THE DOL WEIGHS IN DON’T WAIT FOR THE RULES— CHART A COURSE TO THE NEW NORM

IN ASSOCIATION WITH:

FURTHER, REGULATORY EXPECTATIONS INCREASINGLY CALL FOR robust oversight programs and processes that identify, manage, mitigate or eliminate potential con�icts of interest.

New regulations, such as the U.S. Department of Labor’s re-proposed rules expanding the activities subject to a �duciary standard when providing investment advice to ERISA plans and IRAs, are likely to accelerate the rate of change to operat-ing and �nancial models, product design, technology platforms, supervisory systems and customer experience. Waiting for the �nal rules to come out may cause more pain the long run; leaders are acting now, not merely by commenting on the proposed rules, but also by assessing the impacts of anticipated changes, seeking to gain a com-petitive advantage as the industry moves to a new norm.

or broker-dealers, wealth managers, insurers and

other key segments of financial services, significant

changes to the way they conduct business are on

the horizon, as regulators focus increasing attention on

perceived or inherent conflicts of interest.

New rules underway expand the:

• Activities and account types covered by a fiduciary standards

• Documentation requirements for reporting and disclosures

ABOUT THIS RESEARCH

This report is based on in-depth discus-sions with the following professionals from within the EY Financial Services Organization:

•DanielBender, Executive Director

•KellyHynes, Executive Director

•RanjitJaswal, Principal

•MichaelPatterson, Principal

•NancyReich, Executive Director

•JustinSinger, Senior Manager

•ThomasWard, Partner

•BenYahr, Senior Manager

•MichelleZagorski, Senior Manager

2 | EXECUTIVE BRIEFING: THE DOL WEIGHS IN

on�icts of interest are a key focus of many regulators, including the U.S. Department of Labor (DOL), the U.S. Securities and Exchange Commission (SEC) and the

Financial Industry Regulatory Authority (FINRA), a self-regulatory organization responsible for broker-dealers.

The DOL’s focus on con�icts has played out most recently in its proposed �duciary rulemaking, which was �rst announced in 2010. Similarly, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), signed into law in 2010, directed the SEC to study the appropriateness of adopting a �duciary standard for broker-dealers when deal-ing with retail investors. Prior to Dodd-Frank, there were a number of studies suggesting that the major-ity of customers of �rms dually registered as both broker-dealers and investment advisors had little to no understanding of the nuance of such relationships. That is, says EY’s Nancy Reich, customers were largely

unaware when their �nancial advisor was acting as a broker (subject to a “suitability” standard) versus as an advisor (subject to a �duciary standard). Furthermore, neither did most customers understand the di�erences between each standard. Ultimately, says Reich, “rec-ommendations arose suggesting a common standard be applied to both brokers and advisors when dealing with retail investors.”

The SEC’s Dodd-Frank study recommended that the commission should “exercise its rulemaking authority to implement a uniform �duciary standard of conduct for broker-dealers and investment advisors when providing personalized investment advice about securities to retail customers.” Though recommended by the study to do so, the SEC has not yet engaged in formal rulemaking.

But with the DOL’s proposed �duciary rulemak-ing and much commentary from the industry on the di�culties of addressing a rule that applies to only a portion of the industry, matters may accelerate. For example, the SEC has announced a 2016 focus on retail retirement investing, and FINRA, though lacking the power to require a �duciary standard for brokers, none-theless wields signi�cant in�uence over how brokers engage with customers. As Reich explains, FINRAis “driving a lot of the discussion around identify-ing, minimizing and managing con�icts of interest or otherwise ensuring su�cient transparency surround-ing recommendations to retail customers.” Moreover, FINRA has “issued guidance regarding its expecta-tions on con�icts of interest and announced that it is an exam priority for 2016.”

Indeed, FINRA and the DOL may serve as cat-alysts nudging the SEC into more rapid action. As Reich stated, “Mary Jo White [the current SECChairwoman] has stated that the SEC continues to consider this topic.”

