DOL Fiduciary Rule P II: The SEC Story

While the previous post discussed the Department of Labor’s (DOL) fiduciary rule, it is not the only government agency tackling the issue. In 2010, President Obama signed into law the Dodd-Frank Act, which authorized the Securities and Exchange Commission (SEC) to create its own uniform standard of care for financial advisors. To aid in this endeavor, it also authorized the creation of an Investor Advisory Committee (IAC) whose purpose was to submit recommendations to the SEC regarding, amongst other things, the regulation of securities products and the protection of investor interests.[i] In November 2013, the IAC issued a report endorsing, “that advisory services offered as a part of a transaction-based securities business can and should be conducted in a way that is consistent with a fiduciary standard of conduct.”[ii]

SEC Chairwoman Mary Jo White supports tighter regulations for those making funding recommendation to investors. At an industry conference, Ms. White stated that it was her “’personal view’” that brokers and those for whom the Commission provides oversight should be required to put “clients’ interests ahead of personal gain.”[iii]  Arthur Levitt, SEC chairman from 1993 to 2001, believes the SEC should have addressed the issue long before now, given the complexity of the products being presented to investors by brokers. “’I do not accept the notion that a broker is an order taker. If he’s a good broker, he’s much more than that.”[iv] Industry leaders, including Kenneth Bentsen, president and chief executive of the Securities Industry and Financial Markets Association, have expressed support in the SEC taking the lead in this matter. “’They’ve got the technical expertise.’”[v]

In testimony before the House Subcommittee on Financial Services and General Government Committee on Appropriations, Chairwoman White would not offer a timeframe for the completion, but made it clear that the SEC would be issuing its own fiduciary standards. Though the purposed rules may be similar, she stated that the SEC’s would differ from that of the DOL’s, even though the SEC did provide “’substantial technical assistance’” in crafting the DOL version.[vi]

Mark Trupo, DOL spokesman, claims there was close coordination between the two departments and that, “engagement with the SEC was comprehensive, and that the SEC’s input was incorporated into the plan.”[vii] The SEC refused to comment. Others, however, were more vocal in their questioning in the validity of the statement.

In his report, The Labor Department’s Fiduciary Rule: How a Flawed Process Could Hurt Retirement Savers, Sen. Ron Johnson, chairman of the Senate Homeland Security and Governmental Affairs Committee, claimed the DOL rule failed to address 26 significant concerns posited by the SEC. These included issues regarding the best interest contract exemption, “’conflicts with federal securities laws and [Financial Industry Regulatory Authority] rules, and a lack of cost-benefit analysis of alternatives.’”[viii]

So why hasn’t the SEC issued its own rule yet? It may have to do with administrative structure. While the DOL operates under a single administrator, the SEC has a five-person commission, complicating the approval process. Some believe the make-up of this commission would lead to a 3-2 vote on any fiduciary rule, given the current SEC commissioner and incoming commissioner, both republicans, are likely to vote against such a measure.[ix]

Only time will tell when the SEC releases its own fiduciary rule and how greatly it will differ from that of the DOL. Until then, one can only expect continued speculation and debate, a debate that many believe is long overdue.

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[i] U.S. Securities and Exchange Commission (2012). “Investment Advisory Committee” [Electronic format]. Retrieved from: http://www.sec.gov/spotlight/investor-advisory-committee-2012.shtml

[ii] U.S. Securities and Exchange Commission (2013).  “Recommendation of the Investor Advisory Committee Broker-Dealer Fiduciary Duty” [Electronic format]. Retrieved from: http://www.sec.gov/spotlight/investor-advisory-committee-2012/fiduciary-duty-recommendation-2013.pdf

[iii] Baer, J. & Ackerman A. (2015, March 17) SEC Head Backs Fiduciary Standards for Brokers, Advisors [Electronic format]. Retrieved from: http://www.wsj.com/articles/sec-head-seeks-uniformity-in-fiduciary-duties-among-brokers-advisers-1426607955?mg=id-wsj

[iv] Ibid.

