Here's the latest installment in the long, strange tale of the Department of Labor (DOL) fiduciary rule, originally scheduled to be phased in from April 10, 2017 to Jan. 1, 2018. As of June 21, 2018, the U.S. 5th Circuit Court of Appeals officially vacated the rule, effectively killing it.
President Trump asked for a review of the fiduciary rule shortly after taking office in 2017. First, it was delayed until June 9, 2017, including a transition period for the application of certain exemptions to the rule extending through Jan. 1, 2018. Full implementation of all elements of the rule had been pushed back to July 1, 2019.
Before that could happen – on March 15, 2018 – The Fifth Circuit Court of Appeals, based in New Orleans, vacated the fiduciary rule in a 2-1 decision, saying it constituted "unreasonableness," and that the Dept. of Labor's implementation of the rule constitutes "an arbitrary and capricious exercise of administrative power." The case had been brought by The U.S. Chamber of Commerce, The Financial Services Institute and other parties. Its next stop could be the Supreme Court.
The following Monday, March 19, the Dept. of Labor told CNBC that "pending further review" it "will not be enforcing the 2016 fiduciary rule."
Finally, On June 21, 2018, the 5th Circuit Court of Appeals confirmed its decision to vacate the rule.
History of the Fiduciary Rule
The fiduciary rule expanded the “investment advice fiduciary” definition under the Employee Retirement Income Security Act of 1974 (ERISA). Running 1,023 pages in length, it automatically elevated all financial professionals who work with retirement plans or provide retirement planning advice to the level of a fiduciary, bound legally and ethically to meet the standards of that status. While the new rules were likely to have had at least some impact on all financial advisors, it was expected that those who work on commission, such as brokers and insurance agents, would be impacted the most.
The regulation was initially created under the Obama administration, but in Feb. 2017, President Trump issued a memorandum that attempted to delay the rule's implementation by 180 days. This action included instructions for the DOL to carry out an “economic and legal analysis” of the rule's potential impact. Then, on March 10, 2017, the DOL issued its own memorandum, Field Assistance Bulletin No. 2017-01, clarifying the possible implementation of a 60-day delay to the fiduciary rule.
In late March 2017, the world's two largest asset managers, Vanguard and BlackRock, called for a more significant delay considering the confusion these repeated moves to delay the rule had caused. After a 15-day public comment period – during which time the DOL received about 193,000 comment letters with nearly 178,000 opposing a delay – the DOL sent its rule regarding the delay to the Office of Management and Budget for review.
After the review by the OMB, the DOL publicly released an official 60-day delay to the fiduciary rule's applicability date. The 63-page announcement noted that "...it would be inappropriate to broadly delay application of the fiduciary definition and Impartial Conduct Standards for an extended period in disregard of its previous findings of ongoing injury to retirement investors." Responses to the delay ranged from supportive to accusatory, with some groups calling the delay "politically motivated."
In late May 2017, newly appointed Labor Dept. Secretary Alexander Acosta, writing in an opinion piece for the Wall Street Journal, confirmed that the fiduciary rule would not be delayed beyond June 9 as the DOL sought "additional public input." The DOL officially reopened the pubic comment period for the rule for another 30 days on June 30, 2017.
However, in early August 2017, the DOL filed a court document as part of a lawsuit in the U.S. District Court for the District of Minnesota, proposing an 18-month delay to the rule's compliance deadline. This would have changed the final deadline for compliance from Jan. 1, 2018, to July 1, 2019. The same document suggested the delay might include changes to the types of transactions that are not allowed under the fiduciary rule. The proposed delay was approved by the Office of Management and Budget in August 2017.
Originally, the DOL regulated the quality of financial advice surrounding retirement under ERISA. Enacted in 1974, ERISA had never been revised to reflect changes in retirement savings trends, particularly the shift from defined benefit plans to defined contribution plans, and the huge growth in IRAs.
A set of reforms was proposed back in 2010, but it was quickly withdrawn in 2011 after fierce protest from the financial industry regarding regulatory costs, liability costs and client concerns.
Five years later, the financial industry was put on notice in 2015 that the landscape was going to change. A major overhaul was proposed by President Obama on February 23, 2015: "Today, I'm calling on the Department of Labor to update the rules and requirements that retirement advisors put the best interests of their clients above their own financial interests," the President said. "It's a very simple principle: You want to give financial advice, you've got to put your client's interests first."