SOME BACKGROUND

“Recommendations arose suggesting a

common standard be applied to both

brokers and advisors when dealing with

retail investors.”

— Nancy Reich Executive Director, EY

COPYRIGHT © 2016 FORBES INSIGHTS | 3

t present it is anticipated that the new DOLrule will arrive in the second quarter of 2016. Firms have been tempted to wait for de�ni-tive guidance on the rule’s substance before

de�ning their organizational needs; however, EY’s Dan Bender believes �rms need to consider the impli-cations of a “wait and see” approach. Waiting to adapt to expanded �duciary standards may create mid- to longer-term strategic challenges. Change will likely be signi�cant and rapid, says Bender. As a result, “if you’re not factoring these ideas [of a uniform �duciary standard] into your planning right now, you’ll be mak-ing decisions that may require signi�cant readjustment later on.”

Bender maintains that the broader trends driving change in wealth management, such as the migration from commission based accounts to advisory accounts and digitization of wealth management—with or with-out speci�c rule changes—are disruptive. The resulting implications for the structure of the industry and the ways �rms interact with customers and prospects are profound. For example, product and service costs in general “may rise—in many cases signi�cantly,” says Bender. Overall, he explains, “�rms may need a wide range of adjustments across key elements including tar-get customers, channels, investment o�erings, advice and guidance o�erings, and overall fee structures—a majority of their operating model.”

EMBRACING THE NEW NORM

“If you’re not factoring these ideas [of a

uniform �duciary standard] into your

planning right now, you’ll be making

decisions that may require signi�cant

readjustment later on.”

— Dan Bender Executive Director, EY

4 | EXECUTIVE BRIEFING: THE DOL WEIGHS IN

ADAPTING TO THE NEW NORM

The DOL’s rule is imminent—and �rms will have to comply. The rule itself is the lead-ing edge of a broader trend toward greater transparency in advisory relationships and

investment product distribution. Analysis and decision-making may not be straight-

forward, as nearly all components of strategy, operations

and infrastructure are likely to feel an impact. Any resulting strategy—or compliance-driven moves in one area of the business—may also cause a ripple e�ect, cre-ating the need for recalibration across nearly all other strategies and business processes. The work is complex, however, there are some key steps that should be taken into consideration, including:

REVISIT CORE BUSINESS STR ATEGY

AS EXECUTIVES DEVELOP GREATER INSIGHTinto the complex interplay of all of the above issues, the need for fundamental transformation becomes increas-ingly evident. Such thinking and decisions need to be considered sooner rather than later, because to delay may cause a reactive approach which, in itself may not put a �rm in the best position to succeed.

For example, one of the greatest potential pitfalls that could trip up �rms today would be basing corpo-rate development decisions, such as M&A, alliances and partnerships, on prior �duciary and con�ict of inter-est rules.

As Bender points out, �rms should explore strategic opportunities among key macro trends such as move-ments toward level fee, discretionary advisory programs, enhancing customer segmentation/householding strate-gies to better de�ne total relationship value and attract/retain assets, and enhancing digitally enabled service models and advisor desktop utilities. This, says Bender, “is an opportunity to see more clearly than the competi-tion and to bene�t from disruption.”

However, �rms may elect, for example, to divest or outsource speci�c business activities. Alternatively, other �rms may acquire certain capabilities or simply keep in place their transaction/commission-based plat-form to attract high-producing brokers who prefer that model and compensation structure. Nevertheless, the bottom line, says Bender, is that no signi�cant strategic planning or corporate development should be taking place today “that doesn’t take into account the inevita-bility of some form of �duciary standard impacting all customer relationships and engagement.”

One of the greatest potential pitfalls that

could trip up �rms today would be basing

corporate development decisions, such as

M&A, alliances and partnerships, on prior

�duciary and con�ict-of-interest rules.

