Another Fiduciary Rule?

In early July the Department of Labor introduced another proposed fiduciary rule, replacing the one it finalized in 2016 that was soon thrown out by the 5th Circuit Court of Appeals. This now marks more than a decade of back-and-forth proposals and rules from the DOL and the SEC aiming to raise standards for advisors. This DOL proposal mostly aims to maintain the new status quo, but if DOL finalizes it as written, then there are some details investors and advisors need to know.

In addition to proposing a rule, the DOL also made two other significant changes to guidance and regulation that take immediate effect. An old “five-part” test--originally created in 1975--was restored to determine who is and is not a fiduciary under the Employee Retirement Income Security Act, or ERISA, which governs most private-sector tax-privileged retirement accounts. Though this is a dry topic, this test is at the heart of the ongoing fight over which financial professionals must put their clients’ needs first and which ones can act more as salespeople. The DOL also changed some key guidance on whether a rollover recommendation counts as investment advice--stating that it now counts and could be subject to the new fiduciary rules. Advisors and investors will want to pay close attention to the new rule and the restored five-part test.

Fewer Advisors Will Be Fiduciaries Under ERISA Than Under the 2016 Fiduciary Rule Under the restored five-part test, brokers giving financial advice to retirement savers often will not qualify as fiduciaries if they do not give advice on a regular basis. Insurance agents who sell annuities on a one-time basis probably will never qualify. In contrast, the 2016 proposal would have increased the number of financial professionals operating as legal fiduciaries when offering advice to people who are saving for retirement in IRAs and 401(k)s, as well as in other ERISA-covered investment accounts.

Our view is that when financial professionals give advice to people saving for retirement, even if it is not on the regular basis that the old (and now new again) regulations require, the financial professional should put investors' interests first. Conflicted advice has been linked to millions of Americans rolling over low-cost 401(k) accounts into higher-cost IRAs and investing in funds with higher expense ratios and loads. At a minimum, it should be required for financial advisors to analyze rollover recommendations before making them to ensure they are beneficial for the client, which could help improve retirement security in the U.S.

Advisors Who Qualify as ERISA Fiduciaries Will Need to Justify Rollovers In 2004, DOL took the position that rollover advice was not a recommendation. Now, it depends on whether that advice is part of an ongoing relationship, or under DOL's interpretative statement, whether it could be the beginning of an ongoing relationship. The rule also requires that the advisors who qualify as fiduciaries analyze and document the reasons for the rollover.

For some investors, this could be good news. Advice to participants in 401(k) plans is held to a very high legal standard, and these plans often offer a high-quality, low-cost investment lineup. To the extent that an advisor must demonstrate why a rollover recommendation is in a plan participant’s best interest, then retirement savers should be allowed to put their assets in investments that will best help them reach their retirement goals. While we don’t expect this rule to reduce the flow of assets from 401(k) plans to IRAs, it will help retirement savers see what value their advisors are offering and require advisors to offer value for the fees they charge to justify the rollover recommendation.

For their part, financial advisors will need to figure out procedures to analyze their rollover recommendations. In many cases, the rollovers they recommend will cost retirement savers more in fees than investors would pay to leave their money in a 401(k). Such a recommendation could still be in an investor’s best interest. Advisors add a lot of value by helping to customize a portfolio tailored to a retirees’ needs and other sources of income; by helping retirees invest in asset classes that are not in their 401(k); and by providing more holistic financial advice. Advisors will still need to justify the reason the rollover makes sense and document that value exceeds the costs.

DOL's Approach Is Aligned With Regulation Best Interest--But What Does That Mean? DOL said its goal with this regulation was to reduce investor confusion and to better align the rules governing retirement accounts to the broader SEC standards of conduct for brokers, which is laid out in Regulation Best Interest. Unfortunately, this proposal would increase investor confusion and would be difficult for professionals to interpret. Advisors acting under Regulation Best Interest can generally accept payments from asset managers, which could cause a conflict of interest and therefore are generally barred under ERISA. But, under the new rules, many advisors will be able to accept these payments while calling themselves ERISA fiduciaries.

First, DOL needs to provide further explanation of what it means to be both an ERISA fiduciary and to be regulated by Regulation Best Interest, which should be a standard disclosure to investors. Right now, it appears that there is little daylight between the two standards, except for the requirement to document rollover recommendations, which is hard to decipher since the DOL’s language veers from the SEC’s in places. (To further complicate matters, Regulation Best Interest requires such recommendations to be in a clients’ best interest, but there is no requirement to document it.)

Second, DOL needs to clarify which agency is enforcing what and how they will conduct enforcement. We recommend that a more helpful disclosure--an expanded version of the SEC’s client relationship summary--be provided to all individuals receiving advice on a rollover into an IRA or on an IRA account, and that this document explain an individual’s rights and remedies under both SEC and DOL regulations.

Investors Will Need to Parse the Terms 'Best Interest' and 'Fiduciary' Even More Carefully If DOL fails to take these steps, investors will no longer be able to use the shorthand that a fiduciary follows the highest standards of care. They will need to parse complex disclosures to ascertain the extent to which a fiduciary advisor might be accepting payments that could affect their recommendations or limit the product shelf to which the investor has access. This seems to be the result of a decadeslong fight on the proper regulation of financial advice. Ironically, during that decade, things have become unquestionably better for investors, as asset-weighted fees have continued to fall. Policymakers need to take a step back and redefine the problem they are trying to solve. We think that problem is principally that investors are confused and that rollover recommendations should be intensively analyzed and documented because they represent many people's life savings. DOL's regulation mostly addresses the rollover issue--although we recommend ways to make it even stronger--but it is a step backward on elucidating investment advice for ordinary people.