Compliance January 29, 2021

DOL Q&A: What’s Next with ESG, Fiduciary and Proxy Regs?

The path ahead is clearer for insurance producers and fiduciary investment advisers compared with the potential ambiguities facing broker/dealers, says Eversheds Partner Carol McClarnon.
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Several months ago, Carol McClarnon, an Employee Retirement Income Security Act (ERISA) specialist and partner at Eversheds Sutherland, joined PLANADVISER in a discussion of the evolving regulatory landscape facing her clients, and the broader retirement planning and insurance industries.

At the time, McClarnon explained how the Department of Labor (DOL) had confirmed and formalized the return to the old “five-part test” used by its enforcement staff for determining who is an investment advice fiduciary. She also detailed how this development was tied directly to the Regulation Best Interest (Reg BI) standard implemented last year by the Securities and Exchange Commission (SEC).

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In a new Q&A conversation, presented below, McClarnon gives her updated take on what might come next at the DOL, given the stated interests and objectives of the newly established administration of President Joe Biden. In her view, it is likely that the Biden-led DOL will focus first on addressing the topic of environmental, social and governance (ESG) investing, before potentially turning back to address the fiduciary and proxy voting topics in some way.

 

PLANADVISER: Thanks for your time, Carol. It’s been a little while since we’ve spoken. What have you been working on?

McClarnon: We’ve been busy answering many questions, of course. A lot of people in the insurance and investment marketplace are trying to figure out where the next several months or years are going to take us, especially in the areas of ESG investing and the fiduciary rule stuff. The main question we get is, ‘Should we start making any changes to address the fiduciary developments, or should we wait and see what happens?’

At this stage, there are some areas where we can pull out the crystal ball, depending on who the client is and what they are doing in the marketplace. An insurance company, for example, can choose to rely on the prohibited transaction exemption called ‘84-24,’ rather than working with the new exemption, called ‘2020-02.’ The future of 2020-02 is not clear.  

The answer about what to do next, again, always hinges on what the company actually does. For insurance producers, the nice thing about the 84-24 exemption is that you don’t have to state to your clients in a contract that you are a fiduciary in order to take advantage of it. A lot of insurance companies are saying, ‘We expect that we are going to have to rely on 84-24, so let’s just get started down that road.’

On the other hand, many fiduciary investment advisers have already embraced a certain direction based on the previous versions of the fiduciary regulations put out by prior administrations, so their direction is also pretty clear. I’d say broker/dealers [B/Ds] are in a more uncertain position right now, in particular, because they haven’t traditionally been fiduciaries.

 

PLANADVISER: How much frustration are your clients feeling, after seeing the regulatory situation go back and forth for so long? Are they resigned to the uncertainty?

McClarnon: It depends on the client, I would say. We’ve seen both responses. Right now, there isn’t a ton of clarity about what exactly is coming next. The Biden administration says it is freezing many regulatory projects for reconsideration, including the fiduciary stuff. Our clients rightly want to know, ‘Does that mean we don’t have to comply, or what?’ People are very anxious, in some cases, while others are able to remain calm.

In terms of what comes next, unfortunately, I think the fiduciary issue has become political. I expect the new administration could feel compelled to act here. But, if you sit down and look at the conditions of the 2020-02 exemption, and compare that with supposedly stricter exemption that was put forward under President [Barack] Obama, there are actually a lot of the same basic requirements and conditions. But, as I said, there may be a strong enough sentiment among the consumer advocacy organizations to see additional rulemaking here.

 

PLANADVISER: One feels for the DOL leadership. This is not an easy position to resolve.

McClarnon: I would agree. My personal view is that this proposal has been really created by the career staff at the DOL and that it’s a workable middle ground. Something we should really point out is that ESG is probably going to be the [Biden administration’s] first priority. This fiduciary rule stuff could sit on the sidelines until they feel like dealing with it.

The administration has publicly and consistently stated that it is going to address the ESG rulemaking. And, remember, that rule is actually final now. It’s not like the DOL can just immediately change course there. It will take real regulations. It’ll have to do a whole notice and comment period.

 

PLANADVISER: What’s the likelihood that the new DOL could do ‘sub-regulatory’ or interpretive-type guidance, rather than a regulation? We did see a moderation of the more extreme anti-ESG policy first put forward under the Trump administration. The Biden administration could just come out and say definitely that climate factors, for example, are pecuniary for long-term investors such as retirement savers and pension funds.

McClarnon: That is a definite possibility, and, in fact, that would be a lot easier than doing another full regulation with a notice and comment period. As you say, the outgoing DOL really did make an effort in the final regulation to say this is not about ESG but instead about only using pecuniary factors in investing. This will really be the more interesting thing to watch coming up, and I expect it will be the priority.

 

PLANADVISER: Are there any other potential priorities? What about the proxy voting topic? Is this a topic, almost like the fiduciary rule, where the technicality makes it hard for it to become a mainstream policy priority?

McClarnon: That’s true to some extent. A person who is not enmeshed in the DOL like an ERISA attorney or adviser probably isn’t going to be so concerned about proxy voting issues, you’re right, and they also may not appreciate how proxy voting issues and ESG go together. The Trump administration put its proxy voting regulation into place with many of the same goals in mind as its ESG regulation. This will definitely be an important area to keep paying attention to.