COPYRIGHT © 2016 FORBES INSIGHTS | 5

REASSESS CHANNEL S

BENDER FURTHER EXPLAINS THAT COMINGchanges in the rules, and industry practices surround-ing �duciary status as well as expanded focus on con�icts of interest, may have a signi�cant impact on where and how �rms engage customers. Channels and related “go-to-market” approaches, says Bender, “may require re-evaluation.”

Firms should begin by conducting comprehensive reviews of their business structures and operations, “mapping the touch points with customers.” This includes everything from “pre-point of sale to point of sale/transaction, ongoing services, surveillance and reporting,” says Bender. Firms should consider not only those interactions directly addressed by new regulations, but also those likely subject to increased regulatory and/or investor scrutiny. Start with inter-nal processes and interdependencies, says Bender, but

also look closely at interactions/synergies with external manufacturers, distributors or other parties.

Even without new �duciary regulations, lead-ing �rms are already staging a strategic re-evaluation of where and how they go to market. Many are, for example, re-evaluating each channel, seeking to link servicing costs with customer value in the pursuit of greater optimization.

Alternatively, by proactively seeking to minimize or eliminate any relationships or processes that could be construed as a con�ict of interest, �rms may be able to signi�cantly improve reputation and customer satisfaction and reduce their regulatory risk and expo-sure to litigation and/or �nancial censure. For this and many related reasons, getting ahead of the rule makes good business sense.

RE-EX AMINE THE ADVICE MODEL

MOST FIRMS HAVE A CONFIDENT VIEW OFwhat constitutes good advice, says EY’s Ranjit Jaswal. But under the coming new rules, �rms may need to “re-evaluate their de�nition of ‘good advice,’ taking steps to make sure their processes are not only e�ective but also well-documented.” This begins with pre-senting products that are not merely generally sound investments but also are the appropriate products for any speci�c customer. But �rms may also need to “thoroughly document the qualitative and quantitative [and associated] justi�cation[s] behind their determina-tions,” says Jaswal.

A key problem the industry may face is the juxta-position in perceptions and practice. As Jaswal explains, many producers of investment products use indepen-dent advisors for distribution. Each individual advisor

may, in turn, have his or her own views and methods for establishing and tracking customer risk pro�les. Therefore, “�rms need to assess the consistency of advice between advisors.”

Undoubtedly, �rms will need to do more to understand and justify how, where and why advice is presented. Moreover, they may need to provide more in terms of contemporaneous documentation, surveillance and related processes to receive sound and unbiased advice (see “Documentation” and “Technology” below).

Finally, the new rules have the potential to accel-erate the trend toward fee-based advisory models, which, Bender explains, may increase the transparency to the customer when obtaining advice or an invest-ment product.

6 | EXECUTIVE BRIEFING: THE DOL WEIGHS IN

ADJUST PRODUCT AND SERVICE OFFERINGSOIL

DEMAND FOR VARIOUS FINANCIAL PRODUCTSand services tends to vary with changes in �nan-cial environment, investor demographics and overall customer needs. Today, for example, there exists a pro-liferation of new products and alternative asset classes alongside an observable shift from active to passive or indexed investment products, and from transaction-based products toward fee-based discretionary advisory programs. In any marketplace, �rms must discern:

(1) Which products are necessary to help their cus-tomers achieve their �nancial goals?

(2) Which of these products are pro�table to the �rm, in which channels and with which customers?

This requires keen insight into both fees and costs associated with product/service provision, not only product by product, but also channel by channel and even customer by customer.

But as �duciary requirements expand, cost struc-tures may change—in many cases signi�cantly.

Certain instruments and transactions may require more attention than others. For example, IRA roll-overs are a key focus area of the DOL proposal and both SEC and FINRA examinations. Given the cur-rent constructs of how investment products are sold, this could create a potential con�ict of interest.

