DOL Fiduciary Rule

Today, fiduciaries and financial advisors must meet different ethical standards regarding the advice they give. The Fiduciary Ruling, which was vacated in 2018, proposed that all financial advisors working on retirement accounts meet the higher fiduciary standard. This rule may return through joint mechanisms by the Department of Labor (DOL) and the Security Exchange Commission (SEC).

Return of the Department of Labor Fiduciary Rule

According to Labor Secretary Alexander Acosta, the DOL and SEC will be working together to strengthen Employee Retirement Income Security Act (ERISA) compliance. They intend to do so through the DOL’s new fiduciary rule and the SEC’s action-reform package that is still in proposal. The original Department of Labor fiduciary rule proposed in 2015 required financial advisors to place their clients’ interests ahead of their personal interests. It was supposed to be phased in by Jan. 1, 2018, but faced delays and was eventually vacated.

History of the Fiduciary Rule

The Fiduciary Ruling was part of President Obama’s proposed overhaul of the financial industry on Feb. 23, 2015. The rule would expand the definition of an “investment advice fiduciary” under the terms of ERISA. Under this new rule, all financial professionals that offered retirement advice or worked in tangential rules would have to meet certain fiduciary legal and ethical standards.

In March 2017, the DOL delayed the rule for 60 days. In May of the same year, Secretary Acosta assured the public that the rule would not be delayed beyond June 9, 2017, but it was halted by a 30-day period for public comment starting on June 30, 2017. In August, the DOL proposed an 18-month delay to the implementation of the new rule. Ultimately, the rule was abandoned in 2018. 

Since its implementation in 1974, ERISA hasn’t seen any revisions that consider shifting trends in retirement accounts. Unlike in the 1970s, which had defined benefit plans as the standard, the last decades have seen a growth of defined contribution plans and IRAs.

Defunct DOL Fiduciary Rule

Today, brokers only need to uphold a minimal standard of offering suitable investment recommendations. Register Investment Advisors (RIAs), on the other hand, must act according to a fiduciary’s standard and offer recommendations in their clients’ best interests. 

A 2015 report from the White House Council of Economic Advisers found that biased advice was making retirement investors lose out on $17 billion a year. This report prompted the 2017 proposal. The 2017 rule was designed to prevent financial advisors from putting their interests above their clients’ needs, and commission-based brokers would have to inform their clients of the potential bias through a Best Interest Contract Exemption (BICE). These provisions would reduce the risk of “churning,” or making changes to clients’ managed portfolios that would primarily increase brokers’ profits. 

Breaking Down the Fiduciary Rule and Its Making

The Fiduciary Ruling was extremely controversial because it would lower commissions and churning-based profits for brokers. But it would also protect individual investors by limiting brokers’ ability to act against their interest or conceal conflicts of interest. The rule was vacated in 2018, and its unprecedented nature heatedly discussed, including its:

• Numerous stops and starts with public groundwork.

• Legislative proposals to rewrite or review the rule, as well as a February 2017 order from the White House to review it.

• Numerous requests for public comments.

• Six litigations that challenged the rule.

The Labor Secretary announced a potential revival of the rule in May 2019 and is currently reviewing its regulatory options.

The New Fiduciary Rule

The DOL’s future rule will expound upon the definition of fiduciary. While the rule prohibits some self-dealing or biased recommendations, it will also have exemptions for brokers under certain circumstances. Furthermore, while ERISA doesn’t allow for conflicts of interest, brokers can have conflicts of interest under an SEC regime as long as they disclose the conflict. The new ERISA rule would also adhere closely to current SEC standards in the SEC’s Regulation Best Interest. It might not hold brokers to the fiduciary standard if they offer only incidental advice.

Current Fiduciary Rule Standing

The new rule also faces conflict. Industry opponents consider the rule to be too expensive and think the BICE factor would lead to excessive class action lawsuits. However, after the rule was vacated in 2018, many states introduced their own similar measures. Advisors now face different governing provisions. Recently, Secretary Acosta testified that the department is working with the SEC to release a new federal-level rule.

SEC’s Regulation Best Interest

The SEC’s Regulation Best Interest protects investor interests. It requires brokers and advisors to disclose conflicts of interest and mitigate them when possible. However, the fiduciary rule will offer more protection for individual consumers and investors. In fact, many SEC Regulation Best Interest opponents point to the lack of legal consequences outlined in the provision as a sign that brokers and advisors can continue to operate in their own self-interest.

Fiduciary vs. Suitability

Fiduciaries must meet a much higher standard than simply offering “suitable” recommendations. Brokers must offer at least suitable products, or products that meet investors’ needs and objectives. To meet the fiduciary standard, advisors and brokers would have to disclose conflicts of interest through a BICE. This standard would apply to financial professionals that worked on defined-contribution plans, defined-benefit plans, and Individual Retirement Accounts (IRAs). General education, answers to specific product questions, and advice on post-tax investments would not fall under this new standard.

Effects of the New Fiduciary Rule

The new fiduciary rule will protect investors and limit brokers’ ability to act in their own self-interest during applicable conflicts of interest. 

Positive effects of the new rule might include:

• Increased investor access to sound recommendations.

• Greater trust between financial advisors and clients.

• A potential reduction in annuity sales that don’t help investors.

Some negative effects might include:

• Increased compliance costs.

• An increased and potentially untenable compliance burden on smaller firms.

• Industry consolidation through the closure of small or independent firms.

What Advisors and Their Clients Need to Know

Secretary Acosta testified about plans regarding the SEC and DOL’s collaboration on new rules that would govern fiduciary responsibility for financial advisors who work with retirement accounts. Advisors might want to stay informed about the potential for future fiduciary rulings, compliance structure changes, and increased oversight. To make sure your company can meet future compliance obligations, contact us about our types of fiduciary services.