It sounds like a simple, even obvious, idea: Financial advisors must put their clients’ interests ahead of their own. But that hasn’t been the standard in large swaths of the investment industry, leaving consumers vulnerable to questionable practices that generate high fees for advisors while hurting their clients.

That’s all about to change for retirement accounts, a crucial savings vehicle for many Americans. In early April, the Labor Department published its final rule requiring people who advise on 401(k) plans and IRAs to put clients’ interests first.

It’s known as the fiduciary standard, and it’s such a big change that squadrons of lawyer, lobbyists and advisors are poring over the lengthy new rule trying to figure out what it means for financial services firms.

I think it’s going to be very impactful, even transformative,” says Nir Kaissar, a Bloomberg columnist and founder of Unison Advisors, an asset management firm.

He and other industry experts believe the new standard is likely to pressure the earnings of companies that sell commission-based investment products and eventually force them to overhaul their business models. Consumer advocates largely praised the final rule, saying it improves investors’ chances of building a nest egg, though others said it should have been tougher. Some investment industry executives, however, argue that the new standard will cause advisors to jettison small clients because they are not worth the additional work and cost created by the regulation.

Long Time Coming

The rule has been decades in the making. Barbara Roper, director of investor protection for the Consumer Federation of America, notes that she wrote her first formal comment letter to the Securities and Exchange Commission on the subject in 2000.

“I think [the new standards are] going to be very impactful, even transformative” –Nir Kaissar

Under the old rules, some advisors, primarily registered investment advisors, already operated under the fiduciary standards. But many others, including traditional brokers, operated under a different standard, known as suitability. Suitability requires only that a broker recommend products that are suitable given a client’s financial needs and personal circumstances. Under suitability, brokers are not required to put clients’ interests ahead of their own.

Joseph M. Belth, professor emeritus of insurance at Indiana University, illustrates the difference between the suitability standard of care and the fiduciary standard of care this way: A company sells two annuities. They are identical, except that one pays a larger commission to the agent and leaves the investor with a smaller amount of money if funds are withdrawn early.

“This situation clearly creates a conflict of interest for the agent. Either of the annuities could meet the suitability standard, provided the company is financially strong and meets other requirements,” Belth said. “But the annuity with the larger commission would not meet the fiduciary standard.”

The High Cost of Bad Advice

Additional fees hit consumers hard. The President’s Council of Economic Advisors put the cost of such overcharges on retirement accounts at $17 billion a year. It’s a big number, but investment analysts at Barclays believe it will put only minor pressure on the earnings of companies such as MetLife, Ameriprise Financial, Lincoln National Corp., and Prudential that rely on commissions to sell products.

“It appears that commission-based compensation for annuity providers will likely be permitted, but they could also adjust if needed to a fee-based compensation model,”  Barclays writes in a research note.

Barclays headline states, “DoL Fiduciary Standard Rules Not as Bad as Feared,” because many financial services firms expected tougher rules, including bans on some types of products such as indexed annuities, which feature rates of return pegged to a stock index such as the S&P 500 but also promise a guaranteed income. But they come with fees that can exceed 10%, and investors often get much smaller returns than they anticipate.

How Tough Is the New Rule?

Kent Smetters, a professor of business economics and public policy at Wharton, says the final rule conceded too much to the industry.

He believes commissions exist because they are not transparent, allowing advisors to hide the cost of an investment from clients. For that reason, advisors who call themselves fiduciaries typically can’t charge commissions. Some regulators have become so convinced that commissions create conflicts that are impossible to overcome that they banned them. One example: In 2013, The United Kingdom eliminated commissions and began requiring that advisors charge only fees, disclosed transparently.

But the new U.S. fiduciary standard allows retirement advisors to charge commissions and other forms of compensation — such as sharing revenues with firms that manage investment products — that are usually prohibited in retirement plans. To receive this kind of compensation under the new rule, advisors must commit to a Best Interest Contract exemption — BIC, for short.

The exemption still requires advisors to act in a client’s best interest, but allows them to charge only “reasonable” compensation and requires them to disclose conflicts and fees. The exemption allows retirement advisors to continue selling indexed and variable annuities, non-traded Real Estate Investment Trusts and other products that are controversial because they charge high fees and are difficult to understand.

Smetters says the exemption makes it too easy to sell bad investments.

“Here’s what’s actually legal under this: An advisor can say, ‘Here are five different investments. Each one kicks back same amount of commission to me on your investment, so if I’m picking one it must be in your best interest.’ That’s completely ignoring that I could have picked other funds that are lower cost. That’s an easy game to play. I just pick a bad bunch of funds,” Smetters says.

He adds that the Best Interest Contract relies “on vague language that likely leaves huge loopholes in practice. I don’t know a single commission-based advisor who would regard their current practice as having excessive fees and, therefore, not meeting the test of the BIC.”

