A Look At What’s Exempted In Fiduciary Proposal

The Department of Labor’s new fiduciary proposal, published recently in the Federal Register, barrels on for more than 36,000 words and spans nearly 75 single-spaced pages, footnotes included. The definition of a “fiduciary” alone runs to nearly 4,000 words.

But buried deep within this hefty tome, on Page 48, under the heading “Administrative Prohibited Transaction Exemptions (PTE),” are more than a dozen paragraphs pertaining to who is exempt from receiving various forms of compensation.

The passages’ subheading titled “Proposed Best Interest Contract Exemption (Best Interest Contract PTE),” would provide “broad and flexible relief from transaction restrictions” on compensation flowing to fiduciary advisors resulting from the purchase of an investment for a retirement plan or individual retirement account holder.

The DOL called the Best Interest Contract PTE “a significant departure from existing exemptions,” which in the past have been limited to narrower categories of investments “under more prescriptive and less flexible and adaptable conditions.”

It is a new, standards-based approach that the DOL said is in the best interest of retail investors, individual retirement account (IRA) owners and small plans.

A close reading of the proposal reveals that the Best Interest Contract PTE exemption would apply to registered investment advisors (RIAs), representatives of an RIA, a bank or similar financial institution, an insurance company or a broker/dealer.

In order to benefit from Best Interest Contract exemptions, advisors and the firm to would be required to sign documents that “contractually acknowledge fiduciary status,” according to the DOL proposal.

In addition to the Best Interest Contract PTE exemption, the DOL has proposed a separate “Principal Transaction PTE.”

Principal Transaction PTE refers to a “principal transaction” when broker/dealers or advisors sell debt securities out of their own inventory to retirement plans and IRA owners. This proposal would authorize such transactions between retirement plans or IRA owners and an investment advice fiduciary “under certain circumstances.”

A Principal Transaction PTE would include all of the contract requirements of the Best Interest Contract PTE, but it would also include specific conditions related to the price of the debt security involved in the transaction. Advisors would be required to disclose their compensation and profit they expect to receive from the deal.

The DOL said that to prevent broker/dealers and advisories from controlling the price of a debt security, advisors would be required to get two quotes from “unaffiliated counterparties for the same or a similar security.”

In addition to Best Interest Contract PTE and Principal Transaction PTE, the DOL is proposing to amend and revoke other PTEs related to churning, commissions received for acting as an agent and fees for nonfiduciary services.

The Best Interest Contract PTE and Principal Transaction PTE proposals, grounded as they are in a principles-based rather than a prescriptive approach, represent a compromise between the DOL’s regulators and the industry.

The DOL’s latest proposals retain many elements of the advisory industry’s business model, but also seek to protect investors by committing investment fiduciaries to basic standards of impartial conduct in an attempt to put investors’ interests first.

It is the DOL’s second attempt at redefining a fiduciary and regulating professional advisors operating in the retirement plan sector governed by the Employee Retirement Income Security Act (ERISA). The DOL’s previous attempt at defining a fiduciary was withdrawn in 2011 following public comment.

New regulatory action is necessary, government officials and public interest groups say, because for decades rules around what constitutes fiduciary advice have benefited the financial services industry at the expense of investors.

Financial watchdogs and regulators say many professionals, consultants and advisors have no obligation to adhere to the fiduciary standards or the PTE under ERISA, subjecting advisors to conflicts of interest that are costing investors and retirement plans billions of dollars.

The DOL’s analysis has found that underperformance associated with conflicts of interest — in the mutual funds segment alone — could cost IRA investors more than $210 billion over the next 10 years and nearly $500 billion over the next 20 years.

When ERISA was enacted into law in 1974, retirement security was controlled by a defined benefit plan industry where retirement accounts were professionally managed and workers could rely on monthly pension payments after a lifetime on the assembly line.

But ever since “deregulation” of retirement funding and the birth of the do-it-yourself defined contribution movement, workers have shouldered the burden of retirement investing through their employer-sponsored retirement programs.

Many workers haven’t saved enough for retirement. Critics say the financial services industry is partly to blame, claiming that advisors and brokers have put their interests before those of investors and retirement plan sponsors by charging high fees and selling products on which they earn hefty commissions.

Executives with insurance companies and broker/dealers have told analysts over the past two weeks that their companies are reviewing the DOL’s proposal, but already it’s clear that the rules will affect investment products in different ways.

A recent research note by Credit Suisse analyst Thomas Gallagher featured in a story by Arthur D. Postal on InsuranceNewsNet, found that the DOL proposal will likely affect fixed index annuities in addition to variable annuities, which are regulated as a security.

Mark Stephen Casady, chairman and CEO of LPL Financial, told analysts during an earnings conference call last week that the DOL’s proposed rules would affect companies in different ways depending on the asset mix held within retirement and nonretirement accounts.

In LPL’s case, 30 percent of the company’s assets are retirement account based and 70 percent are nonretirement account based, he said.

While the current version of the DOL proposal would not permit sales of certain alternative investments in brokerage retirement accounts, “such sales represent a minor contribution to our overall financial performance,” he said.

InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

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Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].