Illustrating the maxim about the making of laws and sausages, the U.S. Department of Labor (DOL) has finally “implemented” its new fiduciary rule - but is effectively holding it in a state of suspended animation.
While the law is ostensibly on the books, it will not be enforced until January 2018, and could be repealed before it ever goes into full effect. In the meantime, financial advisers (and their attorneys) are in the difficult position of ensuring compliance with a rule that may never actually be implemented.
What is the Fiduciary Rule?
The DOL has authority to regulate employee benefit plans under the Employee Retirement Income Security Act of 1974 (ERISA), while also having statutory authority over Individual Retirement Accounts (IRA) under certain provisions of the Internal Revenue Code.1
Pursuant to this authority, the DOL recently issued a new rule defining who is a “fiduciary” of an IRA or ERISA plan, presenting a substantial change from standards governing sales of securities and other financial products that have existed for more than 40 years.
Going back to 1975, the DOL has defined a fiduciary as one “who renders investment advice for a fee or other compensation, direct or indirect.”2 The key term in this definition is “investment advice,” which DOL defined narrowly under a five-part test as:
- advice as to the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property;
- on a regular basis;
- pursuant to a mutual agreement, arrangement or understanding, with the plan or a plan fiduciary;
- the advice will serve as a primary basis for investment decisions with respect to plan assets; and
- the advice will be individualized based on the particular needs of the plan.3
Investment advisers, regulated by the Securities and Exchange Commission under the Investment Advisers Act of 1940, have long been held to be fiduciaries who must act in the best interests of their clients.4
Under the 1940 Act, an investment adviser is:
“any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.”5
Duties of Care and Loyalty
Although an investment adviser is specially defined by statute, there are other financial professionals – primarily securities and insurance brokers – who are colloquially referred to as “advisers” and whose work often includes providing financial advice and recommendations to clients about investment products. However, these other professionals have historically been regulated by a different standard under both Wisconsin and federal laws,6 and typically have not met DOL’s narrow definition for providing “investment advice.”
Instead of being bound to act in their customers’ best interests as fiduciaries, securities and insurance brokers have only had an obligation to recommend “suitable” products to their customers.7 A financial product is suitable if it meets the particular means and objectives of an investor.
Laws are like sausages, it is better not to see them being made.
– attributed to Otto von Bismarck (1815-1898)
However, this standard has been criticized as allowing brokers to recommend products that are not in the best interests of the investor. For instance, a broker could recommend a product that pays out higher commissions to the broker and lower returns to the investor than competing products, so long as the product is otherwise “suitable” for that investor. Under a fiduciary standard, however, such a recommendation could be an unlawful conflict of interest.
The new fiduciary rule seeks to eliminate this conflict of interest for financial professionals recommending investment products to be held in an ERISA plan or IRA.8 With some exceptions, the new fiduciary rule imposes on these financial professionals the typical trust duties of care and loyalty.9
While the fiduciary rule will have the effect of proscribing many commission-based sales of investment products, the rule contains an exemption called the Best Interests Contract Exemption (BICE). The BICE allows for commission-based fees, but sets certain standards for disclosure and reasonableness of the fees.10
What is the Status of Implementation?
Incomplete, to say the least. The rule has proceeded on a long and tortured path, and remains only partially implemented today.
A similar rule was first proposed by the Obama administration in 2010.11 This proposed rule was scrapped amid rancor from the industry and some members of Congress. However, the Obama administration proposed a substantially similar rule again in 2015. The proposed rule was then fast-tracked and published April 8, 2016, but with a delayed effective date of April 10, 2017, designed to give industry members time to change their practices.
With April 2017 having come and gone, the rule should now be in effect, right? Not so fast.
With implementation delayed past the end of the Obama administration, the Trump administration has made a concerted effort to stop the fiduciary rule in its tracks:
In February 2017, President Trump issued a memorandum ordering the DOL to provide an updated economic and legal analysis of the rule, including whether it would reduce investors’ access to retirement products or advice or cause investors’ to pay more for retirement services and products.
On March 3, 2017, the DOL issued a proposed rule creating a 60-day delay to the April 10, 2017, implementation date and inviting comments from the public.
A week later, the DOL issued a field advisory bulletin declaring that the fiduciary rule would not be enforced in the near term.
On April 5, 2017, the DOL formally delayed the implementation date until June 9, 2017, and indicated that additional delays could be forthcoming.
On May 22, 2017, the DOL issued a temporary enforcement policy, declaring that the fiduciary rule would go into partial effect on June 9, 2017, as planned, but that provisions related to amendments to certain prohibited transactions by fiduciaries would be delayed to at least Jan. 1, 2018. The DOL would not initiate any enforcement actions to impose compliance with the rule until at least Jan. 1, 2018. At the same time, the DOL invited further comments and indicated that it would consider further delays to full implementation of the rule.
Thus, as of now, the fiduciary rule is in effect but largely toothless. It remains to be seen whether the DOL will order additional delays or embark on the arduous process of attempting to administratively repeal the rule.
At the same time, the DOL and the SEC are engaged in a bit of a turf war over this issue, since the SEC has had primary jurisdiction over the sales of most investment products. Under Section 913 of the Dodd-Frank Act, the SEC was directed to study the effectiveness of regulations over brokers and investment advisers, which resulted in a recommendation that the SEC adopt a uniform fiduciary rule for all brokers that was no less stringent than the fiduciary standard applying to advisers under the 1940 Act. The “study” has since been re-opened under the new SEC Chairman appointed by President Trump, and the future of an SEC-enforced fiduciary rule is entirely uncertain.
Republicans in Congress have also proposed legislation that would replace the administrative rule with legislation imposing a disclosure-based standard for financial advice. Not to be left out, the U.S. Chamber of Commerce and other private industry groups filed suit in 2016 to have the new rule thrown out as beyond the scope of DOL’s authority. A Texas federal court rejected that challenge, and the case is now on appeal. The 5th Circuit Court of Appeals could still quash the rule outright, returning DOL regulations to their previous state.
So, the sausage making continues, and everyone will just have to stay tuned to see if this bratwurst ever gets fully cooked.
This article was originally published on the State Bar of Wisconsin’s Business Law Blog. Visit the State Bar sections or the Business Law Section web pages to learn more about the benefits of section membership.
1 81 Fed. Reg. 20,946, 20,952-20,954 (Apr. 8, 2016).
2 29 U.S.C. § 1002(21)(A)(ii).
3 Definition of the term "fiduciary," 40 Fed. Reg. 50,842 (Oct. 31, 1975).
4 Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11 (1979).
5 15 USCS § 80b-2; See also Wis. Stat. § 551.102(15) (adopting the same definition for Wisconsin’s securities laws).
6 Associated Randall Bank v. Griffin, Kubik, Stephens & Thompson, Inc., 3 F.3d 208, 212 (7th Cir. 1993).
8 See 81 Fed. Reg. 20,946, 20,952-20,954 (Apr. 8, 2016) for the new definition of “investment advice.”
11 See 75 Fed. Reg. 65,263 (proposed Oct. 22, 2010) (to be codified at 29 C.F.R. 2510).