Wharton finance professor Richard Marston predicts that the industry will need some time to determine what the new rule allows.

“There are many talented and well-intentioned financial advisors not currently subject to rules requiring that they must act as ‘fiduciaries.’ They choose investment portfolios that are in the best interests of their clients whether or not those accounts are retirement accounts.”

But “once the new regime is in place, I am confident that these advisors will find ways to satisfy the new fiduciary standard,” Marston points out. “But in order for them to do so, there must be clear guidelines about what is meant by the standard. That is not clear to me at this point. What investments are allowed, and how are advisors to be compensated for choosing them?  So I think that there will be a tough transition period while this nebulous term ‘fiduciary’ is more clearly defined.”

“Once the new regime is in place, I am confident that these advisors will find ways to satisfy the new fiduciary standard.”  –Richard Marston

Roper is confident that the Labor Department’s guidelines will make it difficult for retirement advisors to sell products that are high cost or create unnecessary risks. “They can only sell these products if they can explain why they are in the best interests of the investor, and they have to assess them against other alternatives. And they can’t create incentives to sell them over other better alternatives. The preamble makes it clear that risky, illiquid, high-cost products are going to be very hard to justify.”

Smetters adds that he is also concerned that the new standard doesn’t improve disclosure requirements in a way that will help investors choose wisely. Many consumers don’t read information that is often disclosed in tiny print. Lack of financial education also means many investors can’t understand what they are buying and how much they are paying, even when it is disclosed.

So Smetters is “lukewarm” on the final standard. The new rule “lowers the standard for being a fiduciary. That’s what really annoys me.”

Financial Industry Not Pleased

The Obama administration pushed for the rule because it believed too many investors were victims of bad advice. Some financial industry executives, however, say the new standard wasn’t necessary and will reduce the availability of sound advice for smaller investors.

Lisa Bleier, managing director and associate general counsel for The Securities Industry and Financial Markets Association, or SIFMA, says that’s a flawed premise. “The fact that there are some anecdotes out there does not mean there is a systemic problem.”

Fee-only advisors, who don’t take commissions, typically charge about 1% of a client’s assets yearly. A small account, however, won’t generate enough fees to cover an advisor’s work, Bleier said. Commissions and revenue-sharing arrangements allow advisors to get paid for their work. The Best Interest Contract exemption also exposes advisors to additional legal liability, she points out. As a result, she believes many advisors will simply decide small accounts aren’t worth it.

“They are not going to have the same access [to sound advice] that they have today,” she notes.

Protecting the ‘Little guy’?

Smetters questions whether the advice is worth it. He said a friend of his who did not have a large amount to invest unknowingly paid $7,000 in commissions because she didn’t understand the disclosures.

“The broker-dealer community says it’s all about the little guy,” Smetters says. “But if the little guy understood what they were paying, they might not want the service.” Many smaller investors would be better off investing in low-cost mutual funds.

Instead of the final version, he would have preferred this solution: Require advisers to give clients a one-page document that adds up a product’s fees. He doesn’t believe the financial services industry would like that option.

Some consumer advocates complained that the final standard makes it too easy to avoid disclosing fees. Under the new regulation, advisors must disclose them if a consumer asks and can do so on their web sites.

But the Roper, who has pushed for the fiduciary standard for decades, thinks that in the big picture, the new rule is a giant step forward. “You no longer have to have a degree in finance to tell who is a fiduciary.” Options that have become law in other countries, such as banning commissions, would have faced too much political opposition to become reality in the United States. The government’s final version decreased the chances that the industry will sue to have it reversed.

The Best Interest Contract relies “on vague language that likely leaves huge loopholes in practice.” –Kent Smetters

Roper adds that the new rule has built-in protections that will make it difficult to sell products that are not in a consumer’s best interest. The standard requires that advisors’ employers must identify conflicts, ensure that advisors provide impartial advice and eliminate compensation practices that encourage advisors to select investments based on how much they earn.

Step in the Right Direction

Nikolai Roussanov, a professor of finance at Wharton, says the Labor Department’s decision at last aligns industry practice with what many investors already believe — that retirement advisors are acting in their best interest.

“Most people … kind of assume that [others] … are acting in their best interest, and most advisors are generally not subscribing to that standard.” This lack of financial education, along with opaque fee structures, has resulted in poorly diversified portfolios and high costs for many investors.

Roussanov says he hopes the rule will improve retirement investing by increasing the odds that a client will be offered low-cost products. The standard does leave room for commissions and every type of product, but the fiduciary standard will make it tougher for advisors to sell questionable products without risking litigation, Roussanov says. The final standard also encourages choice.

“Given that even academics disagree on the perfect course of action, I think some flexibility should be allowed, and I think the risk of litigation would limit the downside.”