Broker Dealer | Disclosures | DOL | DOL Fiduciary Rule | ERISA | Investment Advisers Act

The Fiduciary Rule is Dead — What Should Investment Advisers and Broker-Dealers Do Now?

The headlines have been heralding the demise of the Department of Labor’s (DOL) Fiduciary Rule.  But what does it really mean?

Let’s look at what happened.  On March 15, 2018, the Fifth Circuit Court of Appeals issued a ruling vacating the Fiduciary Rule (the “Rule”) in its entirety, on the grounds that DOL lacked the authority to issue the Rule.  The Court also vacated the new (Best Interest Contract Exemption or BICE) and amended prohibited transaction exemptions that allowed fiduciaries to receive sales commissions and other conflicted forms of compensation. The ruling applies nationwide, and the DOL has not sought an appeal.  There have been two attempts to get the court to reconsider its decision, both of which have been denied.   The Rule remains in place until the Fifth Circuit issues its mandate to vacate the Rule.  The DOL has until June 13 to petition the U.S. Supreme Court to rule on the issue, which most commentators feel is unlikely.  The Rule remains effective until Fifth Circuit issues its mandate to vacate the Rule, which, as of the date of this article, had not occurred.  The legal effect of vacating the rule and the prohibited transaction exemptions means that they are legally void.  In layman’s terms, this means that it is like the Rule never existed in the first place.

So the big question is, what does this mean for investment advisers and broker-dealers that provide investment advice to retirement investors?  Let’s look at a few of the biggest questions. 

Can I Ditch the Paperwork?

The Rule expanded the definition of fiduciary advice under ERISA and the Internal Revenue Code (“IRC”) so that any firm and its representatives providing investment, insurance, or rollover advice to ERISA retirement plans, participants or IRA owners is a fiduciary.  Consequently, for the first time, many financial service providers, including broker-dealers and insurance companies dealing with retirement investors, are now subject to the ERISA fiduciary standard.  So instead of merely having to provide “suitable” investment recommendations for retirement investors, they are required to make recommendations in the best interest of these investors.

Under the Best Interest Contract Exemption (“BICE”), financial institutions recommending that clients roll over assets from an ERISA plan to an IRA are required to document the specific reasons why the recommendation was considered to be in the best interest of the retirement investor.  BICE requires that this documentation include:

  • A comparison fees and expenses of 401(k) plan and the IRA;
  • A determination as to whether the employer pays some or all of the plans’ administrative expenses;
  • A comparison of the levels of services and investments available under each option; and
  • An analysis of the individual needs and circumstances of the retirement investors.

Firms developed processes to gather this information, including using checklists to document the rationale for the rollover recommendation.

So now that the Rule has been vacated, at least some financial service providers are wondering if they can ditch all the extra work and documentation that the Rule required to meet the fiduciary standard.

The answer is no.  Although technically BICE will no longer apply, the documentation process is an excellent way to prove that the rollover recommendation meets the “best interest” standard.

First, investment advisers and their investment adviser representatives (IARs) have always been subject to a fiduciary standard.  The fact that this standard may now apply in connection with a recommendation to rollover 401K plan assets into an IRA seems to be a logical extension of an investment adviser’s existing obligation.  Moreover, the SEC has been focused on advice to retirement investors as far back as 2015, when it first announced its ReTIRE Initiative, and this issue has made the list of SEC exam priorities every year since.  The SEC expects RIAs and their IARs to step up to the plate and protect retail retirement investors.

For broker-dealers and insurance companies providing advice on IRA rollovers, the answer is less clear-cut.  If they make recommendations on an isolated basis and there is an understanding that continuous services are not being provided, then it’s possible that the suitability standard could come back into play.  Back in 2005, the DOL issued an opinion stating that as long as a person recommending an IRA rollover is not already a plan fiduciary, the recommendation is not treated as a fiduciary act even if it is coupled with advice on how to invest the IRA.

However, returning to the pre-Rule era seems increasingly unlikely.

