The fiduciary standard was the ideal at the center of the Obama-era Department of Labor’s Conflict of Interest Rule, so much so that it was known as the fiduciary rule.
It was struck down in court, and the Trump administration put together another rule that is not altogether loved by anyone.
Will the Biden administration scrap that one as well and resurrect the fiduciary approach? Or is the Trump rule a new starting point?
President Joe Biden will “almost certainly” pause the Department of Labor investment advice rule early in his administration.
The Biden DOL will likely target a specific and controversial exemption allowing “investment advice fiduciaries” to engage in certain transactions that would otherwise be prohibited, explained Fred Reish, partner with the law firm Faegre Drinker Biddle & Reath.
Otherwise, there are things in the Trump rule that the Biden team will surely warm to, Reish added.
“In the preamble to the rule, the DOL expanded its interpretation of who is a fiduciary,” Reish said. “I suspect the new administration will agree with that and may even build on it. That part will, at the least, survive the change of administrations.”
At stake is a long-awaited resolution for an industry toggling between standards and proposed standards for a decade since President Barack Obama directed his DOL to craft a fiduciary rule in 2010.
There remain plenty of hurdles and a long way to go, but the two sides of the debate are closer than they have been to date. Barbara Roper, director of investor protection for the Consumer Federation of America, has been in the fight since the beginning and called the investment advice rule “a modest step in the right direction.”
She, too, sees the Biden administration working to strengthen existing efforts at both the DOL and the Securities and Exchange Commission’s Regulation Best Interest — as opposed to starting over or bringing back the fiduciary rule.
“It may be that DOL concludes, based on actions by SEC to toughen up Reg BI, that it can base its own standard on the Reg BI standard,” Roper said. “Meanwhile, DOL will still need to figure out how to close loopholes in the regulatory definition of fiduciary investment advice, which has already been reinstated as a final rule.”
Long, Winding Road
As this issue went to press, the DOL’s investment advice rule was slated to take effect in mid-February. In addition to the exemption, the new rule also restores the original “investment advice” regulation and its five-part test for defining an investment-advice fiduciary.
The rule was surprisingly tough, given it was issued under Secretary of Labor Eugene Scalia, who served as lead attorney for an industry coalition that successfully sued to overturn the fiduciary rule. Still, it falls short of where Democrats stand on these issues, Reish noted.
“Historically, Democratic administrations have been more concerned about financial conflicts of interest than Republican ones,” he said. “After all, that is what this new rule is all about. I don’t see the exemption going through unscathed as written.”
For the exemption, the Scalia DOL went back to the “impartial conduct standards” that underpinned the Obama rule. It includes three components:
• A best interest standard.
• A reasonable compensation standard.
• A requirement to make no materially misleading statements about recommended investment transactions and other relevant matters.
Satisfying the best interest definition requires the advisor to act with “prudence” and “loyalty,” terms that have been identified under the Employee Retirement Income Security Act of 1974.
Still, Roper wants to see the rules go a little further to protect investors.
“The guidance in the preamble to the DOL rule is a modest step in the right direction, since it acknowledges that rollover recommendations might constitute fiduciary investment advice; however it falls far short of what is needed to ensure that rollover recommendations are consistently treated as fiduciary investment advice,” she said.
Any rules published in the final 60 days of an administration, known as “midnight regulations,” can be rescinded by the incoming administration.
By withdrawing the rule and doing a bit of rewriting, the Biden DOL can seemingly restart the rulemaking process early in its administration. As recent history shows, that is key to establishing a finality to this issue.
Industry executives and trade associations are hopeful that at least some aspects of the investment advice rule will withstand a Biden review.
Before the election, Andrea McGrew, chief compliance officer with USA Financial, was certain that Biden and the Democrats would work quickly to reverse Trump’s investment advice rule, in part because the party declared that it would in its summer platform.
But now McGrew is not so sure.
“My hope would just be that they recognize this rule for what it is,” she explained. “Everybody in the industry sees it as a great compromise, a great middle ground in getting what everybody needs, yet doing it in a way where it helps the client. But it’s also manageable by firms and financial services companies.”
Boston Mayor Marty Walsh will have a big voice in the future direction of the DOL — if he is confirmed by the Senate as Biden’s labor secretary. A union member and leader for more than 30 years, Walsh will likely be a pro-worker advocate. The assistant secretary and head for the Employee Benefits Security Administration will also be a key nominee to watch.
The state of the economy could be a complicating factor. The Biden administration is expected to have its hands full getting the COVID-19 pandemic under control and sparing the economy from any further erosion of employment and business closures.
With reports of consumer debt soaring, mass unemployment and millions of Americans dipping into their savings and retirement funds, McGrew said the timing isn’t great for tougher rules on investment advice.