The pending regulation may have a signi�cant impact on annuity products. With added �duciary responsibilities, insurance �rms may �nd the cost of providing annuities to relatively lower-income inves-tors prohibitive. As EY’s Ben Yahr explains, “These are relatively complex instruments—and if the �duciary requirement is expanded, it may mean, in many cases, collecting more information about [each] investor and a lot of [handholding].”

This adds considerable cost as well as regulatory and legal risk to the process—which may make working with lower net worth (and therefore lesser-sized invest-ments) less pro�table. Thus, many �rms may decide the cost of compliance is too high for certain customer seg-ments. So adding more regulatory requirements around informing the customer, documenting transactions and the like “may mean that those who could bene�t most from an annuity may have less access than before.”

In general, says Yahr, under higher �duciary or con�ict-of-interest standards, the more complex the product, the more expensive its provision. So in tandem with business models and distribution networks, �rms may need to gather data and make choices about which products to keep, which to add and which to exit/avoid, all in light of the higher risks and costs driven by likely new standards. More than likely, many �rms may decide to simplify or consolidate many of their product and ser-vice models in order to reduce the compliance burden and simplify the customer experience.

With added �duciary responsibilities,

insurance �rms may �nd the cost of

providing annuities to relatively

lower-income investors prohibitive.

COPYRIGHT © 2016 FORBES INSIGHTS | 7

REVISIT THE REVENUE MODEL

AS THE NATURE OF INTERACTION EVOLVES—as business models, channels and products are recon-�gured—�rms may need to reconsider the form and amount of their fees.

Broader industry trends are already leading more �rms “to unbundle �nancial advisory from asset man-agement,” says EY’s Justin Singer. But upcoming new rules, like those from the DOL, are forcing wealth managers to make a distinct choice around how they charge fees for providing education, guidance, dis-cretionary and non-discretionary advice, and other ancillary services, such as �nancial planning.

Regarding IRA rollovers, the DOL is concerned that advisors are too heavily in�uenced by commis-sions paid by various providers of investment products. So the DOL’s proposal seeks to prevent advisors or their �rms from receiving di�erential compensation based on product sales unless they avail themselves of a particular exemption that, as Singer explains, “drives transparency and consistency” across the industry.

Speci�cally, if an advisor or their �rm wishes to continue receiving commissions and di�erential com-pensation from product sponsors, it may do so, but only after signing a “best interest contract exemption”, or BICE, with each a�ected customer. A BICE, explains Singer, stipulates that the advisor is indeed “acting in the best interest of the customer.” Accordingly, says Singer, “the advisor must be able to prove—to document and defend—why recommendations made under a BICErelationship are in the customer’s best interests.”

Note that all of this is taking place during a period in which �nancial services �rms are facing signi�cant fee pressure. As a result, leading �rms are taking a hard look at the fees received for various products and ser-vices versus the resulting expense—leading to clearer choices about customers, channels and products. Again, better long-term decisions can be made by acknowl-edging that the shift toward �duciary standards is inevitable and by planning accordingly, rather than waiting for speci�c regulations. It is also important to note that these decisions are di�cult to make right away given that product manufacturers may potentially change their fee structures considerably.

Firms may need to reconsider the form

and amount of their fees.

8 | EXECUTIVE BRIEFING: THE DOL WEIGHS IN

THE NEW RULES AND BROAD INDUSTRYtrends are driving �rms to rethink the nuts and bolts of their operations. Key elements requiring attention include:

• Documentation/disclosure/transparency.From a regulatory perspective, �rms should begin thinking in terms of doing more to obtain the right sorts of data necessary to provide objective and e�ec-tive advice to their customers. Firms may need to do more in terms of providing greater transparency regarding the nature of their relationship with cus-tomers. This means greater disclosure regarding commissions, fees and any potential con�icts of interest (e.g., the above BICE issue). Leaders may also likely—simultaneously—take steps to simplify their customer communications, particularly for retail customers.

