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Coalition Summary of the DOL’s Re-Proposed Fiduciary Rule

The Coalition has developed the following summary of the Department of Labor’s proposed fiduciary rule for stakeholders seeking to understand the proposal and its impact. A downloadable version is available here.

I. Who Is a Fiduciary Adviser Under ERISA?

Under the Department of Labor (DOL)’s proposed definition, a “fiduciary adviser” is any individual receiving compensation for providing advice that is individualized or specifically directed to a particular plan sponsor (e.g., an employer with a retirement plan), plan participant, or IRA owner for consideration in making a retirement investment decision.

Such decisions can include, but are not limited to, what assets to purchase or sell and whether to rollover from an employer-based plan to an IRA. The fiduciary adviser can be a broker, registered investment adviser, insurance agent, or other type of adviser. It is important to note that the DOL will determine who is a fiduciary based not on the adviser’s title, but rather on the advice provided to the client.

II. Activities That Do Not Trigger Fiduciary Obligation

  • General education on retirement savings: The DOL proposal excludes education from the definition of retirement investment advice so that advisers and plan sponsors can continue to provide general education on retirement saving for employment-based plans and IRAs without triggering fiduciary duties.
  • Order-taking: The proposed rule distinguishes “order-taking” as a non-fiduciary activity.
  • Seller’s carve-out: Brokers who pitch to large plans with a degree of sophistication are not deemed to be fiduciaries.

III. Proposed Rule Accommodates a Broad Range of Business Practices

The DOL’s proposed rule includes new, broad, principles-based Prohibited Transaction Exemptions (PTEs) that can accommodate a range of evolving business models. For example:

  • Best Interest Contract Exemption: To qualify for the “best interest contract exemption” advisers and firms must enter into a contract with their clients that:
    • commits the firm and adviser to providing advice in the client’s best interest;
    • warrants that the firm has adopted policies and procedures designed to mitigate conflicts of interest; and
    • clearly and prominently discloses any conflicts of interest that may prevent the adviser from providing advice in the client’s best interests.

The exemption would allow firms to continue to set their own compensation practices so long as they, among other things, commit to acting in their client’s best interest first and disclosing any conflicts that may prevent them from doing so. Common forms of compensation in use today in the financial services industry, such as commissions and revenue sharing, would be permitted under this exemption.

  • Principal Transaction Exemption: This exemption would allow advisers to recommend certain securities and sell them to the customer directly from the adviser’s own inventory, as long as the adviser adheres to the exemption’s consumer-protective conditions.
  • Pre-existing Transaction Exemption: This exemption would allow advisers to receive on-going compensation payments in connection with a prohibited transaction that was completed before the enactment of the proposed rule, as long as the adviser does not provide additional advice to the plan or IRA regarding the same asset after enactment of the proposed rule.

Additionally, the proposal asks for comment on whether the final package should include a new streamlined “low-fee exemption” that would allow firms to accept payments that might otherwise be deemed “conflicted” when recommending the lowest-fee products in a given product class.

IV. Enforcement of Proposed Rule

Under the proposed rule, enforcement actions could include:

  • DOL: The agency could bring enforcement actions against fiduciary advisers to plan sponsors and plan participants who do not provide advice in their clients’ best interest.
  • IRS: For IRA accounts, the IRS could impose excise taxes on conflicted advice transactions that are not eligible for an exemption.
  • Consumers: A plan sponsor or plan participant harmed by bad advice could bring an action against a fiduciary adviser, per current law. Under the “best interest contract exemption,” customers (both plan participants and IRA owners) could hold fiduciary advisers accountable through a private right of action for breach of contract. The proposed rule would expand the scope of enforcement from current regulations under which neither the DOL nor the client can hold an adviser accountable for advice to IRA owners.

A contract can require that individual disputes be handled through arbitration but must give clients the right to bring class action lawsuits in court if a group of people is harmed.

V. Rulemaking Process Going Forward

The DOL encourages stakeholders from all perspectives to submit comments during the 75-day comment period which ends on July 6, or during a public hearing that will be scheduled shortly after the end of the comment period. The DOL will review public and determine whether any modifications should be made to the proposed rule. The DOL will publish the final rule in the Federal Register.

Questions or comments? Contact the Financial Planning Coalition:

The New York Times: Before the Advice, Check Out the Advisor

The New York Times’ Tara Siegel-Bernard examines the important role of fiduciary standard, how it differs from a suitability standard, and what to look for when it comes to both standards when hiring a financial advisor.

Excerpt: When Elaine and Merlin Toffel, a retired couple in their 70s, needed help with their investments, they went to their local U.S. Bank branch. The tellers knew them by their first names. They were comfortable there.

So when a teller suggested that they meet with the bank’s investment brokers, the Toffels made an appointment. After discussions and an evaluation, the bank sold them variable annuities, in which they invested more than $650,000. The annuities promised to generate lifetime income payments.

