Good news arrived earlier this month for firms struggling with—and protesting against—pending requirements of the Department of Labor’s controversial fiduciary duty rule.
In an Aug. 9 legal brief, the Labor Department announced that it had petitioned the White House’s Office of Management and Budget for a delay in key aspects of the rule. The request, most likely a formality as it awaits approval, calls for the extension of the transition period and delay of applicability dates from Jan. 1, 2018, to July 1, 2019. The first phase of compliance obligations already began on June 9.
The filing was part of the ongoing matter of Thrivent Financial for Lutherans v. Acosta, one of several lawsuits objecting to aspects of the rule. “This step provides for interagency review in preparation for publication in the Federal Register,” the Labor Department wrote.
More than a catch-its-breath request, however, the proposed delay is significant on multiple fronts.
With extra time, the Labor Department is afforded the opportunity to substantially rewrite, if not kill, the Obama-era rulemaking. In one of his first official actions, in February, President Trump issued a memorandum ordering a review of the rule, with an eye toward its demise.
Extra time could also allow the Securities and Exchange Commission to ride to the rescue and pull the Labor Department off the hook by proposing a rule of its own, fulfilling a long-delayed Dodd-Frank Act demand.
What the delay could accomplish
The delay, in particular, applies to the rule’s Best Interest Contract Exemption and other phased implementation aspects of the rule, including a signed contract between customers and brokers that, as needed, certifies that the former is aware of any of the latter’s potential conflicts of interest when providing retirement planning services.
“The DOL’s filing in the ongoing Thrivent litigation provides a clear indication that it intends to significantly extend the transition period under the fiduciary rule, says Ropes & Gray Tax & Benefits Attorney Josh Lichtenstein. “If this new transition period is on the same terms as the current transition relief then firms will still be subject to the terms of fiduciary rule, including the substantive requirements of the Best Interest Contract Exemption, if applicable, but the documentary, disclosure, and technological requirements under the Best Interest Contract Exemption will not apply.”
“We continue to support the SEC acting to establish a best interest standard and believe that the DoL’s misguided rule is not only harmful to investors, but also inconsistent with the administration’s stated priorities and must be rescinded or substantially revised.”
Kenneth Bentsen, President & CEO, SIFMA
With the delay, “the Labor Department will have greater freedom to alter the requirements of the Best Interest Contract Exemption or to create new, streamlined exemptions before the new July 1, 2019, effective date,” he adds. “This proposed delay could be seen, in part, as an attempt to avoid having financial institutions make further changes to their practices before the Labor Department makes final decisions on what the rule and the related exemptions will look like.”
The likely delay was welcome news to Dale Brown, president and CEO of the Financial Services Institute, an advocacy group for independent financial advisers and independent financial services firms. “While the delay is significant, it is critical that the Labor Department uses the 18 months to coordinate with regulators, in particular the SEC, to simplify and streamline the rule,” he says. “We are already seeing the effects of the rule limiting investor choice and pushing retirement savings advice out of those who need it most.”
Where it began
In April 2016, the Labor Department finalized a new rule that creates a fiduciary duty for brokers and registered investment advisers who offer retirement advice. While prohibiting conflicts of interests, the rule also provides exemptions that, if applied for and granted, would allow these advisers to maintain fee-based arrangements.
In general, fiduciaries are prohibited from receiving commissions, which are considered to present a conflict of interest. The new rule, however, creates a Best Interest Contract Exemption for fixed index annuities and variable annuities. It allows fiduciaries to receive commissions only if they adhere to certain conditions, including signing a written contract with the consumer that contains enumerated provisions intended to protect their interests.
In February, President Trump ended his second full week in office by ordering the Labor Department to review the rule and prepare an updated economic and legal analysis. If it concludes that the rule is “inconsistent” with Administration priorities, it was instructed to rescind or revise the rule as appropriate.
In an opinion piece published in the May 22 edition of the Wall Street Journal, Labor Secretary Alexander Acosta said that any repeal of the rule, or comprehensive revisions, would need to conform with requirements of the Administrative Procedures Act.
Meanwhile, House Republicans are taking matters into their own hands. Rep. Ann Wagner (R-Mo.) has filed draft discussion legislation that would repeal the Labor Department’s fiduciary rule “and create standards of conduct for brokers and dealers that are in the best interest of their retail customers.”
The forthcoming bill requires, among other things, “that a broker-dealer must act in the retail customer’s best interest when providing a recommendation that must reflect reasonable diligence; and reflect the reasonable care, skill, and prudence that a broker-dealer would exercise based on the customer’s investment profile.”
The bill also imposes enhanced disclosure obligations on broker-dealers, and provides the SEC with rulemaking authority to promulgate the content of such disclosures.
