Fee-based advisors who don’t charge on cash balances may have to change that practice and start billing clients, thanks to the U.S. Department of Labor’s fiduciary rule.
Some advisors charge nothing on cash to avoid creating a loss for clients who earn little or nothing on cash balances, especially in cases where clients have set aside cash for a specific purpose.
But advisors who use discretion to subsequently move those cash balances into investments that earn the advisor a higher fee risk a prohibited transaction under the DOL’s rules, for which there is no exemption.
“That could be deemed a potential conflict of interest because the advisor is now in a position where they’re going to earn incremental compensation,” said Tom Nally, president of TD Ameritrade Institutional.
The same issue would arise where, for example, an advisor splits fees with outside managers who charge different rates, added Skip Schweiss, director of advisor advocacy at TD Ameritrade Institutional, speaking at Financial Advisor magazine’s Inside Retirement conference in May.
As a result, fee-based advisors may have to charge a level fee on all of a client’s assets that they manage on a discretionary basis--unless the DOL offers further guidance on this aspect of its rule.
While advisors can use the best-interests contract exemption or the streamlined level-fee exemption when their recommendations affect compensation, those exemptions are not available where an advisor has discretion over client assets.
In response, some firms are lowering the basis points they charge, but broadening the asset base to include cash and other assets, Nally said.
“We’ve seen firms moving toward a retainer basis, and we see some firms charge on an hourly basis,” Nally added.
Compliance consultant Cindi Hill of Hill Compliance Advisors suggests advisors segregate cash in an unmanaged account so they can use the Level Fee exemption if they later want to move that cash into fee-generating accounts.
“Technically, you’re not managing that [separated] money,” Hill said.
Observers expect that the DOL may give guidance on this unforeseen consequence of its rule, since advisors are giving clients a break by not charging on some assets.
“My understanding is that was not their intent at all” to force advisors to charge on cash, said Patti Houlihan, chief executive of Houlihan Financial Resource Group in Reston, Va., and a member of the Committee for the Fiduciary Standard, a group of advisors and others that supported the DOL rule.
“Those little glitches will be worked out,” she said.
For now, Houlihan says advisors should document what they do and why they did not bill on cash, and then confirm with the client when that cash can be invested.
Spokespersons for the DOL did not respond to requests for comment.