Morningstar: Fiduciary Rule Litigation Costs Overlooked

A recent Morningstar report suggests that the costs of the fiduciary rule – including class action lawsuits – could be underestimated.

The report by Morningstar analyst Michael Wong notes that the assessments of executives, policymakers and stock analysts of the Department of Labor’s fiduciary rule are missing a key input: the potential class-action litigation cost of using the Best Interest Contract, or BIC, to receive commissions.

He estimates a long-term annual range for the industry from class action settlements of $70 million-$150 million, but notes that he wouldn’t be såurprised if near-term class action lawsuit settlements “exceed this by a multiple, as firms figure out how to determine, demonstrate, and document best interest.” In fact, he says he could envision a bearish scenario where the cost of class action settlements alone could decrease the operating margin on the advised, commission-based IRA assets of affected firms by 24%-36%.

With regard to the question of “to BIC or not to BIC?”, Wong anticipates that firms with economic “moats” – sustainable competitive advantages – are the most likely to make a successful transition, since the quality and diversity of their platforms will retain or attract assets during this tumultuous period.

But if the costs of litigation have been underestimated, Wong lines up with the Department of Labor’s regulatory impact analysis as “well founded, thoughtful, and responsive to private industry input,” and finds that the overall cost estimate of $5 billion of startup costs and $1.5 billion of ongoing costs for the financial sector to be “likely in the right range,” although he says that its cost estimate for individual large financial firms is likely “off by a multiple or, at a minimum, not representative of the largest wealth management firms.”

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