Courtrooms are still a battleground
Aside from political wrangling, federal courts are yet another battleground for the rule, occasionally creating the awkward spectacle of the Department of Justice defending a rule the new administration wants no part of.
Earlier this month, the Department of Labor issued its latest guidance regarding compliance obligations for its embattled fiduciary duty rule. The guidance, like the Fiduciary Rule and related exemptions, is generally limited to advice concerning investments in IRAs, ERISA-covered plans, and other plans covered by section 4975 of the Internal Revenue Code.
Do service providers who are providing fiduciary investment advice as a result of the Fiduciary Rule becoming applicable on June 9, 2017 need to update their disclosures under the 408b-2 regulation, in particular to disclose their status as fiduciaries?
Among other disclosures required under the Department’s 408b-2 regulation, if a service provider under a contract or arrangement with an ERISA pension plan reasonably expects that the service provider, an affiliate or a subcontractor will provide services as a fiduciary within the meaning of ERISA section 3(21), the service provider generally has an obligation to disclose to an appropriate plan fiduciary that services will be rendered in a fiduciary capacity.
In general, if a covered service provider will continue after the Fiduciary Rule to provide services only in a non-fiduciary capacity, or has already effectively disclosed investment advice fiduciary status, no additional disclosure would be required under the 408b-2 regulation.
Following is a short description of the disclosure obligations and the timing of those obligations under the 408b-2 regulation, including transitional guidance for service providers who became investment advice fiduciaries as a result of the Fiduciary Rule becoming applicable on June 9, 2017.
Service providers who do not reasonably expect to provide fiduciary investment advice under the fiduciary rule
In the case of a non-fiduciary service provider to an ERISA pension plan that has structured its service contract or arrangement so that it reasonably and in good faith believes that it will not be providing services to the plan that would make it an investment advice fiduciary under the Fiduciary Rule, the service provider would not be required to disclose investment advice fiduciary status under the 408b-2 regulation.
The Department’s conclusion in this regard would not be affected by the fact that it is possible that actions of individual agents, representatives or employees involved in implementing a service contract or arrangement (call center employees) may exceed, in individual circumstances, contract limits that may result in communications that constitute investment recommendations covered by the Fiduciary Rule.
The Department would not treat such unauthorized and irregular actions that may exceed service contract limitations as necessitating a disclosure of investment advice fiduciary status under the 408b-2 regulation.
Service providers who will or reasonably expect to provide fiduciary investment advice services under the fiduciary rule
On April 7, 2017, the Department announced that the applicability dates for the Fiduciary Rule and related prohibited transaction exemptions would be delayed from April 10, 2017 to June 9, 2017, with certain provisions in the exemptions delayed for a Transition Period extending to January 1, 2018.
One provision in the Best Interest Contract (BIC) Exemption and the Principal Transactions Exemption that was delayed to January 1, 2018, required disclosure of fiduciary status by the financial institution and adviser who use the exemptions. Accordingly, disclosure of fiduciary status is not a current condition of these exemptions or the relief provided in these exemptions. However, service providers may still have a separate obligation to disclose fiduciary status under the 408b-2 regulation.
During the transition period, service providers need not use the term “fiduciary” to satisfy the 408b-2 Regulation as long as they accurately disclose their services
The 408b-2 regulation generally requires covered fiduciary service providers to state that they will provide services “as a fiduciary” to satisfy a disclosure requirement in 29 CFR 2550.408b- 2(c)(1)(iv)(B). Some affected service providers, however, have expressed concern about potential confusion resulting from such an express statement on fiduciary status during the Transition Period, noting that the BIC and Principal Transactions Exemptions do not require such a statement.
Other service providers have expressed an additional concern about making such an express disclosure during the Transition Period because of continued uncertainty about possible changes the Department may make to the Fiduciary Rule and associated exemptions (although they believe they are providing fiduciary investment advice services under the currently applicable Fiduciary Rule).
In light of those concerns, during the Transition Period, the Department would treat a covered service provider as satisfying the 408b-2 regulation fiduciary status disclosure requirement in connection with the person’s provision of fiduciary investment advice as a result of the Fiduciary Rule becoming applicable on June 9, 2017, if, in addition to any other required disclosures under the 408b-2 regulation, the covered service provider furnishes an accurate and complete description of the services that will be performed under the contract or arrangement with the plan, including the services that would make the covered service provider an investment advice fiduciary under the currently applicable Fiduciary Rule.