The DOL proposed its new regulations on April 14, 2016. This time around, the Office of Management and Budget (OMB) approved the rule in record time, while President Obama endorsed and fast-tracked its implementation; the final rulings were issued on April 6, 2016. Before finalizing the ruling, the Labor Department held four days of public hearings. While the final version was being hammered out, the legislation was known as the fiduciary standard. In January 2017 during the first session of Congress of the year, a bill was introduced by Representative Joe Wilson (R, S.C.) to delay the actual start of the fiduciary rule for two years.
Breaking Down the Fiduciary Rule
The Dept. of Labor’s definition of a fiduciary demands that retirement advisors act in the best interests of their clients and put their clients' interests above their own. It leaves no room for advisors to conceal any potential conflict of interest, and states that all fees and commissions for retirement plans and retirement planning advice must be clearly disclosed in dollar form to clients. The definition has been expanded to include any professional making a recommendation or solicitation in this area – not simply giving ongoing advice. Previously, only advisors who were charging a fee for service (either hourly or as a percentage of account holdings) on retirement plans were likely to be fiduciaries. (And even then, to find out for sure you needed to ask.)
Fiduciary is a much higher level of accountability than the suitability standard previously required of financial salespersons, such as brokers, planners and insurance agents, who work with retirement plans and accounts. "Suitability" means that as long as an investment recommendation meets a client's defined need and objective, it is deemed appropriate. Under a fiduciary standard, financial professionals are legally obligated to put their client’s best interests first, rather than simply finding “suitable” investments. The new rule would have therefore eliminated many commission structures that govern the industry.
Advisors who wished to continue working on commission would have needed to provide clients with a disclosure agreement, called a Best Interest Contract Exemption (BICE), in circumstances where a conflict of interest could exist (such as the advisor receiving a higher commission or special bonus for selling a certain product). This was to guarantee that the advisor was working unconditionally in the best interest of the client. All compensation that was paid to the fiduciary was required to be clearly spelled out as well.
Covered retirement plans included:
- defined-contribution plans: four types of 401(k) plans, 403(b) plans, employee stock ownership plans, Simplified Employee Pension (SEP) plans and savings incentive match plans (simple IRA)
- defined-benefit plans: pension plans or those that promise a certain payment to the participant as defined by the plan document
- individual retirement accounts (IRAs)
What Wasn't Covered
- If a customer calls a financial advisor and requests a specific product or investment, that does not constitute financial advice.
- When financial advisors provide education to clients, such as general investment advice based on a person's age or income, it does not constitute financial advice.
- Taxable transactional accounts or accounts funded with after-tax dollars are not considered retirement plans, even if the funds are personally earmarked for retirement savings.
Reaction to the Fiduciary Rule
There’s little doubt that the 40-year-old ERISA rules were overdue for a change, and many industry groups had already jumped onboard with the new plan, including the CFP Board, the Financial Planning Association (FPA), and the National Association of Personal Financial Advisors (NAPFA). Supporters applauded the new rule, saying it should increase and streamline transparency for investors, make conversations easier for advisors entertaining changes and, most of all, prevent abuses on the part of financial advisors, such as excessive commissions and investment churning for reasons of compensation. A 2015 report by the White House Council of Economic Advisers found that biased advice drained $17 billion a year from retirement accounts.
However, the regulation met with staunch opposition from other professionals, including brokers and planners. Financial advisors would rather be held to a “suitability” standard than a “fiduciary” standard because the latter will cost them money – in lost commissions and the added expense of compliance. The stricter fiduciary standards could have cost the financial services industry an estimated $2.4 billion per year by eliminating conflicts of interest like front-end load commissions and mutual fund 12b-1 fees paid to wealth management and advisory firms.
While the best interest contract exemptions would permit broker-dealers and insurance companies to provide plan participants with fiduciary advice while still receiving commissions, many professionals feared that the conflict-of-interest yardstick would essentially eliminate commissions. This in turn would force financial advisors to create or shift fees onto individuals and could have priced many middle- and lower-market investors out of the market, they argued.
Three lawsuits have been filed against the rule. The one that has drawn the most attention was filed in June 2016 by the U.S. Chamber of Commerce, the Securities Industry and Financial Markets Association and the Financial Services Roundtable in the U.S. District Court for the Northern District of Texas. The basis of the suit is that the Obama administration did not have authorization to take the action it did in endorsing and fast-tracking the legislation. Some lawmakers also believe the DOL itself was reaching beyond its jurisdiction by targeting IRAs. Precedent dictates Congress alone has approval power regarding a consumer’s right to sue. This is the suit that resulted in the March 15, 2018, ruling against the fiduciary rule discussed above.