Data & Research January 27, 2021

Pandemic Lessons: The Importance of the Savings Hierarchy

Sources agree that, without a solid foundation of advice about the ‘savings hierarchy,’ even successful investors can find themselves short of liquidity at critical times, most notably during emergencies.
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Laura Varas, Hearts & Wallets founder and CEO, is not shy about diagnosing some of the biggest hurdles facing financial advisory firms and asset managers today.

In her view—which is far from unique—the entire financial services industry would benefit from a fundamental reimagining of the way its goods and services are presented to and consumed by the mass working public. Simply put, the industry’s default mode of product presentation is almost entirely dominated by complex jargon and by discussions of “style boxes,” “factors,” “alpha,” and other sophisticated concepts that relatively few people outside the professional investing community understand.

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Drawing on her background working on consumer packaged goods (toothpaste was her specialty), Varas proposes that investment service providers should focus on more concrete and comprehensible issues. A good place to start, in her estimation, is to refocus the consumer experience on the “savings hierarchy.” This is to say, it is important to present consumers with a broad spectrum of easy-to-understand financial products that are built to work together to solve the specific needs individuals face, including short-, medium- and long-term considerations.

A Consumer-Based Approach

It is no surprise to hear this sentiment from Varas, given that her firm’s role in the financial services ecosystem is, as she puts it, to “make it easier for innovators to reimagine their solutions in the context of what consumers need and are actually doing.” She also draws on her ongoing personal experience of facing college education expenses without necessarily having a rational financial plan to meet them. 

“I run a financial services company and I will freely admit that I have made mistakes because of the complexity of the system and how difficult it is to match your goals to your consumer decisions,” Varas says. “Personally, I have oversaved in my 401(k) plan and I’ve neglected to invest for my children’s college expenses. I’ve actually had to take unqualified withdrawals and pay horrendous taxes to meet these expenses. These are the issues I’m talking about.”

Varas points to Hearts & Wallets data, drawn from a recent survey of nearly 6,000 consumers, showing many savers are missing out by allocating their assets on either end of the liquidity spectrum and skipping the middle. As shown in the chart below, the average U.S. household allocates most of its savings to either end of the liquidity spectrum, with 41% going to “bank savings accounts or certificates of deposit.” On the other hand, 29% goes to employer-sponsored retirement plans such as 401(k)s, 403(b)s and 457s.

“The gap in the middle of the liquidity spectrum includes taxable brokerage, health savings accounts [HSAs], individual retirement accounts [IRAs] and 529s,” Varas says. “These are accounts used by experienced investors to compound wealth for various purposes throughout their working careers and then for retirement.”

The data shows that households that consider themselves “very experienced” with investing send 50% of their savings to the ends of the liquidity spectrum, with the other 50% going to account types in the middle.

“Where to allocate savings is critical to building future wealth,” adds Amber Katris, a Hearts & Wallets subject matter expert. “Experienced investors use the full spectrum of liquidity, compounding wealth and increasing access to funds. Aspiring savers may also benefit from advice to understand how insurance can lessen their perceived need for holding cash deposits, allowing them to invest and benefit longer term in the markets.”

Varas notes that other research conducted by Hearts & Wallets shows a wide disparity in the quality of “savings hierarchy” advice capabilities among the leading U.S. advisory, insurance and brokerage firms. Even those firms that get decent marks on this point—i.e., those that already provide relatively robust advice about how to allocate assets across different account types—could do a lot more to help people meet their goals, Varas says.

Learning From COVID-19

Janus Henderson Retirement Director Ben Rizzuto raises similar points in comments sent to PLANADVISER. In particular, Rizzuto says, the events of the past year have reinforced the importance of being financially prepared for unexpected emergencies and extended periods of work disruption.

“If anything positive came out of 2020, it’s the fact that the challenges we’ve faced over the past year gave us the opportunity to take a step back and consider what is truly important,” he says. “After seeing so many people’s lives turned upside down by the pandemic, many of us have placed a greater focus on our health, priorities and financial stability. As a result, many plan sponsors and business owners have had to reconsider what benefits and savings vehicles their participants and employees need.”

Rizzuto says the cash or cash-equivalent emergency fund is quickly becoming one of the foundational ideas in financial planning, yet it is something very few people take the time to set up and fund.

“In fact, according to the U.S. Federal Reserve, nearly four in 10 American households cannot come up with $400 in a financial emergency,” Rizzuto says, citing the commonly repeated fact. “This startling statistic—along with the economic turmoil the coronavirus pandemic continues to impart on businesses—has caused more plan sponsors and businesses to think about how to help employees put money into an emergency fund. Employers are in the perfect position to do this since their payroll systems can easily link to retirement plan savings options or options outside the plan.”

Echoing comments made by Varas, Rizzuto concludes that behavioral nudges are important to get investors focused on the “savings hierarchy.”

“These nudges help to remind participants what is available and allow a company’s benefits team to have a conversation with employees, so they can make the best decision possible,” he says.

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