Filed Under:Your Practice, Regulatory

Industry girds for DOL fiduciary rule

Phyllis Borzi, left, Assistant Secretary of U.S. Department of Labor. (Jose Luis Magana/AP)
Phyllis Borzi, left, Assistant Secretary of U.S. Department of Labor. (Jose Luis Magana/AP)

Insurance agents and brokers are awaiting with bated breath a revised proposal from the Department of Labor (DOL) that would establish new rules for sale of investment products to beneficiaries of company-sponsored retirement plans and IRAs.

The industry universally fears that such a regulation, if finalized, would eliminate commissions as a source of broker-dealer compensation for such accounts.

They believe that this would potentially “price out” the majority of American IRA holders from affordable financial advice.

The proposal was first published for comment in October 2010, and has generated a huge amount of controversy.

The DOL and the Employee Benefits Security Administration (EBSA) plan to publish the new proposal for comment in July, according to the agency’s updated regulatory agenda, disclosed in late December.

The agency is now in the process of updating and expanding the economic impact statement seen as critical to winning court support for the proposal if any interested parties seek to challenge it based on the fact the agency did not properly weigh the potential cost of the proposal on the industry.

Moreover, an agency official said that the decision of DOL chief Hilda Solis to step down will not affect EBSA’s work on the re-proposal.

Agency officials reiterated that the regulation is needed to “draw a clear line between the sort of investment advice that is fiduciary in nature and, therefore, covered by the regulation and other types of communications that should not be treated as fiduciary communications.” For example, agency officials cite several comments on the original proposal that expressed concern that the earlier proposal would treat service providers as fiduciaries merely for giving customers some basic investment education or plan information. “That was never the Department’s intent and the re-proposed regulation will make that clear,” an agency official said.

And, the DOL is not the only agency examining the standards investment advisors must use in selling investment products to consumers.

The Securities and Exchange Commission (SEC) has also been evaluating how to establish a uniform fiduciary standard on the sale of investment products.

See also: Infographic: 2013 regulatory landscape: State and federal

However, Mark Smith, a partner at Sutherland, Asbill & Brennan in Washington, joins a number of industry officials and lawyers in predicting that the DOL is much farther along in its efforts to update the standards investment advisors, such as insurance agents and brokers, must use in selling investment products. The DOL confirmed this in its December regulatory update.

Knut Rostad, president of the Institute for the Fiduciary Standard, contends that all the DOL/EBSA is doing is “fairly and comprehensively applying the standard as originally envisioned in the legislation.”

Rostad said that is “the point that is being overlooked” in all the controversy generated by the DOL/EBSA rule.

“It is totally inappropriate to say they are ‘redefining’ the standard,” Rostad said. “That is a bunch of malarkey.”

But, Smith disagrees.

“All the statute [ERISA] says is that you are fiduciary if you provide investment advice for a fee,” Smith said.

“The statute on its face is neither broad nor narrow,” he explained. “We should interpret words or statutes on what they mean in their legal sense, and not attribute broader or narrow construction to them,” he said.

The industry consensus is that the DOL will publish a revised rule for comment sometime in the third quarter, perhaps as early as July.

Presently, the DOL and EBSA are working with the Washington-based Financial Services Institute (FSI) on preparing a regulatory impact analysis that is more comprehensive than the one contained in the original proposal, FSI officials said.

At the same time, Ken Bentsen, executive vice president of public policy and advocacy for the Securities Industry and Financial Markets Association recently said that the SEC plans to issue a “concept release,” which will also likely include a request for information, in the first quarter regarding its rule to put brokers under a fiduciary mandate.

What the SEC wants is more feedback on its cost-benefit analysis on its fiduciary rule.

But, Smith and other industry officials believe that the DOL is much further along on its work on a revised fiduciary standard.

The DOL or EBSA proposal has generated a great deal of debate.

The current standards have been in effect since 1974. But, DOL officials contend in pursuing the new standard that times have changed.

As explained by Sutherland in an investment alert, the DOL believes that since 1975, ERISA retirement plans have shifted from predominantly defined benefit to predominantly defined contribution.

DOL officials argue, the Sutherland alert explains, that the financial markets have also changed during that time and have become more complex.

 “As a result, the investment practices of plans, along with their relationships with their advisors, have changed,” Sutherland officials say in defining why DOL and EBSA officials see a change as necessary, because, “In this more complex environment, plan fiduciaries seek out impartial assistance and expertise from consultants, advisors and appraisers to advise them on investment-related matters.”

