The long, winding saga of the Department of Labor’s quest to update investment advice rules took another turn recently that can be fairly described as “Back to the Future.”
As expected, the Trump administration pushed out new advice rules that substantially return the industry to a pre-2016 regulatory environment — with a twist. The underlying standard will again be the Employee Retirement Income Security Act “five-part test” developed in 1975.
But these rules add a new class exemption that would enable certain types of investment advice fiduciaries to receive a wide range of fees and other compensation without engaging in non-exempt prohibited transactions.
The proposed exemption “would give Americans more choices for investment advice arrangements, while protecting the retirement savings of American workers,” Secretary of Labor Eugene Scalia said. “The exemption would add to the tools individuals need to make the right decisions for their financial future.”
Scalia is no stranger to these issues. He was last seen debating investment advice rules in court as a Gibson, Dunn & Crutcher attorney representing several clients suing the previous DOL rule, a true fiduciary standard put in place by President Barack Obama’s administration.
Industry groups who called the fiduciary rule a gross overreach are understandably pleased with the new rule package.
“The DOL’s new proposal would remedy many of the problems with the original fiduciary rule,” said Kevin Mayeux, CEO of the National Association of Insurance and Financial Advisors. “It is designed to allow existing business models, product offerings and compensation arrangements to continue.”
But opposition to the Scalia proposal is widespread, including from the advisory world.
Prominent analyst Jamie P. Hopkins, director of retirement research at Carson Group, is calling the rules a softball to financial services, especially those in insurance.
“In essence, it is keeping a lot of the status quo in place, but creating more ways to engage in conflicted advice than ever before by providing legal protections from the prohibited transaction rules for fiduciaries that engage in certain types of self-dealing or conflicted compensation models,” Hopkins said.
While the rules do not need approval from Congress, Sen. Patty Murray, D-Wash., rushed out a statement blasting the effort.
“This inadequate proposal will leave financial advisors free to put their interests ahead of their clients,” Murray said. “We need a strong fiduciary rule to protect people’s hard-earned savings.”
And political realities likely make the rules an endangered entity long term. With President Donald J. Trump lagging badly in the polls, the DOL advice rules could be a prime candidate for reversal should Democratic challenger Joe Biden win the White House.
But while Biden is certain to oppose the new rules, how high a priority it would be for him is hard to gauge. It took the Trump DOL more than three years to complete a new advice proposal.
For now, the new advice rules are set to take effect 60 days after final publication in the Federal Register. Comments are being accepted on the proposed exemption until Aug. 6.
One important goal for Trump administration regulators and the industry is harmonization of rules. The new DOL rules are very similar to the Securities and Exchange Commission’s Regulation Best Interest. That rule took effect June 30 and theoretically holds brokers to a best-interest standard.
SEC examiners have indicated that they are merely looking for a “good-faith effort” to comply given the COVID-19 stress on the industry.
A Big Exemption
The key to the new rules is the prohibited transaction exemption for which the DOL is specifically soliciting comments.
“This rule says if you are a fiduciary, you can engage in a lot of self-dealing and conflicted compensation that is currently not allowed as a fiduciary in selling products and engaging in rollover advice,” explained Hopkins, also a finance professor of practice at Creighton University. “In essence, the DOL is acknowledging a standard only to build an exception from having to adhere to it.”
In order for investment advice fiduciaries to rely on the proposed class exemption, the law firm Carlton Fields noted, they must satisfy the exemption’s “impartial conduct” standards, which include 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 ERISA. According to Carlton Fields, this is one area of disagreement between the DOL rule and RegBI, as the latter rule does not require “prudence.”
The exemption also requires specific disclosures to retirement investors, conflict mitigation procedures and retrospective compliance review. The disclosure condition requires financial institutions to disclose to retirement investors their status as investment-advice fiduciaries and provide an accurate written description of their services and material conflicts of interest, Carlton Fields said.
Much like the SEC rule, the DOL standard expects financial institutions to establish mitigation policies to keep their advisors from issuing conflicted advice.
‘A Free Pass’
But critics maintain that the proposal does little more than gloss over conflicted advice problems that accompanied the growing complexity of products.
“Insurance agents will get a free pass from DOL to encourage retirement savers to withdraw a lifetime of savings from their retirement plans and sink that money into a high-cost, opaque, illiquid annuity that saddles the retirement saver with subpar performance,” said Barbara Roper, director of investor protection for the Consumer Federation of America.
Furthermore, there is no enforcement mechanism in the DOL rule, so investors harmed by conflicted advice will have “no recourse and no ability to recover their losses,” she added. “We don’t expect to see any meaningful changes in harmful practices that pervade the industry.”