A fiduciary is a person whose task it is to protect your assets and act in your best interests. We already have many fiduciaries in our lives:: bankers, trustees, employers with 401K or pension plans for their employees, attorneys, corporate officers and board directors, certified financial planners, and the list goes on. Legally, the duties of a fiduciary are “care” (for the assets) and “loyalty” (to the principal’s interests). As for me, I am already considered a fiduciary.
Under the new DoL Fiduciary Rule, a fiduciary is ….”an individual receiving compensation for providing advice that is individualized or specifically directed to a particular plan sponsor, plan participant, or IRA owner for consideration in making a retirement investment decision.” This would cover advice on which investments to make, which assets to purchase or sell, or whether to roll over funds from an employer sponsored plan to an IRA.
Advisors subject to this rule must give (1) prudent advice in line with the client’s best interest; (2) avoid misleading statements; and (3) receive no more than reasonable compensation. Further, advisors must provide necessary disclosures to reveal fiduciary status, and disclose all material conflict of interests, which includes compensation. The disclosures will also include the acknowledgment of fiduciary status, standards used for recommendations (skill, care, prudence, and diligence), and designation of the person who will mitigate conflicts of interests (known as the Financial Institution).
When the Congress passed the Dodd-Frank law in 2009, among the various provisions were requirements to apply a fiduciary duty to all those advisors to people’s retirement funds. The Securities and Exchange Commission (SEC) was already involved in working the issue of refining the “suitability” standards in use by licensed financial professionals, and moving toward a revised or a fiduciary standard that would be broadly applicable. Some financial sector professionals, such as brokers/dealers or traders, operate within the equity markets, but are not necessarily trained or positioned to provide financial planning services or investment advice to individuals (commonly called “retail” investors). Many assumed that the SEC would provide the expanded definition of “fiduciary” responsibilities, but their processes stretched on for several years as they worked to draw together the various interests that the SEC oversees.
Instead, policymakers in the Department of Labor, which has responsibility under ERISA (Employee Retirement Income Security Act of 1974) oversee employer-sponsored retirement programs, such as pensions and 401K plans, decided to draw up their own fiduciary rule for application to all parties involved in the management of retirement funds. Their first efforts, begun in 2010, did not bear fruit. Fast forward to 2015, the DoL released a draft of a revised rule and requested public comments. Something on the order of 3 million comments flooded into the department. In April 2016, the final version was released in the Federal Register with an implementation or effective date of June 7, 2016. The rule provided a delayed application date to April 10, 2017. The Rule, therefore, goes far beyond the employer-sponsored plan environment regulated by ERISA, and applies to any instrument through and from which retirement funds can be invested or withdrawn.
Congress, through the Congressional Review Act, attempted to block the regulations, but President Obama vetoed the legislation. Later in June 2016, four challenges were filed in various federal courts to block the entire rule or elements of it. The suits were based on different arguments, but eventually all were defeated, albeit for different reasons. Appeals and revised pleadings are due to be filed in July.
President Trump directed the Department of Labor to re-examine the rule, and delayed its applicability date to June 9, 2017. The new secretary of labor, issued a report that he could find no legal reason to delay the application date beyond June 9th. Actual use of required legal forms will occur on January 1, 2018.
The re-examination of the rule will continue under normal bureaucratic processes, and the SEC, now under new management, has recently said that they will seek to finally flesh out their rule and harmonize it with the DoL.
Fiduciary Rule proponents are fond of saying that “Financial sector professionals and advisors will now be required to act in consumers’ best interests,” implying that they had not done this previously. But while broker/dealers have other functions in the market, most financial professionals already operate under either a fiduciary rule, or a suitability rule. So, there is a lot more here to understand, so let’s talk first about how this rule will actually be implemented.
First, understand that while the main targets of the DoL Fiduciary Rule are 401Ks and IRAs, the Rule may also apply to HSA funds, education savings accounts, Keogh and solo plans, or any plan or product that is funded by funds that are rolled over or distributed from a qualified, retirement fund. Therefore, something like life insurance, funded with after-tax money following an RMD (required minimum distribution) will also be affected. In addition, variable or fixed index annuities are also going to be affected. In short, the “source of funds” issue will define how advice is delivered.
ERISA discusses “prohibited transactions” and “exceptions to prohibited transactions.” In a general sense, advisors are prohibited from receiving payments (ie. variable compensation, or commissions) from third parties, unless the advisor meets the requirements for an exemption. If the advisor meets the Section 84-24 exemption they can receive variable compensation. To meet the requirements for this exemption, the advisor must acknowledge in writing that he/she is a fiduciary and agrees to adhere to the best interest standard of care. Further, the advisor’s statements cannot be materially misleading, and must disclose conflicts of interest (the primary conflict being receipt of a payment for sale of the product). The advisor’s compensation can be no more than reasonable and cannot include incentive-based rewards. The client, will receive these disclosures prior to finalizing the sale of the product and will acknowledge the receipt in writing.
Beginning in January 2018, the Best Interest Contract will be introduced with respect to the sale of variable and fixed index annuities. Client acceptance of the BIC will constitute the Best Interest Contract Exemption.
Herein lies the essence of how you will have to deal with an advisor going forward and how the advisor has to communicate with you. We have already heard, to note, that one investment fund has been established that has already assembled millions of dollars to pursue these fiduciary lawsuits.
To conclude, objections to this Rule are not based on “acting in a client’s best interest.” As mentioned previously, most financial services professionals already adhere to either a suitability or fiduciary standard. Rather the resistance focuses on the lack of specifics provided by the DoL (ie. what is reasonable compensation), the inclusion of a class action lawsuit provision, the lack of a DoL oversight process, which was left instead to the courts, and the broadly drawn curtain around all funds that were ever placed in a fund or instrument that could provide the source of retirement income. It is feared that many specifics will only come about from the results of a court case at seome point in the future.