A Tale of Two Rules

Independent financial advisors have their hands full. On top of market, geo-political, economic and industry headwinds and anxious clients, the community is contending with two potentially paradigm-shifting scenarios: one regulatory, the other legislative.

Both have been on the industry’s radar. Both have prompted push back. The first, FINRA Rule 4111 is a done deal, with a new reporting element that’s taking effect June 1, 2023. The other, revisiting the PRO Act’s independent contractor rules, has some runway before adoption – as well as the possibility of dialing back the disruption. Let’s see where we are right now and what they mean to the independent advisor space.

The 411 on FINRA Rule 4111

On January 1, 2022, FINRA Rule 4111 became effective. The Rule’s intent is to protect investors by identifying firms with a history of misconduct (“Restricted Firms”) and subjecting those firms to certain obligations. Such obligations include depositing cash or qualified securities in a segregated, restricted account (enough to pay clients’ pending arbitration claims or unpaid arbitration awards); adhering to specified conditions or restrictions; or complying with a combination of the two.

So, what’s happening on June 1, 2023? That’s the day information from FINRA’s so-called “Leper List” of current or former Restricted Firms will appear on BrokerCheck, FINRA’s online research tool.

While 4111 is already in effect, there are options to mitigate the risk of triggering a Restricted Firm designation. Financial advisors with complaints or blemishes on their records can take steps to have their records expunged. It may be time-consuming and, with FINRA fees and the potential cost of an expungement attorney, may prove expensive.

On the firm level, an organization that has been informed by FINRA that it meets the preliminary Restricted Firm criteria for the first time has a one-time option to separate from advisors with a history of misconduct.

The Independent Contractor Rule

I think we can all agree that treating workers fairly is in everyone’s best interest (no pun intended). However, as is sometimes the case with good ideas, unintended consequences can lurk in the shadows. Take the efforts by the U.S. Department of Labor to add clarity around classifying workers.

Historically, independent financial advisors affiliated with wealth management firms have been considered independent contractors … a situation that has worked well by all accounts. But an October, 2022 rule proposed by the U.S. Department of Labor (DOL) would make it more difficult for IBDs to continue classifying their advisors as independent contractors.

The Protecting the Right to Organize (“PRO”) Act was the original DOL proposal addressing “who’s an independent contractor?” It was under consideration by the House of Representatives beginning in February 2021, passed the House in early March of 2021 and then stalled in the Senate.

Fast forward to today. A modified version of the original legislation – the newly-christened Richard L. Trumka Protecting the Right to Organize (PRO) Act – was reintroduced to Congress earlier this year (Feb. 28). New name, same angst for the financial services industry.

The intended beneficiaries of the Act are freelancers and part-time employees. But, the Act, which is intended to protect that audience, casts a wide net. Treating independent financial advisors as members of the gig economy is a demonstrable disconnect. Absent a carve-out or an adjustment to the proposed legislation, the ramifications are clear.

A recent FSI survey, conducted with Oxford Economics, found that only 10% of the industry wants to become employees, while nearly 20% of advisors said they’d retire almost immediately if the Act was implemented. That leaves a lot of clients without advisors, in an environment where an aging advisor population is already heading toward retirement in greater numbers and there’s not enough younger ones to replace them.

Additionally, the survey indicates that a shift from independence to employee would most likely trigger rising expenses for both firms and advisors – which would be passed on to investors. Importantly, independent advisors as employees may lose the ability to monetize their books of business.

So, the financial fallout from implementing the Act as it stands has the potential to negatively impact both financial advisors and Main Street investors. A carve-out for independent financial advisors can avoid this. And it’s not an unreasonable ask.

That being said, given the current Congressional make up, the PRO Act 2023 has a steep hill to climb for passage.