[v] Ibid

[vi] SEC, DOL Fiduciary Rules Will Likely Be Different, White Says (2016, March 22). [Electronic format] Retrieved from: http://www.thinkadvisor.com/2016/03/22/sec-dol-fiduciary-rules-will-likely-be-different-w

[vii] Barlyn, S & Lynch, S (2016, February 24) U.S. Labor Dept., SEC Clash Over Retirement Advice Rule: Report [Electronic format]. Retrieved from: http://www.reuters.com/article/us-usa-brokers-fiduciary-idUSKCN0VX0XZ

[viii] Senator Blasts DOL for Ignoring SEC’s Fiduciary Rule Concerns (2016, February 24). [Electronic format]. Retrieved from: http://www.thinkadvisor.com/2016/02/24/senator-blasts-dol-for-ignoring-secs-fiduciary-rul

[ix] Why SEC Fiduciary Rule May Be ‘Unattainable’ (2016, March 10). [Electronic format]. Retrieved from: http://www.thinkadvisor.com/2016/03/10/why-sec-fiduciary-rule-may-be-unattainable?ref=related-embedded

DOL Fiduciary Rule: Part I

After much nail-biting by many in the industry, the Department of Labor (DOL) recently released its anticipated and long-awaited final fiduciary rule, which it touts as the fulfillment of its mission to protect the retirement of investors through education and empowerment.[i] In this first installment of a multi-part series, we take a quick look at the rule responsible for making waves in the American financial sector.

The rule is the culmination of a multi-year project to modernize the Employee Retirement Income Security Act (ERISA) of 1974, in response to the growth of unregulated market products. The consequence of this growth has been an array of investment professionals who could advise in the direction of their own personal gain over the best interests of their clients, so long as the recommendation was “suitable;” unacceptable behavior for fiduciaries.[ii]

The DOL rule expands the scope of those who qualify as “fiduciaries,” such as those related to individual retirement accounts or IRAs. “Any advisor who makes investment recommendations …in exchange for compensation will be considered a fiduciary (and)…are legally required to recommend investments that are in their client’s best interest, not their own.”[iii]  According to the White House, the conflicts of interest that exist when the client’s needs do not take precedent cost American families an estimated $17 billion a year.[iv]In the same manner, another goal of the rule was to curb billions of dollars currently being lost by investors in fees paid when transferring money out of 401ks and into IRAs.[v]

Some don’t consider this the fail-safe that the government is touting it to be. Situations in which conflicts are present, such as with mutual fund families and broker-dealers, will still continue to operate, only with the additional “Best Interest Contract Exemption” (BICE) disclosure.[vi]  As one author surmised, “Just picture the speed with which you click ‘Agree’ everytime (sic) iTunes does a software update, and you can imagine how little of an impediment this sort of thing represents.”[vii] 

The former head of the DOL’s Employee Benefits Security Administration, Brad Campbell, considers BICE to represent the most significant issue in the rule. “’There are frivolous litigation risks and liability risks in the BICE that still remain, and that are going to increase costs for small businesses where advisors are willing to use the BICE exemption at all.’”[viii]  There are others who have expressed concerns regarding the DOL rule, including the Securities and Exchange Commission, the insurance and securities industries, as well as politicians, which shall be discussed in future postings.

Still, many in the government feel the rule is a victory. Department of Labor Secretary Tom Perez expressed that putting the client first is, “now the law,”[ix] while Senator Elizabeth Warren (D., Mass) proclaimed the rule a day in which the government was working, “for the people.” [x]  This is assuming, of course, the next administration doesn’t kill it altogether before the final 2018 implementation deadline.

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[i] United States Department of Labor. (2016, April 13) Department of Labor Finalizes Rule to Address Conflicts of Interest in Retirement Advice, Saving Middle-Class Families Billions of Dollars Every Year [Electronic format]. Retrieved from http://www.dol.gov/ebsa/newsroom/fs-conflict-of-interest.html

[ii] Ibid.

