The Obama administration’s new fiduciary rule, finalised by the Labour Department in April, will one day serve as a case study in government overreach, a clear example of how faulty regulation can have severe unintended consequences. The new rule requires financial advisers and broker-dealers handling retirement assets to either move to a fee-based compensation model or, if they want to continue receiving variable compensation such as commissions and 12b-1 fees, sign a Labour Department “best-interest contract exemption,” or BICE, with clients. The BICE stipulates advisers can only earn “reasonable compensation” on non-fee-based products. If those clients feel their “best interests” have been violated, they can file class-action lawsuits against advisory practices. Firms need to be compliant on broader provisions of the rule by April 2017 and fully compliant by 2018. Putting the word “fiduciary” in the title was a clever rhetorical trick. How could someone oppose a rule requiring financial advisers to act in the best interests of clients? The problem is the new rule doesn’t actually protect investors. It makes sound retirement advice harder to get and more expensive. Plaintiffs including the US Chamber of Commerce have filed six separate lawsuits to prevent the new regulation from taking effect. They argue the rule would expose financial advisers to significantly higher regulatory costs and litigation risks while preventing small account holders from getting good, affordable advice. Out of an abundance of caution, most firms have reluctantly begun the transition to fee-only accounts, but Morgan Stanley last week bucked the trend by announcing it would take the risk of continuing to offer client choice. Here are a few of the undesirable effects the new rule will likely have on investors and investment advisers: Push investors excessively into passive index funds. The investment adviser’s job is to create a long-term asset allocation mix for clients producing the highest possible risk-adjusted return-and the new fiduciary rule prevents him from doing that job effectively. Indexes have outperformed actively managed funds in the post crisis era due to zero interest rates and quantitative easing, leading to a surge in popularity for passive strategies. Over the past decade, passively managed index funds have nearly doubled their market share to around 30% of 401(k) assets, contributing to frothy valuations for indexed stocks. The new fiduciary rule will accelerate the growth of the indexing bubble by making it impractical and uneconomical for advisers to allocate client money to more-expensive actively managed funds-even if they are deemed more appropriate based on market conditions. As a result, investors will likely be more defenceless than ever heading into the next downturn. Cost investors more money. Like many federal regulations, the new fiduciary rule will hurt the very people it purports to protect. The rule is designed to save retirees money by eliminating excessive commissions, but research shows it could lead to tens of billions of dollars in new costs. According to Morningstar Inc., fee-based accounts often yield up to 60% more than commission-based accounts, which could translate into another $13 billion in revenue for the financial industry. Punish small and independent registered investment advisers, or RIAs. Dodd-Frank was supposed to end “too-big-to-fail,” but instead unduly punished small community banks, which couldn’t afford significantly higher compliance costs, leading to further consolidation in the industry. The new fiduciary rule will have the same effect on retirement planning. Large wire houses will be able to adapt and survive, but small and independent RIAs lacking the resources to set up expensive new compliance systems based on the 1,023-page rule will be forced to exit the business or pursue mergers. Punish small savers. The increased threat of litigation over commission-based accounts will cause most advisers to switch to fee-based systems that don’t make economic sense for accounts with low balances. Advisers will drop smaller accounts, forcing less-wealthy individuals to use robo advisers, whose technology is unproven in more volatile environments. Financial crises and market crashes are often the result of overregulation creating bad incentives. Economist Milton Friedman once said, “One of the great mistakes is to judge policies and programs by their intentions rather than their results.” The Community Reinvestment Act of 1977, for example, aimed to reduce discriminatory lending practices against low-income households, but instead paved the way for the housing crisis by forcing banks to give mortgages to people who couldn’t afford them. The Affordable Care Act has made insurance premiums significantly more expensive by reducing competitiveness in the health-care industry. The Obama administration’s new fiduciary rule is the latest example of onerous regulation that may have good intentions but will lead to disastrous outcomes. Let the free market dictate where assets flow. Firms putting client interests first thrive organically in a capitalist system.