As a result, the Sutherland paper says, DOL and EBSA officials say that in structuring their relationships with plans, “advisors can too readily take advantage of the [current] five-part test to avoid fiduciary status.”

The DOL proposes to replace the existing five-part test for an exemption from the fiduciary standard with a two-part definition subject to a series of carve-outs, according to Smith.

He cites language in the proposal justifying it as noting that, in recent years, non-fiduciary service providers — such as consultants, appraisers, and other advisors — “have abused their relationships with plans by recommending investments in exchange for undisclosed kickbacks from investment providers, engaging in bid-rigging, misleading plan fiduciaries about the nature and risks associated with plans investments, and by giving biased, incompetent and unreliable valuation opinions.”

Yet, the proposal states, “no matter how egregious the abuse, plan consultants and advisors have no fiduciary liability under ERISA, unless they meet every element of the five-part test.”

The proposal has generated a large amount of bickering. It has generated 202 comment letters, and 39 organizations testified at a public hearing EBSA held on the issue last year.

In regards to SIFMA, which represents hundreds of securities firms, banks and asset managers, 94 members of Congress have sent letters to the DOL raising concerns with the proposed regulation. Seventy representatives and 24 Senators have sent a letter, including 62 Democrats and 32 Republicans. 

The DOL’s previous fiduciary proposal was “contrary to where Congress wanted the SEC to go in Section 913 of Dodd-Frank,” Bentsen said. Section 913 “makes it clear that you could have dual models under a uniform standard of care,” however, “the way the DOL is moving would eliminate the ability to have a commission-based model for ERISA accounts.”

Robert Smith, president of the National Association of Insurance and Investment Advisors (NAIFA), said NAIFA is concerned about the impact of the proposal on people who need advice on IRAs.

Currently, Smith said, “IRAs are not qualified plans and thus are outside the current ‘enforcement’ jurisdiction (they do have ‘definitional authority’) of the EBSA, the DOL agency which oversees ERISA. We are concerned about the impact of the proposal on a person's ability to seek advice from a member of NAIFA on how to make use of IRAs.” 

“Under the DOL proposal, many independent financial advisors might be forced to exit the IRA and company-sponsored retirement plan businesses, rather than face the onerous costs of restructuring their service offerings to suit the new rule,” argues Christopher Paulitz, senior vice president, membership & marketing for the FSI.

“The result: potentially millions of Main Street investors could be left without access to affordable and objective investment advice just as more and more of them are facing imminent retirement and a difficult economy.” Paulitz said.

Robert Kerzner, president and CEO of LIMRA, LOMA and LL Global, Inc., has a more sinister and broader concern. He sees the DOL/EBSA effort as part of an “alarming” worldwide trend by regulators “to take increasingly aggressive actions” against commissions through tightening of fiduciary standard rules.

“Regulators worldwide have a belief that commissions are bad … it’s sad but true,” he said last October at the LIMRA annual meeting. He cited the fact that Norway banned commissions in 2007, Finland in 2008, and Australia and the United Kingdom have banned commissions effective this year.

“Some regulators and some in the press have maligned producers for years —  questioning their motivation in recommending certain products,” Kerzner said. “We are seeing an alarming trend by regulators to take increasingly aggressive actions,” he said.

Kerzner said that only 1 in 5 consumers are willing to pay more than $100 for investment advice even though a decline in savings for retirement is reaching critical proportions.

Specifically, he said that four out of five American workers are saving less than 10 percent of their income for retirement. Moreover, almost 25 percent save nothing at all, he said.

Kerzner also said LIMRA research in 2012 indicated that only between 9 and 11 percent of consumers are prepared to pay commissions to get investment advice, while 55 percent prefer a flat fee. He said between 8 and 11 percent are prepared to pay an annual fee to get advice.

The DOL comments    

In background briefings for industry officials and lawyers, the agency has indicted that it intends that the revised proposal will provide examples on prohibited transaction exemptions and the economic analysis will be “robust.” Industry lawyers and trade groups have been advised that, as with all proposed rules, in addition to the regulatory text and preamble, it will have a regulatory impact analysis. The agency is making it clear that it “has put a lot of time and effort into revising the regulatory impact analysis in response to public comments. “We believe the revised regulatory impact analysis will enable interested parties to fully understand why the Department believes the regulation is necessary and what it considers to be the costs and benefits of the regulation,” an agency staff official said.

In general, agency officials cite comments by Phyllis Borzi, director of EBSA, and Solis that “this is fundamentally a consumer protection issue.”