“We wanted to make the most amount of interest we could so if we needed it to live on, we could use it,” said Ms. Toffel, 74, of Lindenhurst, Ill.

What she says they didn’t fully understand was that the variable annuities came with a hefty annual charge: about 4 percent of the amount invested. That’s more than $26,000, annually — enough to buy a new Honda sedan every year. What’s more, if they needed to tap the money right away, there would be a 7 percent surrender charge, or more than $45,000.

Michael Walsh, a spokesman for U.S. Bank, said that the investments were appropriate for the Toffels, that fees were disclosed and that the sale was completed after months of consultations. But the Toffels now question whether they were given financial advice that was truly in their best interests. Like many consumers, they say they didn’t realize that their broker wasn’t required to follow the most stringent requirement for financial professionals, known as the fiduciary standard. It amounts to this: providing advice that is always 100 percent in the consumer’s interest.

Many people think that they are getting that kind of advice when they are not, said Arthur Laby, a professor at the Rutgers School of Law and a former assistant general counsel at the Securities and Exchange Commission. “Brokerage customers are, in a certain sense, deceived,” he said. “If brokers continue to call themselves advisers and advertise advisory services, customers believe they are receiving objective advice that is in their best interest. In many cases, however, they are not.”

Brokers, like those at the Toffels’ bank, are technically known as registered representatives. They are required only to recommend “suitable” investments based on an investor’s personal situation — their age, investment goals, time horizon and appetite for risk, among other things. “Suitable” may sound like an adequate standard, but there’s a hitch: It can mean that a broker isn’t required to put a customer’s interests before his own.

There are some specific situations when brokers must act as fiduciaries — for example, when they collect a percentage of total assets to manage an investment account, or when they are given full control of an investor’s account. But under current rules, a broker can take off his fiduciary hat and recommend merely “suitable” investments for the same customer’s other buckets of money. Confusing? Absolutely.

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SEC Investor Advocate Makes Case for User Fees

This week, Rick Fleming, the SEC’s Investor Advocate, delivered a speech at the Southwest Securities Conference in Dallas, Texas.  In his remarks, Fleming described the newly created Office of the Investor Advocate, created under the Dodd-Frank Act, and the core issues impacting investors that the office will focus on during its inaugural year.  In addition, Fleming acknowledged the need to provide the SEC with sufficient funding to “conduct an adequate number of investment adviser examinations,” going so far as to recommend Congress authorize the SEC to collect user fees as a long-term solution to funding RIA examinations.  The following is an excerpt from his speech, the full text of which can be found here.

“As many of you are aware, the SEC examined only about 9 percent of registered investment advisers in Fiscal Year 2013. This equates to a frequency of approximately once every 11 years, a rate that many observers find unacceptable.

“There are multiple reasons for the lack of exam coverage, but in my view it primarily boils down to the fact that the SEC has not received sufficient resources to keep up with the burgeoning workload. The number of SEC-registered advisers has grown by approximately 40 percent over the past decade to nearly 11,500 today. And, as the number of investment advisers has grown, so too has their complexity. The amount of assets managed by investment advisers is on a steep ascent, climbing from $20 trillion a decade ago to an estimated $55 trillion by the end of Fiscal Year 2015. In comparison, staff in the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) has grown only about 10 percent in the past decade.

“From my own personal experience, I know that investors are exposed to fraud and abuse when regulators cannot maintain an adequate regulatory presence. While most investment advisers are trustworthy and honest, I have personally prosecuted one who stole more than $7 million from his clients. In the course of that case, I met with numerous victims who did everything right – they worked hard, saved their money, and entrusted their savings to a licensed person who they thought was investing it in a normal portfolio of legitimate securities – only to have their life savings taken by that licensed “professional.” For those investors, an ounce of prevention would have been worth far more than the pound of cure. With their money gone, a maximum prison sentence did little to help those retirees who had to return to work or face a diminished standard of living, or the individual with diminished capacity whose trust fund was stolen, or the church that lost its building fund.

“Not surprisingly, then, as my very first recommendation to Congress, I recommended that Congress appropriate the needed funds this year so that the Commission can hire more examiners without further delay. In addition, I voiced support for a more long-term, sustainable solution. I recommended that Congress authorize the SEC to collect an annual “user fee” from registered investment advisers and to limit the use of those funds to expenses associated with investment adviser examinations.

“Admittedly, a shorter examination cycle won’t stop all fraud, but I believe it will allow the SEC to halt these types of activities sooner and will provide a stronger deterrent to advisers who might otherwise succumb to the temptation to steal. It will also curtail other unethical practices, including excessive fees, excessive trading, and undisclosed conflicts of interest. Many of you in this room have uncovered these types of practices and can attest to the damage it causes to investors.”