[iii] Brandon, E. (2016, April 8) The New Retirement Account Fiduciary Standard [Electronic format]. Retrieved from http://money.usnews.com/money/blogs/planning-to-retire/articles/2016-04-08/the-new-retirement-account-fiduciary-standard

[iv] The White House. (2016, April 13) Fact Sheet: Middle Class Economics: Strengthening Retirement Security by Cracking Down on Conflicts of Interest in Retirement Savings [Electronic format]. Retrieved from http://www.whitehouse.gov/the-press-office/2016/04/06/fact-sheet-middle-class-economics-strengthening-retirement-security

[v] Hayashi Y. & Prior A. (2016, April 6) U.S. Unveils Retirement-Savings Revamp, but With a Few Concessions to Industry [Electronic format]. Retrieved from http://www.wsj.com/articles/u-s-unveils-retirement-savings-revamp-but-with-a-few-concessions-to-industry-1459936802

[vi] Brown, J. (2016, April 6) Wall Street Dodged a Bullet on the Retirement Fiduciary Rule [Electronic format]. Retrieved from http://www.fortune.com/2016/04/06/retirement-savings-fiduciary-rule/

[vii] (Brown, J., 2016, April 6)

[viii] Campbell, B. (2016, April 11) DOL Fiduciary Rule: The Good, the Bad and the Ugly [Electronic format]. Retrieved from http://www.thinkadvisor.com/2016/04/11/dol-fiduciary-rule-the-good-the-bad-and-the-ugle

[ix] (Ebeling, A., 2016, April 7)

[x] (Hayashi Y. & Prior A., 2016, April 6)

DEPARTMENT OF LABOR PROPOSES RULE TO EXPAND THE DEFINITION OF “FIDUCIARY” UNDER ERISA

On October 21, 2010, in an effort to further protect employee benefit plan participants and beneficiaries, the U.S. Department of Labor’s Employee Benefits Security Administration announced a proposed rule to expand the definition of “fiduciary” under ERISA. Specifically, the proposed rule would more broadly define the circumstances under which a person is considered to be a “fiduciary” by reason of giving investment advice to an employee benefit plan or a plan’s participants.

ERISA Section 504 imposes a number of duties on plan fiduciaries, including a duty of undivided loyalty, a duty to act for the exclusive purposes of providing plan benefits and defraying reasonable expenses of administering the plan, and a duty of care grounded in the prudent man standard. Despite the care taken to protect plan participants from poor fiduciary conduct, the definition of “fiduciary” has been left unchanged since ERISA’s enactment in 1975. And given the significant changes to employee benefit plans, the financial industry and the expectations of plan participants, the Department of Labor recognizes that the current definition of “fiduciary” may inappropriately limit the types of investment advisory relationships that give rise to fiduciary duties on the part of the investment advisor. Indeed, the Department of Labor noted in the new proposed rule that since 1975:

the retirement plan community has changed significantly, with a shift from defined benefit (DB) plans to defined contribution (DC) plans. The financial marketplace also has changed significantly, and the types and complexity of investment products and services available to plans have increased. With the resulting changes in plan investment practices, and relationships between advisers and their plan clients, the Department [of Labor] believes there is a need to re-examine the types of advisory relationships that should give rise to fiduciary duties on the part of those providing advisory services.

The proposed rule was published in the Federal Register on October 22, 2010, and written comments on the proposed regulations must be submitted to the Department of Labor on or before January 20, 2011.

A complete copy of the proposed rule can be found here.

U.S. DEPARTMENT OF LABOR ISSUES FINAL RULE MANDATING GREATER DISCLOSURES IN PARTICIPANT-DIRECTED RETIREMENT PLANS

On October 14, 2010, the U.S. Department of Labor issued a final rule requiring the disclosure of certain plan and investment-related information, including fee and expense information, to participants and beneficiaries in participant-directed individual account plans (e.g., 401(k) plans). The regulation is intended to help ERISA plan participants better manage their retirement savings by ensuring that they have the information they need to make informed decisions about their investments.

