Fiduciary Crunch Time
Be honest—have you read the whole thing?
The final published form of the Department of Labor (DOL)’s landmark fiduciary rule weighs in at over 1,000 pages.
Anyone even half familiar with the nitty-gritty of employee benefits law and of federal rulemaking in general can imagine just how terse those pages are, and just what the process of actually sitting down and carefully digesting the mountain of paper and ink entails. Luckily for advisers and plan providers alike, there is no shortage of ERISA [Employee Retirement Income Security Act] attorneys to provide guidance.
One voice is Steven Wilkes, a partner with the Wagner Law Group, who is based in Boston. Wilkes says that, as plan advisers head into the final quarter of 2016, many will need to institute formal changes to ensure compliance with the DOL’s fiduciary rule reform.
It will not be easy or particularly fun, actually sitting down to read the rulemaking language, he admits, but there is so much that can vary from practice to practice, individual firms absolutely must perform their own close review.
Even for firms that decide to maintain their old business models and rely instead on the Best Interest Contract (BIC) exemption, technical compliance does not ensure client satisfaction. Experts interviewed for this article pretty much agree that flat-fee models clearly favored by the DOL for being perceived as less conflicted will have a competitive edge in the new fiduciary future.
“As you consider and then implement any necessary adjustments to compensation, any ERISA counsel you have access to should review your documentation and the documentation needed by any providers you work with,” Wilkes says. “It’s a complicated rule, but there is nothing like engaging with the language yourself and asking the tough questions for yourself, whether about your own business or that of a partner.”
On Wilkes’ reading, the new rule “clearly broadens the scope of advisers who will be deemed individual retirement account [IRA] or defined contribution [DC] plan fiduciaries.” What is less clear are the specific approaches individual firms and advisers will take to ensure compliance—not to mention how these approaches will stack up against one another and affect client decisionmaking throughout the sales and service process. So, in that sense, the big task currently ahead of advisers is to understand both internal and external change driven by the rule.
“The rule impacts all plan vendors in at least a peripheral way,” Wilkes points out, “not just broker/dealers [B/Ds] or registered investment advisers [RIAs] earning commission-based compensation and also selling IRAs. Exclusions from the new definition will directly encourage the increased flow of information to plans, so that is something else to watch out for. If you have not already, you will soon start seeing drafts of disclosures and warranties coming from asset managers, recordkeepers and other providers.”
ERISA experts universally agree that retirement plan advisers will have to coordinate responses to the new fiduciary paradigm very closely and carefully, both within their own firms and across service provider partners, especially brokerage and investment platform providers.
Bradford Campbell, counsel at Drinker Biddle & Reath LLP in Washington, D.C., and former head of the Employee Benefits Security Administration (EBSA), suggests that advisers’ own plans for responding to the new regulations may be superseded by those of their service provider partners. At the very least, advisers will have to make sure the response they would like to implement will still be possible after any pending changes their brokers or investment provider partners and others may themselves choose to make.
“For advisers who find themselves becoming fiduciaries for the first time, a lot of the response will be determined by how your broker is going to want to handle the Best Interest Contract exemption,” Campbell says, noting that both before and after the final rule language emerged, the BIC exemption was—and remains—a major point of contention between regulators and the regulated. “At a very high level, we believe there will basically be three responses that brokerage platforms are going to take, and that advisers will have to take into account in adjusting their own business models.”
First is the model that the DOL, it is fair to say, is trying to encourage through the strict new rulemaking and wide expansion of those qualifying as fiduciary advisers. “This would be the full level-fee approach, taking away all sources of variable compensation to get around the prohibited transaction concerns entirely,” Campbell explains. “This will be attractive because it will be by far the most simple and direct way to comply with the final rule.”
This is obviously an attractive approach on a theoretical level, Campbell says, because it would ease much of the concern that has emerged on the part of advisers who want to serve both defined contribution plans and IRA owners. But it could be difficult to pull off for many firms that have not previously structured their business this way, he advises. “It’s going to be a fundamental change to make in the relatively short timeline the DOL has given us.”