Given overall industry trends and retail customer attitudes and concerns, �rms may wish to evaluate the impact of mere compliance with new regulations versus a more complete response to the spirit of such reforms. The latter may deliver signi�cant marketplace advantage.

• Customer service.Firms may also need to rethink their fundamen-tal customer strategies, beginning from a standpoint that greater transparency is essential because of rule requirements or competition. The best approach is to create products/services/processes that minimize or eliminate any semblance of con�ict of interest in the �rst place. But barring this, says Yahr, “�rms may need to do more to disclose all relevant information regard-ing any potential con�icts that might remain.”

• Compensation model.Financial advisor compensation plans are critical to attracting high-quality professionals and driving strate-gic �rm growth. From a risk management perspective, under the new rules, says Yahr, “�rms may simplify compensation plans and focus on creating appropri-ate behavioral incentives to align advisor compensation with a customer’s best interest. For example, some �rms may decide to tie variable compensation to speci�c activities instead of basing it on sales.” This may prove challenging, as most �rms tend to design compensation plans to favor the advisor, to drive advisor behavior to grow �rm revenue and to drive front-o�ce e�ciency. With the new rule in place, �rms must realign the tar-gets while still incentivizing top producers to grow their book of business. Further, to operationalize these changes, �rms may need to enhance or replace existing compensation platforms.

Firms may also need to review and update any and all marketing processes, including call center scripts, as well as printed collateral or related informational mate-rials such as that appearing in prospectuses, websites or advertising. Pay particular attention to the sorts of training and disclosure information shared with inter-mediaries. Updating these materials and procedures may prove relatively more challenging, depending on speci�c segments.

RECALIBR ATE THE OPER ATING MODEL

The best approach is to create products/

services/processes that minimize or

eliminate any semblance of con�ict

of interest in the �rst place.

COPYRIGHT © 2016 FORBES INSIGHTS | 9

• Compliance/surveillance.It is not enough to announce new procedures. As Yahr explains, �rms may also need the means to monitor behavior over time to make sure they comply. “Each time there is an interaction, a discussion, a transaction, that information needs to be observable and auditable.” Moreover, “systems should be able to detect non-compliance, generating an exception notice within a suitable time frame for the �rm to respond.”

• Customer/channel education.With advice unbundled from transactions, �rms may need to evaluate both the fee and the form for edu-cation. Thus decoupled, executives may have greater visibility into the margins generated within each phase of each relationship. Note also that much of the educa-tion process takes place through intermediary channels. Broker-dealers, for example, may likely need to take greater steps to make certain that �nancial advisors are thoroughly briefed on each product or service and how it can impact end-customers. All this will likely lead to rethinking the approach to educating various cus-tomer segments. Many �rms may �nd new ways to standardize education processes, including the adop-tion of technology-based tools. The shifting and more visible cost of education may drive changes in prod-ucts, channels, documentation, information systems, fee structures and other key business elements.

• Technology.All of the above presents profound implications for IT. Consider customer onboarding. According to Thomas Ward of EY, �rms today often use a minimalist approach, gathering only the bare minimum necessary to execute a transaction. Going forward, says Ward, �rms may need to build systems able to “gather and manage much more data up front.” That means “a lot more technology [aimed at] improving point-of-sale and supervisory sys-tems to reduce regulatory risk,” says Ward.

Such systems are needed to aid in the supervision of �duciary compliance, and be able to generate cus-tomer-speci�c alerts such as signi�cant changes in market conditions, prices or other key drivers of a cus-tomer’s risk tolerance. In essence, says Ward, �rms may need technology that not only “captures interactions contemporaneously,” but that “also issues alerts com-mensurate with �duciary standards.”

