In early July, the U.S. Department of Labor (DOL) published a proposed regulation aimed at streamlining conflict of interest rules and investment advice protections provided to workers and retirees under the Employee Retirement Income Security Act (ERISA).
The measure includes a best interest standard intended to align with a broader investment advice regulation issued by the U.S. Securities and Exchange Commission (SEC) that took effect June 30, as well as a complementary model regulation for annuity sales adopted earlier this year by the National Association of Insurance Commissioners (NAIC).
As proposed, the rule has three primary components. First and foremost, it would establish a new prohibited transaction exemption (PTE) for ERISA-covered investment advice fiduciaries who, among other requirements, meet a best interest standard and a reasonable compensation standard. Notably, these are also components of the SEC’s Regulation Best Interest (Reg BI). Second, the DOL is officially reinstating the “five-part test” for fiduciary status and other guidance that had been modified by the prior administration’s 2016 rule. The 2016 rule was vacated by the 5th U.S. Circuit Court of Appeals in 2018. Lastly, the proposal clarifies the circumstances under which fiduciary status would be triggered by advice to roll over retirement savings from a 401(k) or other employment-based plan to an individual retirement account (IRA).
When the rule proposal was published, some retirement industry stakeholders voiced concern that the DOL gave the public just 30 days to file comments—but they also appreciated that the regulator committed to holding a number of hearings on the matter. One of these hearings took place today via teleconference, and the comments shared by various parties embodied the years of intense regulatory debate that have led to this point.
Among those who filed positive comments about the fiduciary rule proposal is the Financial Services Institute (FSI).
“We support the DOL’s proposal, and we commend the department’s efforts to align its rules with the SEC’s Regulation Best Interest,” Dale Brown, FSI president and CEO, said about the hearing. “There is room for improvement, which we explained in our comment letter. However, it is imperative that the DOL continues moving forward with the rulemaking process in order to ensure clarity and consistency as to the obligations of financial professionals.”
The comment letter from FSI says its members support the DOL’s proposed exemption approach because it would enable investment advice fiduciaries to continue providing their essential services to retirement investors while receiving a broad range of otherwise prohibited commission-based compensation types and payments from third parties. FSI members feel the exemption will be essential in connection with many types of critical transactions involving employee benefit retirement plans, IRAs and annuities.
“FSI supports the breadth and flexibility of the proposed exemption, which is not tied to any particular investment product and is equally available to an array of financial professionals, including registered investment advisers [RIAs], broker/dealers [B/Ds], insurance companies, banks and their respective employees or agents,” the FSI letter states.
The letter goes on to list some points of concern, where FSI members hope to see changes made to the proposal prior to its final publication and implementation.
“Notably, we are concerned that the disclosure requirement concerning ERISA ‘fiduciary’ status under the proposed exemption will be both confusing and misleading to retirement investors,” the letter states. “This requirement will be confusing and misleading, particularly when a best interest standard, aligned with Regulation BI, separately applies to firms and professionals utilizing the exemption. By using the term ‘fiduciary,’ such disclosure implies there is something more or different than the best interest standard. … A statement by financial institutions and investment professionals that they are fiduciaries might be misunderstood to imply a legal obligation to an IRA owner that would create a private right of action enforceable by the IRA owner.”
The letter further suggests that the proposed rule’s disclosure requirement is “unworkable in situations where the DOL determines that an investment professional is a ‘retroactive fiduciary’ based on the later formation of an ongoing advice relationship.”
Other commentators at the DOL hearing voiced far more skepticism about the fiduciary regulation, including Barbara Roper, director of investor protection at the Consumer Federation of America (CFA).
“Since the comment period closed, I have had a chance to review the comments filed by broker/dealer and insurance firms and their lobbyists in response to the proposal,” Roper said. “I have to admit it was a dispiriting exercise. And I was particularly taken aback by the cynical claim, repeated here today, that the preamble’s explanation of how the reinstated definition of fiduciary investment advice would apply to rollover recommendations would somehow ‘effectively reinstate the invalidated 2016 fiduciary definition,’ just because the department indicated it might not always interpret the definition’s five-part test exactly as it had in the past.”
Roper also said the DOL’s decision to reinstate the five-part test is wrong.
“The department has previously found this approach enables firms to evade their fiduciary obligations in circumstances where they are clearly functioning as advice fiduciaries and are reasonably relied on as advice fiduciaries by retirement savers,” Roper said. “The amount of comment the department has received on this point demonstrates just how unwise it was to reinstate the definition through a final rule, with no opportunity for input.”
Though her comments broadly criticized the DOL’s decisionmaking, Roper did have a few positive points to make.
“Saying that rollovers in the context of an ongoing relationship constitute fiduciary investment advice is a small step in the right direction, but it is a far cry from unequivocally covering all rollovers in the definition, as the 2016 rule would have done,” she said. “Similarly, saying that firms may need to do more than stick a disclaimer in six-point type in a disclosure document to avoid any fiduciary obligations is appropriate, as far as it goes, but it would still appear to leave firms plenty of room to come up with a way to avoid those obligations, even in circumstances when the retirement saver will rely on those recommendations as a primary basis for their investment decision.”
Roper also expressed concern about the speed of these developments.
“Since the department issued its proposal one day before the SEC’s Reg BI was due to take effect, and the comment period closed when that new rule had been in effect for just over a month, there hasn’t been time for us—or the department—to comprehensively study whether, or to what extent, Reg BI has caused firms to change the way they do business,” she said. “In particular, there hasn’t been time to fully assess whether Reg BI has caused firms to abandon incentive practices that the department has previously determined, as part of the regulatory record for this proposal, are likely to induce financial professionals to base their recommendations on their own interests, rather than their customers’ best interests. We have even less information regarding the effect of the NAIC model rule.”
In comments echoed by other parties focused on consumer protection during the hearing, Roper repeatedly expressed the general concern that a disclosure-based framework such as Reg BI is insufficient to protect investors.
“It is virtually impossible to ascertain from most of the disclosures what, if anything, a firm may be doing to ‘mitigate’ these conflicts,” she said. “A few firms make boilerplate statements about addressing conflicts through a combination of training, supervision and disclosure. But there is no evidence in the disclosures we’ve reviewed of meaningful changes to reduce widespread, harmful incentives—certainly nothing on the order of magnitude needed to reassure retirement savers that their interests are likely to come first.”