Second will be essentially the opposite approach. “This will mean brokers deciding they are OK with advisers relying fully on the BIC exemption for pretty much all of their client relationships, which will also be tough because of the extensive disclosure requirements that go along with papering the BIC, even under the final rule, which has been softened from the proposed version pretty substantially,” Campbell says. “This will be the approach for brokers who are unwilling or unable to forgo variable compensation and commission-based models for advisers, especially in the short to medium term.”
The last approach, Campbell says, will be something of a hybrid: “The third approach will essentially entail using the BIC exemption in some circumstances, but also making sure the adviser who is actually on the ground making recommendations is getting level compensation no matter what he advises the client to do,” he says. “This will potentially allow the financial institution to get variable compensation, and so it may still require the BIC exemption to be used in certain circumstances. The main idea is to protect the wider firm from liability and litigation by making sure the boots-on-the-ground adviser, specifically, is not conflicted.”
Will All Advisers Be Fiduciaries?
David Bellaire, executive vice president and general counsel
at the Financial Services Institute in Washington, D.C., agrees with Campbell
that advisers will be unable to respond unilaterally to the new fiduciary
paradigm. He also warns that, whatever approach is taken, “advisers can’t
ignore the principles at the heart of the final rule.”
“Even under the BIC, you can’t misalign the best interest of the adviser and the participant,” he says. “You will have to quantify and justify any increased compensation, should you choose to continue with commissions and other variable compensation models. Doing business that way will frankly mean more risk and a lot more compliance work, and that’s what DOL wants.”
Even with a broader rule, experts are quick to add that there will still be forms of nonfiduciary service out there. Recordkeeping platform providers are excluded from the rule in some important ways, for example, and so are those professionals engaged solely in unbiased investment education. General communications a reasonable person would not view as investment recommendation are also excluded, such as newsletters, talk shows, speeches at conferences, research or news reports, market data, etc.
Wilkes further observes that large plan sponsors will see the rule play out a little differently, given the “sophisticated investors” exclusion that basically gives large plans and their advisers more flexibility, built around the assumption that sponsors at the largest plans will have sufficient experience to protect themselves and their participants from any bad deals or advice. But even advisers exclusively serving large plan sponsors may see significant changes in terms of process, product availability and documentation, and they should be prepared in some cases to start spending more on new compliance procedures.
Overall, experts urge advisers to not put too much faith in the crop of lawsuits that have come up seeking to halt the fiduciary rule’s implementation via an injunction from a district or appellate court.
“So far, there have been dozens of different points of complaint against the rulemaking, contained in a small handful of lawsuits, ranging from First Amendment challenges to suggestions the DOL is purposefully being arbitrary and capricious in widely expanding its fiduciary standard,” Wilkes says. “There are some important issues to consider in these complaints, certainly, but I have to say we are expecting that the new rule is here to stay and that the deadlines we have seen will be enforced.”
Likely Points of Friction
Anthony Domino Jr., managing principal of Associated Benefit
Consultants in Rye Brook, New York, is among the sizable group of advisers who
appreciate the motivation of the DOL in crafting a new fiduciary paradigm but
who also believe the final rule is far from perfect.
“The DOL really just wanted to solve a specific problem of conflicted advice in the defined contribution and individual retirement account arena, and that’s an admirable goal, but, frankly, I still don’t think it’s done this, even with a thousand pages of rulemaking,” Domino says. “The main issue is that DOL does not have the necessary enforcement power. I don’t think any regulatory system that relies primarily upon open litigation as the main and really only enforcement is a good way to go about doing things. That’s just going to create more costs, more litigation and animosity for all parties involved, right at the time when DC plans are more important than they ever have been.”
Domino suggests the DOL has opened a can of worms by requiring that fees “have to be reasonable, predictable and transparent.”
According to Domino and others, the plaintiffs’ bar is “clearly interpreting the rule as it exists now and as it will exist in 2018 and beyond to say that fees have to be as low as theoretically possible.” In that sense, it does not really matter what the DOL is intending, given that it is relying on litigators to enforce the new rule for it.
KEY TAKEAWAYS
- The new fiduciary rule is likely to accelerate some trends that were already underway, such as moving to flat fees, because the easiest way for advisers to comply with the rule is to charge by that means.
- Advisers who continue to charge commissions will need to use the Best Interest Contract exemption.
- Some attorneys foresee advisers using a combination of flat fees and the BIC exemption, but advisers, broker/dealers and others are still determining how they will respond to the rule.