Given the SEC’s proposed “Regulation Best Interest” for broker-dealers, and the possibility that various states may seek to impose their own fiduciary standards (see Nevada’s Fiduciary Rule) on broker-dealers.   “Suitability” is no longer enough; financial advisers will be required to put investors’ interests first.  Under the SEC’s proposal, this means that broker-dealers and their registered representatives must:

  • Disclose, in writing, to the retail customer the scope of the relationship, and all material conflicts of interest;
  • Exercise reasonable diligence, care, skill and prudence in making a recommendation, meaning that the firm and its representatives have a reasonable basis to believe that the recommendation being made is in the best interest of the retail customer, based on that customer’s investment profile and the potential risks and rewards associated with the recommendation;
  • Establish, maintain and enforce written policies and procedures reasonably designed to identify, disclose and mitigate, or eliminate material conflicts of interest arising from financial incentives associated with such recommendations.

So for broker-dealers and their registered representatives, certain aspects of the Rule will continue. As envisioned by the SEC’s proposal, the standard will be applied at the point in time that the recommendation is made, and there may not necessarily be an on-going duty to monitor the investments of a retail customer.  It will depend on the extent of the relationship between the firm, the registered representative and the retail customer.

The idea of requiring financial service providers to act in the best interest of retail clients is amazingly popular throughout the press, the politicians, and the regulators.  Therefore, it is short-sighted to set aside current procedures and policies in place that provide evidence of a “best interest” process.  Although the situation may appear fluid, there is plenty of momentum to require financial professionals to meet a higher standard when dealing with investors’ retirement nest eggs.

Can I Go Back to Receiving Commissions, 12b-1 Fees and other Types of Compensation?

As a result of the expansion of fiduciary liability under ERISA and the IRC under the Rule, many common compensation practices are prohibited transactions.  Specifically, ERISA and the IRC prohibit fiduciaries from receiving compensation from third parties in connection with providing services to IRA owners, including 12b-1 fees; revenue sharing payments; and payments, products and services from custodians.  ERISA and the IRC also prohibit fiduciaries from receiving compensation that varies based on the particular investment, such as a commission. The only way to continue receiving such payment would be to comply with a prohibited transaction class exemption, such as BICE or PTE 84-24.

So now that the Rule, along with BICE, has been vacated and the old definition of “fiduciary advice” is back in play, financial service providers are wondering if they can go back to their past practices.

Simply put, the answer is no.

Back in 2005, the DOL issued an opinion stating that as long as a person recommending an IRA rollover is not already a plan fiduciary, the recommendation is not treated as a fiduciary act even if it is coupled with advice on how to invest the IRA.  This opinion was explicitly struck down by the Rule.  Now that the rule is vacated, this opinion would seem to apply.

However, a lot has changed since 2005. The Pandora’s Box has been opened, exposing many conflicts of interest, including revenue sharing arrangements, products, services and other enticements offered by service providers in connection with the sale of IRAs and other retirement products.  A pivotal development was a report called 401(k) Plans: Labor and IRS Could Improve the Rollover Process for Participants issued by the Government Accountability Office (GAO) in 2013, which found that 401(k) participants “are often subject to biased information and aggressive marketing of IRAs” when seeking help with their plans.”  Both the SEC and FINRA took up the torch in 2014, making rollover IRA sales practices a top examination priority.  They were concerned that investment advisers and broker-dealers were persuading workers retiring or changing jobs to rollover their 401(k) assets into higher-cost IRA investments.  Moreover, such investors may not have understood the conflicts of interest that can influence rollover advice.

As a direct result of all the changes made by broker-dealers and investment advisers to comply with the DOL’s Fiduciary Rule, many investors now understand that the advice they receive is influenced by payments and other incentives received by financial advisers.  Consequently, regulators have sufficient public support to impose a higher standard of care for advice to retail retirement investors, including disclosure and mitigation of conflicts of interest, resulting in a certain amount of fiduciary “creep.” For example, FINRA issued Regulatory Notice 13-45, which sets forth standards that a broker-dealer and its registered representatives must meet when recommending IRA rollovers.  This notice addresses conflicts of interests and states that

Firms must supervise these activities to reasonably ensure that conflicts of interest do not impair the judgment of a registered representative or another associated person about what is in the customer’s interest and that they neither confuse investors nor interfere with significant educational efforts.