Some critics suggest the new fiduciary rule would make no difference anyway. Those observers say that consumers will still be subject to being cheated by “bad actors.” For example, complying with the new rule would require more paperwork. Paperwork, critics say, is a great place to hide a scam and then later say the customer signed and knew what he or she was signing. More recently, members of President Trump's advisory team have criticized the rule, and Trump signed an executive order to delay its implementation. The DOL continued to defend the rule in multiple lawsuits in 2017.
After the DOL officially announced the 60-day delay to the rule's applicability, a "Retirement Ripoff Counter" was unveiled by Senator Elizabeth Warren and AFL-CIO President Richard Trumka. Partnering with Americans for Financial Reform and the Consumer Federation of America, this counter attempts to highlight the "...cost to Americans of saving for retirement without the fiduciary rule, starting from Feb. 03, 2017." The press release from Americans for Financial Reform states, "Every day that conflicted advice continues costs them [Americans] $46 million a day, $1.9 million per hour, and $532 a second.
Who Did the Fiduciary Rule Affect?
The new DOL rules were expected to increase compliance costs, especially in the broker-dealer world. Fee-only advisors and Registered Investment Advisors (RIA) were expected to see increases in their compliance costs as well.
The fiduciary rule would have been tough on smaller, independent broker dealers and RIA firms. They might not have had the financial resources to invest in the technology and the compliance expertise to meet all of the requirements. Thus, it's possible that some of these smaller firms would have had to disband or be acquired. And not just small firms: The brokerage operations of MetLife Inc. and American International Group were sold off in anticipation of these rules and the related costs.
Advisors and registered reps who dabble in terms of advising 401(k) plans might have been forced out of that business by their broker-dealers due to the new compliance aspects. This could have reduced the number of advisors who serve smaller plans. That's what happened in the U.K. after the country passed similar rules in 2011. Since then, the number of financial advisors has dropped by about 22.5%. Ameriprise CEO Jim Cracchiolo said, “The regulatory environment will likely lead to consolidation within the industry, which we already see. Independent advisers or independent broker-dealers may lack the resources or the scale to navigate the changes required, and seek a strong partner.”
Annuity vendors also would have had to disclose their commissions to clients, which could have significantly reduced sales of these products in many cases. These vehicles have been the source of major controversy among industry experts and regulators for decades, as they usually pay very high commissions to the agents selling them and come with an array of charges and fees that can significantly reduce the returns that clients earn.
Which Investments Would the Rule Have Impacted?
The main impact of the rule would have been felt by IRAs, since these vehicles are often handled at brokerages. In particular, rollovers from 401(k) plans to IRAs might have come under scrutiny. There have been many instances reported in the financial press (and likely tens of thousands more in reality) about advisors suggesting rollovers to IRAs, even though it might not have been in the client’s best interest – either in terms of moving the client’s money out of a low-cost company retirement plan that offered solid investment choices or in terms of the types of high-cost investments recommended in the new IRA.
In Jan. 2017 DOL released answers to common questions they'd received about the Fiduciary Rule in the form of FAQs, which addressed topics from investments to advisor compensation. In March 2017, the questions were taken down. You can still read them here.
More Rules From the SEC?
As if there weren't enough confusion among advisors and clients about the new plan, the Securities and Exchange Commission (SEC) projected proposing its own set of fiduciary rules in April 2017. That was under its previous Chairwoman Mary Jo White, who indicated support of non-governmental, third-party examinations of investment advisors. The Financial Industry Regulatory Authority (FINRA) would be an example of such a third party.
Her successor also is looking at an SEC ficudiary rule. "I don't think it's any secret that we're going to make a big effort to try to bring clarity and harmony to the investment adviser, broker-dealer standard of conduct regulation – something that's important to me," SEC Chairman Jay Clayton told the Practicing Law Institute's SEC Speaks in Feb. 2018. It's something that the market needs. I think it's something that regulators need." It is not clear how the latest court ruling will affect his plans.
Any new SEC rules might well extend beyond retirement accounts and govern the way in which RIAs and brokers treat clients in all dealings, mandating that the client’s interests must come first in all cases. It's not clear how Clayton will approach it, but White said SEC enforcement priorities would include:
- increased examinations of investment advisors who are regulated by the SEC.
- enhancing SEC oversight of FINRA as it takes on a bigger role in overseeing broker-dealers.
- economic risk and analysis of various investment vehicles.
- data analytics to better focus SEC resources for the examination of investment advisors.
A major concern of many advisors and brokers was whether or not a new set of SEC rules would be consistent with the new DOL fiduciary rules. They may no longer need to be concerned about that, given the Federal Appeals Court ruling of March 15, 2018.