“Let’s focus on some different areas where we can get the economy going,” she said.
No Going Back
Out of the gate, Biden seemed intent on rounding up the old team, and Obama administration veterans dominated his early nominees. Dusting off the fiduciary rule seemed like a logical route — except for one major detail.
In 2018, the Fifth Circuit Court of Appeals in New Orleans tossed out the fiduciary rule, handing a major win to industry opponents. The chief legal voice for the industry plaintiffs, Eugene Scalia, would later be appointed by President Donald Trump to lead the DOL, and he helped write the successor rule.
Judge Edith H. Jones wrote in the majority opinion that the DOL rule “fails the reasonableness test” of the Administrative Procedures Act by extending the department’s ERISA authority to one-time IRA rollovers and similar transactions.
The decision went on to admonish the DOL for exceeding its authority and reaffirmed the role of Congress and the SEC in regulating agents and advisors.
“That was an incredibly aggressive piece of legislation, probably one of the most aggressive ones that I’ve seen in 16 years of being a compliance officer,” McGrew said of the fiduciary rule. “It was so aggressive that I don’t think they sort of understood all of the different trajectories of the rule. So it was a relief when the Fifth Circuit struck that down.”
What it all means is that any new rules put forth by the Biden administration will have to abide by the Fifth Circuit decision — unless the administration can find a court to overturn it.
It all adds up to yet another complication that the Biden team might not want to tackle, analysts say. The Consumer Federation of America is hoping the team does. In particular, Roper said the Biden administration should establish a bold definition of “fiduciary investment advice.”
The Fifth Circuit decision “was wrong on the facts and wrong on the law, but the new leadership at the department will have to decide whether they want to take on that fight,” Roper added. “Or, if the Democrats take the Senate, there’s at least a remote chance of a legislative solution to that problem.”
Very Different Rules
It is worth backtracking a bit to recall what made the fiduciary rule so unpopular in the first place.
For starters, the fiduciary rule hewed closely to the common law of trusts by mandating an Impartial Conduct Standard for conflicted investment advice. That standard requires fiduciaries to offer investment recommendations under a duty of care and loyalty, “without regard to the financial or other interests of the [firm or agent].”
The standard included three items that caused headaches for compliance executives:
• Best interest contract exemption. The BIC exemption would have allowed advisors and others to be paid for selling proprietary products and to earn commissions when they recommended select products. It would have dispensed with traditional commission structures and attached substantial documentation and liability to such sales. The rule required sales to be backed by a financial institution, of which the rule identified four: insurers, banks, broker-dealers and registered investment advisors.
• Private right of action. The fiduciary rule opened the door for investors to use BIC exemption contracts to file state breach of contract claims and, potentially, class actions.
• Impact on IMOs. Independent marketing organizations faced major disruption if the fiduciary rule had taken full effect. DOL regulators said they wanted to make sure the largest IMOs were tightly regulated as the “super-IMOs” to potentially act in a supervisory capacity for other smaller IMOs. Only seven IMOs — those with an average annual fixed annuity contract sales volume averaging at least $1.5 billion in premiums over each of the three previous fiscal years — were even eligible to qualify as financial institutions under the rule.
Industry trade organizations pushed back aggressively on the rule, coming together for a joint legal push. Financial professionals are already heavily regulated, industry executives said, and a tough DOL rule will only limit Americans’ access to advice.
It is worth noting that Tom Perez, 59, secretary of labor under Obama and chairman of the Democratic National Committee, was mentioned for roles in a Biden administration. Phyllis Borzi, assistant secretary for the Employee Benefits Security Administration, has remained a sharp critic of Trump’s DOL efforts, but she appears unlikely to rejoin a Biden administration.
Best Interest World
While the Fifth Circuit court victory was certainly welcomed by the industry, it was Trump’s surprise win in November 2016 that doomed the fiduciary rule. The twin victories cemented the industry’s determination, with tacit agreement by many regulators, for harmonized rules among state insurance, securities and federal regulators.
The middle ground verbiage was not far from language that appears in the fiduciary rule: the best-interest standard. The difference is the absence of the word “fiduciary,” any hint of a private right of action or other liability attached to a financial institution.
Work advanced at a faster pace at the SEC and at the state level within the National Association of Insurance Commissioners. Both navigated controversy and have these rules on the books:
• The SEC made steady progress under departed chairman Jay Clayton, and its Regulation Best Interest took effect in June 2020. Reg BI requires that four factors be considered in developing a recommendation for a retail customer: the customer’s investment profile, potential risks, potential rewards and costs. It also includes a new “customer relationship summary” disclosure between broker and customer.