A particularly noteworthy aspect of such change is the way in which this will likely drive more �rms to invest in technology-enabled advice. Capabilities could include IT-enabled “direct to customer” and “self-service” capabilities (i.e., “robo-advisor” and sim-ilar digitally enabled utilities) as well as technology improvements to enable advisors to more e�ciently work with clients, thereby lowering minimum thresh-olds. As Bender explains, unless �rms are able to harness technology, “the cost of servicing complex products and customer relationships” may, in many cases, become prohibitive. Certainly, �rms may devote signi�cant resources to addressing the needs of their most valuable customers. However, for lower-balance accounts, says Bender, “robo-advisory and customer-directed, self-service capabilities, where more elements of the relationship are automated, will likely become more prominent in the industry.”

• Cost structure.As reviews progress, �rms may begin to recognize how any likely new environment will result in signi�cant changes to their cost structures. For those customer interactions and processes likely requiring more ele-ments of a �duciary status, costs will tend to rise—in many cases, signi�cantly. Not only may representatives in such positions require greater training themselves, but �rms overall may need to provide signi�cantly more in the way of process and IT support to capture, document and track—and produce to regulators as evi-dence of compliance—more information about each customer and each transaction (see sections on “Talent” and “Technology”).

10 | EXECUTIVE BRIEFING: THE DOL WEIGHS IN

NEARLY ALL WEALTH AND ASSET MANAGERS,broker-dealers, asset managers and related industry executives agree: there is already a war for the top tal-ent. But stricter �duciary rules and related changes, as Yahr explains, means “more �rms may need even more sta� on hand with the appropriate training and certi�cations.”

Accordingly, �rms should begin reviewing their operating models—products, technology and related issues—in light of their likely talent challenges. Any talent gaps resulting from the coming changes may require attention to everything from training and cer-ti�cation to recruitment and retention.

Closely related, as sta� from di�erent parts of the �rm perform more �duciary-level duties, �rms may need to revisit compensation structures and, in partic-ular, vouch for the absence of any pay-driven con�icts of interest.

Finally, �rms may also need to update their train-ing programs in alignment with new regulations and industry trends. Leading �rms will likely emphasize a culture of doing what’s best for the customer.

UPDATE THE TALENT MATRIX (STAFFING AND COMPENSATION)

Any talent gaps resulting from the

coming changes may require attention to

everything from training and certi�cation

to recruitment and retention.

COPYRIGHT © 2016 FORBES INSIGHTS | 11

onsequently, EY recommends that �rms should begin taking a comprehensive look at all of their strategies and operations and begin making adjustments that align to the

spirit—consistent with the industry trend—of greater �duciary obligations and con�ict mitigation.

As speci�c rules appear, �duciary standards may attach to more aspects of each business. Companies may face greater regulatory and customer scrutiny relating to con�icts of interest. Together, this may drive sig-ni�cant change across business models and processes. Sales and servicing costs, no doubt, may rise for many products and services. Data collection and documenta-tion burdens may increase, placing pressure on IT and reporting systems.

All �rms may need to take a comprehensive look at the whole of their product lines and sales and ser-vice channels to recalibrate based on new risk and cost structures. For many, the coming changes may have impacts such as accelerating the trend to fee-based advisory services or restructuring fees, commissions or other key business elements.

In conclusion, according to Jaswal, “the coming changes may be a major source of disruption in the industry.” As such, this is an opportunity to ride the coming wave of disruption to build competitive advan-tage. Firms should take steps to look further a�eld, looking for opportunities to expand/grow/protect their business, with the goal of “optimizing the mix of chan-nels/products/fees/costs and revenues.” In conjunction, consider aspects such as information technology, talent management and corporate development too.

Those �rms moving proactively and decisively will be in a stronger competitive position than those �rms that take a wait-and-see approach. An early start will allow �rms to be �exible and ready for change, rather than making rushed decisions that will need to be revisited later.

CONCLUSION: THRIVE IN THE NEW NORM

Regulatory change is coming and there is no question of its direction.

Those �rms moving proactively and

decisively will be in a stronger competitive

position than those �rms that take a

wait-and-see approach.

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