Revamped Fiduciary Proposal
This spring, the Department of Labor (DOL) introduced the latest version of what it calls a consumer protection proposal—or what the industry knows as the fiduciary redefinition. This represents the latest step in the years-long effort by the DOL to strengthen investment-advice and conflict-of-interest standards under the Employee Retirement Income Security Act (ERISA).
At the most basic level, the rewritten fiduciary standard, released in mid-April, would increase the number of advisers and brokers who serve plan sponsor and participant clients in a fiduciary capacity—as well as the types of services and product recommendations that fall into the domain of fiduciary advice.
The new rule would supersede and replace ERISA’s current five-part test for determining whether a person or entity is providing fiduciary investment advice.
The DOL is proposing to replace that regulation, established in 1975, with a broader definition, under which “a person renders fiduciary investment advice simply by providing investment or investment management recommendations or appraisals to an employee benefit plan, a plan fiduciary, participant or beneficiary, or an IRA [individual retirement account] owner or fiduciary.” Along with providing this advice for a fee, he would “either a) acknowledg[e] the fiduciary nature of the advice, or b) act … pursuant to an agreement, arrangement or understanding with the advice recipient that the advice is individualized to, or specifically directed to, the recipient for consideration in making investment or management decisions regarding plan assets.”
Despite what many say is complicated phrasing, and 120 pages of supporting rulemaking language, the DOL says its new fiduciary definition is driven by a far broader and simpler principal than the one in place now. As explained by Labor Secretary Thomas Perez, “You want to give financial advice, you’ve got to put your client’s interests first.”
The DOL has offered industry service providers and stakeholders 90 days, starting April 15, to comment on the proposal, with a public hearing taking place within 30 days of the end of the comment period.
Adding Protections to ERISA
Since originally proposing a stronger fiduciary standard back in 2010, the DOL has contended that the lines drawn by the five-part test frequently permit evasion of fiduciary status and responsibility in ways that undermine the statutory text and purposes of ERISA and subsequent guidance. Service providers rejected that interpretation and debated strongly with the DOL; their protests continue today, despite the fact that the revised rule language has been softened.
For an example of the problem with the current fiduciary standard, the DOL highlighted an adviser’s assistance with a one-time purchase of a group annuity to cover promised benefits when a defined benefit (DB) plan terminates. The agency says that, due to the “regular basis” requirement—the first part in ERISA’s test—the adviser here would not be a fiduciary. Under the new rule, however, this adviser would be deemed one. In addition, the DOL argues that the regular basis requirement deprives individual participants and IRA owners of statutory protection when they seek specialized advice on other one-time transactions—such as with the decision to make an annuity purchase or to transfer a 401(k) account balance to an IRA.
The new proposal would make the person or entity giving this advice a fiduciary and provide statutory protection to the participant in these cases, Perez says. Though the rule distinguishes simple “broker order-taking” from broker-provided investment advice, and provides specific carve-outs for providers’ call center representatives, the proposal takes a step forward on unifying standards for all brokers and advisers touching retirement plans. The new definition of fiduciary investment advice will generally cover single investment recommendations, multi-asset investment product recommendations, appraisals of investments, or recommendations of persons to provide investment advice for a fee or to manage plan assets.
Exemptions-Based Approach
Matching the expectations of some industry practitioners and analysts, the DOL appears to be taking an exemptions-based approach to building a stronger fiduciary standard. As Perez explained during a national media call, the wider application of the fiduciary standard would come along with a new set of prohibited transaction exemptions (PTEs) designed to allow fiduciary advisers—newly deemed or legacy fiduciaries—to continue to receive commissions, 12b-1 fees and other widely practiced forms of compensation—so long as proper disclosures are made.
Perez explained that, at present, individuals supplying fiduciary investment advice to employer-sponsored retirement plans are required to act impartially and give advice that is in their clients’ best interests. Under ERISA, individuals providing fiduciary investment advice are not permitted to receive payments that would create conflicts of interest without citing and complying with the requirements of a specific PTE. This basic scheme continues under the new rule, Perez noted.
“Drawing on comments received and in order to minimize compliance costs, the proposed rule creates a new type of PTE that is broad, principles-based and adaptable to changing business practices,” he said. “This new approach contrasts with existing PTEs, which tend to be limited to much narrower categories of specific transactions under more prescriptive and less flexible conditions.”
One important PTE under the new rule is referred to as the “best interest contract exemption,” or “BIC,” which will allow advisory firms to continue to set their own compensation practices so long as, among other things, they and the individual adviser who gives the fiduciary advice enter into a contract with their client to formally commit both firm and adviser to ensuring the advice they give is in the client’s best interest. The contract commits the adviser to “act with the care, skill, prudence and diligence that a prudent person would exercise based on the current circumstances,” Perez noted. “In addition, both the firm and the adviser must avoid misleading statements about fees and conflicts of interest.”
To use this or any other PTE under the new rule, an advisory firm must provide evidence to the DOL that the firm has proactively investigated and identified material conflicts of interest and compensation structures that could encourage individual advisers to make recommendations not in clients’ best interests. Although an adviser will need no prior approval from the DOL to use the exemption, the agency may later determine that a prohibited transaction occurred if errors or improprieties are found.
Different Opinions
Advisers responding to the recent fiduciary proposal have “distinct and divergent viewpoints about the rule,” says Mark Spina, executive vice president and head of U.S. intermediary distribution at Pioneer Investments in Boston, referring to a Pioneer survey of 875 advisers.
Findings from the live webinar poll, conducted April 30, show that 38% believe the new fiduciary proposal will hurt their business, while 27% believe the rule will help it. Spina suggests that the latter may hold this belief because they have already established business protocols consistent with the best practices expressed in the rule. About 21% of advisers said the rule would be a nonevent, and 14% were unsure how it would affect their business.
The National Association of Plan Advisors (NAPA) holds steady on its position. The DOL’s long-awaited fiduciary re-proposal will add cost and complexity to the rollover process, the group said in a statement, citing potentially burdensome initial and annual disclosures. —John Manganaro and Rebecca Moore