More recently, the SEC has proposed Regulation Best Interest for broker-dealers, the new Disclosure Form CRS for broker-dealers and investment advisers (intended to provide client relationship summary to retail investors), and a written Standard of Conduct for Investment Advisers.   So one way or another, investment advisers, broker-dealers and other financial institutions serving retail retirement investors are going to have to disclose conflicts of interest, mitigate such conflicts to the extent possible, and provide investment advice that is right for the investor, regardless of the compensation paid in connection with the implementation of such advice.

To that end, investment advisers, broker-dealers, insurance companies and their representatives should continue to follow the transition rules for complying with BICE, which require adherence to the “Impartial Conduct Standards.”  One important reason is the fact that the DOL and the IRS have agreed to allow financial institutions to continue to rely upon the temporary enforcement policy outlined in the Fiduciary Rule pending the issuance of additional guidance, expected to be issued “in the future.” So the DOL and the IRS will not pursue financial institutions for prohibited transaction violations if they are working diligently and in good faith to comply with the impartial conduct standards.  It is expected that the DOL will issue another prohibited transaction exemption that will apply retroactively to June 9, 2017.

Can I Dump the Disclosure in my Form ADV Part 2A about the Fiduciary Rule?

Many firms included disclosure about compliance with the Impartial Conduct Standards in Form ADV Part 2A after the Rule became effective. Some firms also included disclosure about an investor’s options when considering rolling over their assets from an employer-sponsored 401(k) plan to an IRA.

Do investment advisers still have to include disclosure about compliance with the Rule?

The answer is YES.  Although the Rule may be gone, I expect the impartial conduct standards to survive in one form or another.  Moreover, the DOL and the IRS have indicated that they will not go after firms for prohibited transaction violations if they comply with these standards.  So it seems prudent for investment advisers to continue using the policies and procedures in place to comply with the Rule for the time being.

Can I Hire Back My Solicitors?

The expanded definition of fiduciary under the Rule makes the recommendation of an investment adviser to a retirement investor a fiduciary act.  This means that solicitors for investment advisers are now considered fiduciaries when recommending an RIA to a retirement investor.  So fiduciaries are prohibited from receiving compensation from third parties in connection with transactions involving qualified plans and IRAs under ERISA and the IRC.

After the Rule became effective, many solicitation arrangements had to be discontinued, first because solicitors would have a difficult time meeting the “best interest” standard for the referral, and second, as a fiduciary, receiving compensation for the referral would be a prohibited transaction for which no exemption was available.

So can investment advisers go back to engaging solicitors and paying them for soliciting new IRA clients once the mandate to vacate the Rule has been issued?

The answer is IT DEPENDS.  Investment advisers are allowed to pay cash for referrals, as long as they comply with the requirements of Rule 206(4)-3 of the Advisers Act, which include written disclosure of the arrangement to the prospective client.  I would recommend caution in this regard, since the DOL may issue a new regulation defining fiduciary investment advice, which could be expansive enough to include referrals.  Moreover, some referral arrangements contemplate more than just a warm handoff.  In some situations, the referring party retains a relationship with the underlying client.  Depending on the facts and circumstances, this continuing participation of the referring party could be viewed as a fiduciary role.

Does this Change My Legal Liability? 

Compliance with BICE requires that advisers include a provision in their advisory contracts with retirement investors (including IRA clients) acknowledging their fiduciary status, which means these clients have a right to sue the adviser for breach of fiduciary duty.

Will advisers and other fiduciaries to ERISA plans and retirement investors still have to worry about lawsuits from clients for breaches of fiduciary duty under ERISA and the IRC?

For fiduciaries to ERISA plans, the answer is yes, since ERISA provides for private rights of action by plan fiduciaries.  For IRAs, only the IRS can enforce violations of the IRC, so the answer is no.   There is no private right of action under Section 206 of the Advisers Act of 1940 for a breach of fiduciary duty; it’s up the SEC to enforce such breaches.  Moreover, the latest proposal from the SEC, Regulation Best Interest, also does not include a private right of action for investors.


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