DOL Proposes Less-Restrictive Fiduciary Standard for Investment Advisors

Professionals who advise 401(k) participants could receive third-party payments

Stephen Miller, CEBS By Stephen Miller, CEBS July 7, 2020
investment advisor making recommendations to couple

On July 7, the U.S. Department of Labor (DOL)  published in the Federal Register proposed new guidance that would update requirements for advisors who recommend investments to 401(k) and similar defined contribution plan participants and to individual retirement account (IRA) owners. The guidance, a proposed class exemption, would allow investment-advice fiduciaries to receive compensation from mutual funds they recommend, which would otherwise violate the prohibited-transaction provisions of the Employee Retirement Income Security Act (ERISA).

The DOL also issued a fact sheet on the proposal, first released on June 29, and will accept comments through Aug. 6, 2020.

The proposal would still require advisors to act in participants' best interests and to avoid conflicts of interest when recommending specific investments, but it is less restrictive than a 2016 rule by the Obama administration, which was struck down in 2018 by the 5th U.S. Circuit Court of Appeals when it ruled that the regulations exceeded the DOL's rulemaking authority and failed to meet reasonableness requirements.

The plaintiffs in that case—business groups such as the U.S. Chamber of Commerce, the Financial Services Institute and the Financial Services Roundtable—argued that the rule would make investment advice prohibitively expensive for those with modest portfolios, who would have to bear the cost of paying an advisor.

Separately, the DOL issued a final rule implementing the court order vacating the 2016 fiduciary rule and reinstating earlier guidance, including 1975's five-part test for determining fiduciary status and 1996 investment education guidance.

The proposed class exemption on prohibited transactions, if finalized, would not place new requirements on employers that sponsor retirement plans; but plan sponsors, as fiduciaries, have a duty to ensure that their service providers who counsel participants act in the participants' best interest under ERISA and related DOL regulations.

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]

Impartial Conduct Required

Under the proposal, investment advisors would be required to abide by "impartial conduct standards" with three key components:

  • Investment advice must be in the best interest of the investor and must not place any other interests ahead of that interest.
  • Compensation paid for such advice must be reasonable.
  • Statements made with respect to the transaction must not be materially misleading.

Third-Party Payment for Advice

Opposition to the DOL's proposed revamp of the fiduciary standard is focused on the class exemption, which is based on an existing temporary policy adopted after the 5th Circuit blocked the 2016 fiduciary rule.

To receive the exemption, an investment professional or financial institution, among other requirements, must abide by the impartial conduct standards. Investment-advice fiduciaries who meet those standards could receive "a wide variety of payments [from mutual fund companies and investment firms] that would otherwise violate the prohibited transaction rules," according to the proposal.

Those payments include "commissions, 12b-1 fees, trailing commissions, sales loads, mark-ups and mark-downs, and revenue-sharing payments from investment providers or third parties," and would extend to advice on rolling over 401(k) funds to an IRA.

Since the 5th Circuit's ruling in 2018, the Securities and Exchange Commission (SEC) has issued a package of advice standards, including Regulation Best Interest (Reg BI), which took effect June 30. The standards in the DOL's proposed rule align with Reg BI.

"Together, the actions of the SEC and the Department of Labor will strengthen retirement security for Americans," the DOL said. The proposed exemption, modeled on Reg BI, "would allow investment advice fiduciaries to give more choices for retirement using impartial conduct standards, including a best-interest standard, a reasonable compensation standard and a requirement to make no materially misleading statements."

Gray Areas for Plan Sponsors

While the proposal is primarily targeted at service providers, it raises issues that may affect plan sponsors who have their own fiduciary duty to monitor the conduct of persons with whom they've contracted for services to the plan or plan participants, noted Mike Barry, a senior consultant at retirement plan advisory firm October Three. Among the unanswered questions:

  • If a plan sponsor official is advising participants in a retirement-preparation presentation, to what extent might he or she be considered an advice fiduciary, subject to the proposed class exemption, under this new interpretation?
  • If call center operators are advice fiduciaries, to what extent do plan sponsors have a legal obligation to monitor their compliance with the proposed class exemption?

"Hopefully DOL will provide some clarification (and relief)" with respect to these issues, Barry wrote.

Supporters and Critics

Dale Brown, president and CEO of the Financial Services Institute, a financial industry advocacy group, said his organization is "thoroughly reviewing the rule proposal. However, we expect the department heeded the concerns outlined by the 5th Circuit Court of Appeals and consulted with the SEC to avoid conflicts" with the SEC's regulations.

"The SEC's Reg BI achieves increased transparency and investor protection while also preserving their choice of financial advice, products and services," Brown said. "We are hopeful that the DOL's proposed rule strikes the same balance," which would give plan participants "access to the quality, affordable financial advice they need to achieve their financial goals."

But the DOL's reliance on the SEC's Reg BI has dismayed some consumer advocates. Barbara Roper, director of investor protection at the Consumer Federation of America (CFA), tweeted that the DOL proposal "reopens loopholes in the definition of fiduciary investment advice, making the standard easy to evade. It creates a new exemption to allow advisors to get conflicted compensation, subject only to Reg BI's weak, non-fiduciary standard."

Micah Hauptman, CFA financial services counsel, noted, "There's no way DOL can reasonably adopt a rule based on Reg BI as satisfying fiduciary obligations under ERISA."

Others had a nuanced response.

"It is definitely a watered-down version of the prior fiduciary rule, but not so much as to have no teeth in it at all," wrote Michael A. Webb, vice president at retirement plan advisory firm Cammack Retirement Group, on LinkedIn.

Much of the proposal focuses on rolling over workplace plan assets to an IRA, and "clearly the DOL has a concern in this area," Webb noted. The proposal, which "will require documentation of the reasons why each individual rollover was prudent, will appear to do a lot to address the current 'asset raiding' of retirement plan accounts by some providers."

He subsequently reflected, "There are a decent number of hoops to jump through to take advantage of the prohibited transaction exemptions, which will likely discourage many bad actors from attempting to exploit participants."

What's Ahead

The fate of the new rule may depend on November's presidential election. "In the time remaining before the end of the year, it would be difficult to finalize a regulation under the Administrative Procedure Act that couldn't be overturned by a change in administration, as were the Obama-era regulations on state-run and municipality-sponsored plans at the beginning of the Trump administration," the National Association of Plan Advisors pointed out in June, before the DOL proposal was issued.

Related SHRM Article:

New SEC Best-Interest Regulation Affects Retirement Plan Rollovers, SHRM Online, June 2019



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