Language underlying a revised “consumer protection proposal” from the Department of Labor (DOL) has been made public—representing the latest step forward in a years-long effort by the DOL to strengthen investment advice and conflict of interest standards.
Matching the expectations of some industry practitioners and analysts, the DOL appears to be taking an exemptions-based approach to a stronger fiduciary standard. As explained by Labor Secretary Thomas Perez during a national media call, the DOL expects its rule to significantly expand the number of advisers and brokers who will be considered fiduciaries in the context of investment advice. However, Perez was quick to add the wider application of the fiduciary standard would also come along with a new and lengthy list of prohibited transaction exemptions designed to allow new fiduciary advisers to continue to receive commissions, 12b(1) fees and other widely practiced forms of compensation—so long as proper disclosures are made.
Perez was joined on the call by Jeff Zients, director of the National Economic Council and assistant to President Obama for economic policy. Both reiterated Obama’s controversial comments that there is a rampant problem in the U.S. investment advice industry related to conflicted advisers and brokers, who put their own financial interests ahead of the well-being of their clients. While they introduced the call with harsh language about the impacts of bad financial advice on the typical U.S. workplace retirement investor, both Zients and Perez were clearly trying to ease some of the longstanding fears of the advisory industry surrounding potential unintended consequences of a new and stronger fiduciary standard.
For example, Perez highlighted part of the rulemaking language that will establish a new type of contract for advisers/brokers and their clients, which can be used when an adviser wants to recommend a type of product or a type of investment maneuver (such as an individual retirement account rollover) that he feels is in the client’s best interest—but which also could result in additional compensation for the adviser. Perez says an adviser and client could enter this type of a formal contract without requiring prior approval from DOL. Once the contract is signed it gives the adviser the ability to enact transactions that would otherwise be prohibited by ERISA.
As an example of how this works, Perez described his own dealings with his family’s investment adviser:
“Currently I get advice from a trusted certified financial planner, who under the rule must be a fiduciary,” he explains. “Even as a fiduciary, there are some investments he can offer me that are commission-based or involve some type of revenue sharing or other fees. The new rule makes it clear that he has an obligation to look out for my best interest first, but it doesn’t make it impossible for him to make these recommendations.”
Perez explains that an advisory firm will not have to apply for an exemption directly with the DOL in this case—instead it has to "enter into a proper contract," Perez says, and then the necessary exemptions will automatically apply.
“They first simply have to notify us that they intend to rely on this type of a contract and this exemption, and that they have properly disclosed their own financial interest in said advice relationship,” Perez continues. “Part of this will be to show they have policies and procedures in place that will mitigate the advisers’ own financial conflicts of interest and ensure the client understands the financial interests of the people giving them advice.”
Perez expects this prohibited transaction exemption to be used extensively in the individual retirement account (IRA) portion of the market.
“In the IRA market, the way it will work is, if the broker or adviser doesn’t have any conflicts of interest with respect to a given piece of advice, he or she doesn’t need an exception simply for recommending a rollover,” he says. “But if they are getting a commission or other payments that give him a personal financial interest in the outcome of the advice, this exception will force them to commit to give advice that is prudent and puts the customer first, and has reasonable fees. They can’t mislead the customer and they have to be upfront about their conflict, but when that hurdle is met, the transaction can move ahead.”
The new rule language is outlined in a DOL fact sheet here, and will be published soon in full in the Federal Register. According to the DOL fact sheet, the new rule language is built on “a very simple principle: You want to give financial advice, you’ve got to put your client’s interests first.”
The top line impact of the rulemaking language is that it will expand the types of retirement investment advice covered by fiduciary protections under ERISA. While it distinguishes simple “broker order taking” from broker-provided investment advice, the proposal seems to lump together advisers and brokers under a single fiduciary standard. At the same time it provides a “new, broad, principles-based exemption that can accommodate and adapt to the broad range of evolving business practices.”
Perez explains the impact of the exemptions as follows: “Because of the exemptions and a number of other features, the new rule does not bar or end commissions or other common forms of payment that advisers depend on. It also doesn’t apply to appraisals or valuation of stock within an employee stock ownership plan (ESOP).”
Perez also took time during the call to note that the new rule language “will explicitly allow employers and call centers alike to continue to provide their own general investment education without becoming fiduciaries.” Many advisers have raised concerns about this very point, that forcing call centers to only give fiduciary advice would shut huge numbers of low-balance savers out of access to any advice whatsoever.
On the timing of a final rule, Perez says the DOL is “very confident we’ll get new insights and commentary from the industry and other stakeholders in the days and months ahead,” so he “can’t say when the final rule is likely to come down.” He wouldn’t even commit to trying to get it done before the end of the Obama Administration, but as one journalist suggested, that seems basically to be a requirement, given the largely partisan nature of the proposal and the uncertainty that it would move forward under even another Democratic president. He also feels its possible the rule will change substantially before it is finally adopted.
The full text of the proposed rule is available here, and the DOL is inviting all stakeholders to submit commentary via its website or the eRulemaking portal on www.regulations.gov.
Stay tuned to www.plansponsor.com this evening and throughout the week for coverage of industry responses and other important follow up.