped up spending to prepare for the previous Department of Labor fiduciary rule, and much of that spending and change in procedures can probably be used for Regulation Best Interest. In our February 2017 Financial Services Observer "Weighing the Strategic Tradeoffs of the U.S. Department of Labor's Fiduciary Rule," we estimated start-up implementation costs of $36 million to $206 million and annual, operational compliance costs of $9 million to $52 million for some of the publicly traded wealth management firms we cover. We had also estimated short-term class action lawsuit settlements as high as $131 million. Given that Regulation Best Interest looks similar to current Finra rules and that the regulation doesn't add new exposure to class action lawsuits that the DOL fiduciary rule did, we don't foresee restitution or fines significantly increasing. For context, we had calculated annual restitution and disgorgement of profit payments, not including fines, among five wealth management firms ranging from 0.01 to 0.19 basis points of client assets during the period we studied.