Under the unique circumstances of the Department’s ongoing review of the Fiduciary Rule and related exemptions, the Department would not treat the failure to expressly use the term “fiduciary” as a violation of the 408b-2 regulation’s fiduciary disclosure requirement until the applicability date of the BIC and Principal Transactions Exemptions’ requirement to disclose fiduciary status (currently Jan. 1, 2018).
To the extent that circumstances surrounding this interim compliance standard give rise to the need for other temporary relief, including prohibited transaction relief, EBSA will consider taking such additional steps as necessary.
Source: Department of Labor
Among those suing the government over the rule are the U.S. Chamber of Commerce, Financial Services Institute, Texas Association of Business, and the Securities Industry and Financial Markets Association. Among other reasons, they say the rule should be repealed because it is arbitrary and capricious.
They also asserted that the Labor Department lacked authority to revise its interpretation of the statutory definition of investment advice fiduciary and condition relief from the prohibited transaction provisions on the terms that it did.
As plaintiffs, they also argued that imposing fiduciary conduct standards on investment advisers is an impermissible restriction of speech.
After hearing those arguments, the U.S. District Court for the Northern District of Texas upheld the Labor Department rule. An appeal is now being heard in the U.S. Court of Appeals for the Fifth Circuit.
Erin Sweeney, a member of law firm Miller & Chevalier who was previously a senior benefit law specialist at the Labor Department, was in attendance at the oral arguments on July 31. Although oral arguments may not ultimately reveal judicial tendencies, they can illustrate the state of the case.
Judge Edith Jones “took the Labor Department to task” on the final conflict of interest regulation and related exemptions, Sweeney says.
“Judge Jones, a Reagan appointee, relentlessly peppered the Labor Department’s attorney, Michael Shih, with questions on how the Best Interest Contract Exemption could be ‘harmonized’ with the statutory ‘eligible investment advice arrangement’ exemption, the basis for the DoL’s authority over individual retirement accounts, and whether the BIC exemption impermissibly creates a private right of action,” she says.
On the IRA front, Judge Jones pressed to know exactly how many regulations and prohibited transaction exemptions the DoL had promulgated and issued addressing IRAs.
“Jones proffered that the Employee Retirement Income Security Act covers ‘employment plans and is not directed at IRAs,’ ” Sweeney says. “She further offered that the Fiduciary Rule ‘transforms the lenient treatment of IRAs into an architecture of regulation.’ ”
Jones also “took issue with the Labor Department’s position on the First Amendment argument, noting her view that the analysis of the First Amendment issue was the ‘weakest’ part of the lower court decision.”
“This statement may suggest that she believes the lower court’s decision upholding the Labor Department’s authority to issue the Fiduciary Rule is well reasoned,” Sweeney says. “Given the relatively few comments made by the other panelists … it is difficult to predict the outcome of the hearing, which has been scheduled for expedited treatment.” Sweeney says.
In the meantime, opponents of the rule can be expected to continue their attack.
On Aug. 10, the Securities Industry and Financial Markets Association submitted a study to the Labor Department “with new data on the rule’s potentially negative impact on retirement savers.” It also reiterated “the need to delay the Jan. 1, 2018, applicability date and stresses the need for a workable standard to protect investors.”
“We continue to support the SEC acting to establish a best interest standard and believe that the DoL’s misguided rule is not only harmful to investors, but also inconsistent with the administration’s stated priorities and must be rescinded or substantially revised,” Kenneth Bentsen, Jr., SIFMA president and CEO, said in a statement.
SIFMA commissioned Deloitte & Touche to perform a study of a cross-section of SIFMA members to analyze how financial institutions responded to the Fiduciary Rule and the potential impact of those changes on retirement savers and the institutions themselves. The 21 financial institutions that participated in the study represent 43 percent of U.S. financial advisors and 27 percent of the retirement savings assets in the market.
“The study found that access to brokerage advice services has been eliminated or limited by many financial institutions as part of their approach for complying with the Rule, and that retirement assets have shifted to fee-based or advisory programs because of those limitations,” SIFMA says.
Fifty-three percent of study participants reported limiting or eliminating access to advices brokerage for retirement accounts, affecting an estimated 10.2 million accounts and $900 billion AUM.
Ninety-five percent of participants indicated that they had reduced access to or choices within the products offered to retirement savers as a result of efforts to comply with the rule.
Participants also indicated that they spent approximately $595 million preparing for the initial June 9, 2017 deadline and expect to spend over $200 million more before the end of 2017.
“Multiplied industry-wide, that equates to a projected spend in excess of $4.7 billion in start-up costs relating to the Rule, far-exceeding the DoL’s 2016 estimated start-up costs for broker-dealers of $2 billion to $3 billion,” the SIFMA study says. “The ongoing costs to comply are estimated at over $700 million annually.”