The Department of Labor estimates that 72 million people are invested in participant-directed retirement plans nationwide, compiling a total of nearly $3 trillion in assets. A “participant-directed plan” is one that provides for the allocation of investment responsibilities to participants or beneficiaries. While participants in these plans are responsible for making their own investment decisions, “current law does not require that all workers be given the information they need to make informed investment decisions or, when information is given, that it is furnished in a user-friendly format.” This is particularly true with respect to the fees and expenses associated with certain investment choices.

The final rule aims to assist plan participants in this regard, and will impact plan sponsors, fiduciaries, participants and beneficiaries, as well as the service providers of such plans. To be sure, the final rule provides that when a plan allocates investment responsibilities to participants or beneficiaries, the plan administrator must take steps to ensure that such participants and beneficiaries (1) are made aware of their rights and responsibilities with respect to the investment of their assets, and (2) are provided sufficient information regarding the plan and the plan's investment options to make informed decisions with regard to the management of their individual accounts. The plan administrator must also provide each participant with certain plan-related and investment-related information.

In addition, the final rule provides that the investment of plan assets is governed by the fiduciary duties set forth within ERISA Section 404(a)(1)(A)-(B), which require plan fiduciaries to act prudently and solely in the interest of the plan’s participants and beneficiaries. Accordingly, the regulation requires plan fiduciaries to:

• Provide plan participants with quarterly statements of plan fees and expenses deducted from their accounts;

• Provide plan participants with core information about investments available under their plan, including the cost of these investments;

• Use standard methodologies when calculating and disclosing expense and return information to achieve uniformity across the spectrum of investments that exist in plans;

• Present the information in a format that makes it easier for plan participants to comparison shop among the plan's investment options; and

• Provide plan participants with access to supplemental investment information in addition to the basic information required under the final rule.

A complete copy of the final rule can be found here. In addition, for a concise overview of the final rule, please click here.

THE U.S. DEPARTMENT OF LABOR PROVIDES A HELPING HAND FOR EMPLOYEE BENEFIT PLAN FIDUCIARIES

On July 16, 2010, the U.S. Department of Labor issued an interim final rule aimed at enhancing disclosure requirements to fiduciaries of employee benefit plans. Specifically, the rule requires that certain service providers disclose specified information to assist plan fiduciaries in assessing the reasonableness of contracts or arrangements, including the reasonableness of the compensation paid for services and the conflicts of interest that may affect a service provider’s performance of services to the plan.

As the Department of Labor points out, in recent years, employee benefit plans have undergone a number of changes to improve efficiency and reduce the cost of administrative services for the plans and their participants. However, these changes are quite complex, making it difficult for plan fiduciaries to understand what service providers are actually paid for the specific services they render. Nonetheless, ERISA § 404(a)(1) provides in pertinent part that:

[A] fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and—

(A) for the exclusive purpose of:

(i) providing benefits to participants and their beneficiaries; and

(ii) defraying reasonable expenses of administering the plan.

In order to comply with Section 404(a)(1), fiduciaries must have access to information sufficient to determine the reasonableness of the compensation paid for administrative services. The interim final rule is intended to provide fiduciaries with this key information by requiring certain service providers to disclose both the direct and indirect compensation they receive in connection with the services they provide to the plan. According to Phyllis Borzi, Assistant Secretary for the Employee Benefits Security Administration, the rule should allow plan fiduciaries to make more informed decisions about plan services, including the costs of services and potential conflicts of interest.

In addition to protecting and assisting plan fiduciaries, the Department of Labor believes that “mandatory proactive disclosure will reduce sponsor information costs, discourage harmful conflicts, and enhance service value.”

A complete copy of the final interim rule is available here.