10-Apr-18
The Death of the Fiduciary Rule – Is It Premature?
Take-Away: In 2016 the Department of Labor expanded ERISA’s definition of investment advice fiduciary to include investment advice that is given with regard to an IRA account, informally called the Fiduciary Rule. This Rule has endured a rocky start. With the new administration in Washington, the implementation of the Fiduciary Rule has been delayed until July 1, 2019. In the meantime, one court has cast doubt on the lifespan of the Fiduciary Rule.
History: Briefly, the Fiduciary Rule provides that a individual is an investment advice fiduciary as defined in ERISA if he/she receives direct or indirect compensation for a ‘recommendation’ as to the advisability of holding or disposing of securities, how assets should be invested after a rollover from a qualified plan account to an IRA, or the management of securities. The Fiduciary Rule describes a ‘recommendation’ as a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage or refrain from taking a particular course of action. As such, key to being classified as an investment advice fiduciary under ERISA is making an investment recommendation, which is broadly interpreted by the Department of Labor (DOL.) As part of the DOL’s expansion of this definition, it also added an exemption to ERISA’s list of prohibited transactions. The key exemption added is what is called a Best Interest Contract Exemption ( or BICE). The BICE exemption requires a financial advisor who works on a commission basis to provide his/her clients with a disclosure agreement noting when a conflict of interest exists, e.g. when the advisor would receive an additional commission if their client picked a particular investment product. With the DOL announcement of this rule change and what would be required to be disclosed to clients in the DOL’s prohibited transaction BICE exemption, the financial services industry and the US Chamber of Commerce pushed back- hard.
Administrative Delays: The Rule was initially announced by the DOL on April 6, 2016. The ‘impartial conduct’ portion of the Fiduciary Rule, which requires financial advisors who manage retirement accounts, including IRAs, or who provide retirement advice, to act in the best interest of their customers over the interest of the advisor, went into effect on June 9, 2017. All other aspects of the Fiduciary Rule have been delayed until July 1, 2019. In July 2017, the DOL announced that it would not pursue claims against fiduciaries who worked diligently and in good faith to comply with the new rule, nor would it treat those fiduciaries as being in violation of the fiduciary rule pending challenges to the Rule.
The Courts: In April 2017 the Chamber of Commerce filed a lawsuit that sought a court order to stay the implementation of the Fiduciary Rule. That motion to stay that implementation of the Fiduciary Rule was denied by a federal District Court. That decision was then appealed to the U.S. Fifth Circuit Court of Appeals (a court that is notorious in its hostility towards the IRS and its rule-making power, but only mildly less hostile with regard to the DOL) which was reversed. See Chamber of Commerce of the United States v. United States Department of Labor, 2018 U.S. App. LEXIS 6472 (5th Cir. March 15, 2018). The DOL announced, as a result of the reversal, that the Fiduciary Rule will not be enforced, pending further review. Note, however, that another federal Appeals Court almost on the same day held that the Fiduciary Rule was enforceable and not arbitrary, finding that no irreparable harm resulted when it required a BICE conflict-of-interest disclosure with respect to the sale of fixed index annuity. Market Synergy Group, Inc. v. United States Department of Labor, 2018 U.S. App. LEXIS 6209 (10th Cir. March 13, 2018.)
Court Holding: The Fifth Circuit Court of Appeals vacated the Fiduciary Rule on several grounds, and distinguished it from other DOL rules:
- Excess of Authority: The Court found the Fiduciary Rule was an arbitrary and capricious action in excess of the DOL’s rule-making authority, as the Rule was extended to IRAs not just other retirement accounts held in qualified plans. The Court noted that the DOL has different authority under ERISA for its rule-making: Title I applies to qualified plans, and Title II applies to IRAs, and the discretion given under each Title is not the same. The upshot is that the DOL apparently does not have any authority to regulate IRA advisors as it tried to do with the expanded Fiduciary Rule, and ERISA does not give DOL any such authority.
- Distinction Between Employer and Plan Advisors and Brokers: The Court distinguished between investment advice fiduciaries to employers and union sponsored retirement plans who are compensated on a fee basis, and brokers and insurance salespersons who earn a commission on their ‘sales.’ The big distinction, per the Court, is that the concept of fiduciary requires a special relationship that involves trust and confidence between the advisor and the recipient of the advice; a fiduciary relationship is where an advisor’s services are furnished regularly and are the primary basis for the client’s investment decisions. The Court noted that a stockbroker or insurance salesperson will typically engage in a one-time transaction for a commission; consequently, those advisors will not meet the requirement of providing advice on a regular The Court concluded that giving advice on a rollover from a qualified plan account to an IRA was likely to be a one-time transaction which would not result in the advisor being a fiduciary absent a regular relationship involving trust and confidence between the participant and the advisor.
- Prohibited Transaction Exemption: The Court observed that the BICE prohibited transaction exemption would subject brokers and insurance salespersons selling investments to IRA owners to the same obligations of loyalty as ERISA plan fiduciaries, but it found that such disclosures were not administratively feasible to monitor.
- Separation of Powers: The Court also found that the DOL’s attempted rule making and the BICE prohibited transaction exemption was beyond the DOL’s delegated rule-making power, and hence a violation of the executive branch’s separation of powers with Congress. Specifically, Congress’ Dodd-Frank Act empowered the Securities and Exchange Commission (SEC) to create standards for broker-dealer behavior, not the DOL.
Comments: Planning a party that celebrates the death of the Fiduciary Rule may be premature. First, the DOL can ask for a rehearing before the entire Fifth Circuit (beyond just a 3 judge panel where there was a dissenting decision.) Or, the DOL can file an appeal with the U.S. Supreme Court, which might be inclined to take that appeal in light of the differing conclusion on the legality of the Fiduciary Rule announced in the 10th Circuit Court of Appeal’s decision. Not to be overlooked, either, is that the SEC has invited public comments with respect to standards of conduct for investment advisors and broker-dealers; who is to say that the SEC doesn’t comes up with its own equivalent Fiduciary Rule? Finally, many states are busy looking at proposed legislation comparable to the Fiduciary Rule in light of the many claimed abuses of the commission-based sale of fixed annuities to seniors after the Great Recession. Consequently, it may be awhile before investment advisors and broker-dealers who work with IRA owners can take comfort that they will not be viewed as fiduciaries.
While I have never been a big fan of government regulation, this is one time I tend to agree with the DOL that extending fiduciary principles to advisors of IRA retirement assets, especially when big IRA rollovers are involved, would be a good thing for the public. IRA owners, or plan participants who intend to rollover their account balance to a rollover IRA on retirement, should have some assurance knowing that the person who is giving them advice always has their best interests in mind, and if a conflict of interest exists in that recommendation, that conflict will be fully disclosed to the customer. We at Greenleaf Trust always operate putting our client’s interest first so application of the principles imbedded in the Fiduciary Rule is nothing new to us; it’s the rest of the world that I tend to worry about.