Financial advisors who charge more than their peers for products and services are in the greatest jeopardy under the concept of “reasonable compensation limits,” the compliance idea that the Department of Labor has brought to the forefront with its fiduciary rule.

But at the same time, the DOL didn’t create that idea. Reasonable compensation limits have been, in fact, already created by ERISA and IRS codes. And these won’t be undone by the DOL, the SEC or Finra rule-making, said Fred Reish, a partner with Drinker Biddle in Los Angeles and a leading expert on the DOL’s fiduciary rule.

“These limits are here to stay,” the veteran securities attorney said in an interview with Financial Advisor.

“Where we will see the most impact of these limits are on advisors who are outliers in terms of compensation,” Reish added.

“If you are an advisor, you will definitely have to think about what services you’re providing in order to justify what you charge. If you just want to just sell products and not offer service, you’ll have to charge less. If you’re an overpriced advisor, you’ll have to offer more services.”

For the bulk of typical advisors who are reasonably priced, their focus will be on creating a business model that underscores services.

“Not everyone will like this, but the rule will get rid of the outliers in terms of overpriced advisors. Investors will get more planning and advice,” Reish said.

The DOL fiduciary rule has been delayed until July 2019. The rule includes a delay of the requirement to get a best-interest contract exemption (or BICE) from clients, which takes into account the reasonable compensation standard, as well as a private right of action giving individual investors the right to file lawsuits or arbitration claims against their advisor for the first time.

But Reish says that because rules on reasonable compensation limits are already in effect under ERISA and the IRS code for qualified plans and IRAs (and have been for decades), the rule is essentially in effect today.

Not even a lawsuit like the one filed by the Financial Services Institute and SIFMA to vacate the DOL’s fiduciary rule can eliminate the reasonable compensation limits, Reish said. The lawsuit is currently pending in the U.S. Court of Appeals for the Fifth Circuit in Dallas.

“Even if the DOL, SEC or Finra roll back the fiduciary rule so that lots of advisor reps and insurance agents are no longer fiduciaries, the reasonable compensation limits would still apply,” Reish said. That’s because ERISA rules and IRS code are not predicated on any professional or firm being a fiduciary. If you provide service to a qualified plan or an IRA, you’re subject to the reasonable compensation rules.

Reish said that while in-house attorneys understand the ramifications of reasonable compensation limits, “if you’re talking about reps and insurance agents out in the field, there is a vague feeling that the fiduciary rule might go away without realization that [the reasonable compensation] piece is here to stay.”

The impact of the compensation limits, when it finally sinks in, will be multi-fold, Reish said. It will accelerate the industry’s transition from commissions to fees, because determining “reasonable compensation,” at least in the DOL’s mold, depends on services provided, not on products sold.

“Just because a product says you get a 5 percent commission, doesn’t mean your service warrants 5 percent or that the 5 percent will be seen as reasonable,” Reish warned.

Reasonable compensation limits must also be determined by a transparent, competitive marketplace, as the rules have been interpreted by the DOL.

“That will drive lower compensation and product prices, since everyone is using benchmarking and can see exactly what most products cost,” Reish said. The impact in the 401(k) world has been to flag overpriced plans and costly compensation, which have all gone down.

The IRA market is likely to undergo the same type of disruption, Reish predicted. While IRAs have been governed by IRS “reasonable compensation” rules for decades, the IRS code has been largely unenforced to date, the attorney said.

The products that are hardest to value will give firms and advisors the greatest compliance challenge when it comes to defining reasonable compensation. These products include variable annuities; hedge funds; private equity funds; and any hard-to-value, illiquid asset where the consumer can’t find, understand or justify an advisor’s compensation because of the dearth of transparent markets, Reish predicted.

While DOL, ERISA and IRS rules govern qualified assets and IRAs, the SEC can rein in registered reps’ unreasonable compensation practices in the nonqualified market with its own rules. The agency has said it is on track to release a proposal in the second half of 2018.

“Whatever the SEC decides, it seems to me almost certain that it will develop a hybrid best-interest standard for investment advisor reps,” Reish said.

For life insurance agents and those who sell annuities and life insurance, the National Association of Insurance Commissioners has advanced a proposal, but it remains unclear if it will focus on enhanced suitability or be tightened up to include an actual best-interest standard that requires agents and reps to offer the best product to customers, not just one that is suitable, he said.

“If we have this conversation in 2020, I think we will see an entirely different world in terms of investment protections and best standards,” Reish predicted.