Agency officials explain that, “When individuals and firms hold themselves out as impartial investment experts, and are compensated for their services, they need to put their customers’ interests first. They cannot subordinate the interest of their customers to promote their own financial interest. The Department holds that that is not what was intended by the framers of ERISA, and is revising this 30-plus year-old regulation to better reflect the statutory language and to minimize these conflicts of interest.”

An agency official said the re-proposed rule will set out the circumstances under which a fiduciary relationship arises based on the provision of investment advice. “ERISA protects plan participants, first and foremost, by regulating the conduct of plan fiduciaries — by making sure that these fiduciaries act with loyalty to plan participants and IRA customers and that they refrain from giving advice that is tainted by dangerous conflicts of interest,” the official said.

One agency official noted that, “It is worth remembering that at the time ERISA was enacted, most plan participants were in defined benefit plans, 401(k) plans didn’t exist, and IRAs had only just been authorized by statute.”

In today’s retirement market, however, the official said, “the overwhelming majority of participants are invested in defined contribution plans and IRAs.”

The official added that, “These investors need help in choosing from a bewildering range of investment options, and are dependent on the integrity and quality of the advice that they receive. It is past time to revisit the rule, and to make sure that it properly serves its statutory function.”

While there is staunch industry opposition, the proposal has strong support from some segments of the industry as well as consumer advocates.

The Pension Rights Center and the National Employment Lawyers Association said in a comment letter on the original proposal said it would replace current regulations, adopted in 1975, that “tightly circumscribe” the circumstances under which a person or entity becomes a fiduciary when providing investment advice to a plan or participant for a fee.

The 1975 regulation and a 1976 advisory opinion “were not compelled by the statute” and … “reflected an improper narrowing of the congressional definition of fiduciary.”

In addition, the groups said, as the DOL suggests in its preamble to the proposed regulations, “economic and legal developments in the fields of investments and employee benefit plans have rendered the earlier positions anachronistic and, at times, at cross-purposes with the statute.

“The proposed regulations are much-needed and long-overdue,” the letter said.

The AFL-CIO also supported the proposed rule. In a comment letter it said that the current rule is … “too narrow.”

The union organization said that “plan fiduciaries and participants must be able to determine when advisors rendering investment advice are subject to ERISA’s fiduciary standards and whether the advice they receive maybe affected by undisclosed conflicts of interest.”

As for the proposed rule, NAIFA’s Robert Smith said interested parties have not been provided with a “lot of detail” about what DOL/EBSA will propose, “but we do know that EBSA intends to include a class exemption to be sure people who advise but are paid by commission can still advise and still be paid by commission.”

As noted by Paulitz, Smith added that, “We also know they plan a robust economic impact analysis.”

Sutherland’s Mark Smith agrees with NAIFA’s Smith that the reproposal will be refined in line with the commentary received on the earlier proposal, and that it will add a proposed class exemption to those issues.”

But Mark Smith said, “to this point, the DOL/EBSA has not been willing to discuss in detail the changes they are planning to make.” But, he said his concern is that DOL/EBSA has “not previewed the scope, content or the conditions of this new exemption.”

He also said he is withholding judgment as to whether the new proposal will be acceptable to the industry. “It is entirely unclear whether any refinement we see in the new proposal will adequately respond to the concerns of the industry.”

C. Frederick “Fred” Reish, partner in Drinker Biddle’s Employee Benefits & Executive Compensation Practice Group, adds that he believes that the re-proposed regulation will require that, in some cases, service providers say that they are adverse to the plans and their fiduciaries.

“I think that, by and large, the re-proposed regulation will be very similar to the proposal that was withdrawn, but there will be some meaningful differences,” Reish stated.

For example, Reish said he believes that DOL will be concurrently issuing a series of proposed prohibited transaction exemptions.

In some ways, those proposed exemptions will be more important than the wording of the regulation … particularly if my prognosis is correct that the re-proposal will be similar to the previous proposal.

Reish said he hopes that the DOL/EBSA re-proposal  will be expansive and cover all of the customary and usual fees paid by investments in IRAs.

Reish predicts that “some of the most objectionable language in the initial proposal will be removed and that more acceptable language will replace it.” 

Elizabeth Festa of National Underwriter and Melanie Waddell of AdvisorOne contributed to this article.


See also:

Washington regulation: 6 things to look for in 2013

Incoming fiduciary standards likely to level commissions

Borzi: DOL to offer new version of fiduciary rule in "several months"

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