• The NAIC Executive Committee finalized revisions to its suitability in annuity transactions (275) model law in February 2020. Arizona and Iowa quickly adopted versions of the new rules, but adoption lagged after the COVID-19 pandemic hit. Finally, the association convened a panel to develop guidance for states in the hopes of prodding more state officials to advance the best-interest update. Several states, including Rhode Island, Delaware and Alabama, moved to adopt the rules at the end of 2020.
But having rules on the books does not mean they harmonize or that they are even good rules, Roper said. She hopes that Biden can prod the SEC to strengthen Reg BI in concert with tweaks to the DOL investment advice rule.
But the state efforts are likely going to stand apart, Roper added. The NAIC model largely remains a suitability standard, and it exempts cash and noncash compensation from the definition of material conflict of interest.
“The NAIC model rule is explicit and weak,” Roper said. “That’s not a rule that can be tweaked into shape through strengthened interpretations of its key components. I don’t know how DOL will plan to handle that.”
The Trump administration’s best-interest rule did not come together as fast, and its experience serves as a cautionary tale for Biden. While Trump immediately paused the fiduciary rule after taking office, he ran into significant trouble getting a secretary of labor confirmed.
His first candidate, Andrew Puzder, withdrew on the eve of his Senate confirmation hearing after it became clear that he did not have the votes. Trump quickly nominated Alexander Acosta for the post, but his confirmation was delayed until April 27, 2017.
By 2019, Acosta found his own controversy from a plea bargain he had authorized for financier and convicted sex offender Jeffrey Epstein while serving as U.S. attorney in Florida. The resulting fallout eventually led to Acosta’s resignation in July 2019. By the time Scalia, the son of the late Supreme Court Justice Antonin Scalia, was confirmed on Sept. 30, 2019, much time had been wasted.
With Scalia taking an active role, the DOL finally released its investment advice rule replacement on June 29, 2020. Many in the industry did not like it — their dissatisfaction boiling over during a September public hearing.
Brad Campbell, onetime head of the DOL’s Employee Benefits Security Administration, called the guidance on the five-part test “fundamentally flawed,” adding that although it acknowledges that the sale of insurance products “is not fiduciary advice,” the guidance “goes on to create some significant ambiguity in the application of the five-part test, making it impossible to know with clarity where the department thinks the line has been drawn.”
Specifically, the preamble to the rule caused angst over how the DOL would interpret “regular basis” as it relates to the sale of insurance products. While a one-time sale of, say, an annuity, would not meet the five-part test, the agent could conceivably have future interactions as part of doing a good job for the client. Would that constitute an ongoing relationship defined in the test?
The DOL clarified this key aspect of the rule, Sidley Austin wrote in a December alert.
“A single instance of advice to roll over assets from a Title I plan to an IRA would fail to meet the regular-basis prong and, likewise, that sporadic interactions between a financial services professional and a retirement investor do not meet the regular-basis prong,” the law firm wrote. “In any case, it is clear that the determination of whether a fiduciary relationship exists in a given situation will be dependent on the specific facts and circumstances.”
All the industry is hoping for after a decade of wrangling are fair rules and a level playing field, said Marc Cadin, chief executive officer of Finseca, a rebranded trade association representing the entire industry.
“There are so many layers of regulations that financial security professionals have to comply with,” he said. “The beauty of the DOL and the SEC working in close coordination to create disclosures that fit both sides of the compliance burden is that ultimately provides consumers with more protection, more efficiency, and continues to give them access to the products.”
Your Move, Mr. President
The momentum, and simple common sense, favoring a harmonization of rules might further sway a Biden DOL to let the best-interest movement play out for the immediate future.
After all, the president might have total control over what the Labor Department does next, but his influence with the SEC and the states is less and little, respectively. Biden will nominate a new SEC chairman, but the protocols are very different with the independent agency.
An enormous difference in rules is that the SEC Reg BI rule cannot be withdrawn, while the DOL rule can. But beyond that, historically, presidents do not exert such an overtly political policy role over the SEC. Analysts are united in expecting the SEC rule will be around for some time. At best, the new administration might influence a more active enforcement and examination role for the agency.
Otherwise, the Biden White House is likely to have its hands full just getting a secretary of labor confirmed and avoiding the political hassles that bogged down the Trump DOL.
“The Department of Labor [nominees] would probably take among the longest,” Cadin said, “because there is the greatest divide between the two parties in terms of the regulatory approach within the Labor Department and how it impacts and protects consumers and impacts industry.”
Finseca had end-of-the-year conversations with the Biden team that were encouraging, Cadin added.
“In some of our conversations with the incoming Biden administration, they’ve made it clear that what the country needs now is stability,” he said. “We can’t have this whipsawing of laws and rules and the lack of clarity, because that inhibits the decision-making process and will ultimately hurt the economy.”