As befits a basketball fan, former president Barack Obama launched the political equivalent of a buzzer beater when his administration pushed a so-called “fiduciary duty rule” through the Labor Department.
With time running out on his administration’s time in office and the Securities and Exchange Commission showing no urgency in meeting a similar Dodd-Frank Act obligation, proponents of the rule tried to seize the narrative.
Democrats, however, would soon lose control of the White House. Now, with a fast-approaching June deadline, the confirmation of a conservative labor secretary, and fresh legal attacks, the controversial rule may be living on borrowed time.
In April 2016, the Labor Department finalized a rule that creates a fiduciary duty for brokers and registered investment advisers who offer retirement advice. The rule—originally scheduled to be phased in between April 10, 2017 and Jan. 1, 2018—expands the “investment advice fiduciary” definition under the Employee Retirement Income Security Act.
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 “determine whether it may adversely affect the ability of Americans to gain access to retirement information and financial advice.”
As part of this examination, the Department was directed to 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 March, in response to the presidential memorandum, the Labor Department announced a 60-day extension of the applicability dates of the fiduciary rule and related exemptions, including the Best Interest Contract (BIC) Exemption.
Under the terms of the extension, advisers to retirement investors must adhere to “impartial conduct standards” beginning on June 9, rather than April 10 as originally scheduled. The Labor Department also began accepting a new round of public comments on the rule.
The public has spoken
With new uncertainty regarding the status of the rule and its application, more than 2,500 proponents and opponents took advantage of the new comment period.
“Rather than increasing access to investment education and expanding consumer choice, the Fiduciary Rule will make it more difficult for America’s workers and retirees to receive quality advice about their investment options. This chilling effect comes at the expense of the First Amendment.”
Cory Andrews, Senior Litigation Counsel, Washington Legal Foundation
Among those weighing in was the Securities Industry and Financial Markets Association (SIFMA), which represents broker-dealers, banks, and asset managers. It called upon the Labor Department to delay applicability beyond June 9.
“Notwithstanding the industry’s longstanding and continued support for a best interest standard, [we] believe the rule will do investors much more harm than good,” Kenneth Bentsen, president and CEO, wrote. “The evidence gathered as firms have moved to implement the rule shows the negative consequences of less choice, greater cost, and increased legal liability.”
“The rule has proven to be impractical, unrealistic, and inconsistent with the new administration’s stated priorities and must be rescinded or revised,” added Lisa Bleier, SIFMA’s managing director and associate general counsel.
SIFMA’s comment letters include results from a survey it conducted of financial firms. Among the findings:
More than half the firms are considering moving IRA brokerage clients to call center services only. Of those limiting services, nearly three quarters would not permit small accounts to have advisory accounts.
Nearly 44 percent of respondents anticipate that more than half of their clients could see a change in services; more than 50 percent anticipate offering only advisory services to some current IRA brokerage customers.
Nearly three quarters of responding firms said their compliance plans could limit or restrict services available to retirement investors.
More than 60 percent of the firms anticipate that some or all of the costs resulting from the potential increase in litigation and liability insurance may be passed on to clients.
SIFMA called for the BIC exemption to be “completely overhauled” because “it goes too far, offering solutions in search of problems, and creating more roadblocks than help for retirement investors.”
The Insured Retirement Institute (IRI), an association for the retirement income industry, urged the Labor Department to delay the applicability date for all aspects of the rule. Requiring all financial professionals to operate as ERISA fiduciaries is inconsistent with the statutory text of ERISA “and will cause significant dislocations or disruptions within the retirement services industry,” its letter argues.
During a May 5 speech at the IRI’s annual membership meeting, President and CEO Paul Schott Stevens elaborated on these concerns and expressed hope that the SEC would enter the fray.
“[Members] will be as ready as humanly possible on June 9,” he said. “That [being] said—we are deeply disappointed that the rule’s implementation was delayed by only 60 days—because the rule is already causing great harm.”
Stevens claimed “hundreds of thousands of small retirement accounts have been ‘orphaned’ since the Labor Department finalized the rule.”
THE BIG REVIEW
The following is from President Donald J. Trump’s “Presidential Memorandum on Fiduciary Duty Rule.”
One of the priorities of my Administration is to empower Americans to make their own financial decisions, to facilitate their ability to save for retirement and build the individual wealth necessary to afford typical lifetime expenses, such as buying a home and paying for college, and to withstand unexpected financial emergencies.
The Department of Labor’s (Department) final rule entitled, “Definition of the term “Fiduciary”; Conflict of Interest Rule-Retirement Investment Advice,” may significantly alter the manner in which Americans can receive financial advice, and may not be consistent with the policies of my Administration.
Accordingly, by the authority vested in me as President by the Constitution and the laws of the United States of America, I hereby direct the following:
Department of Labor Review of Fiduciary Duty Rule. (a) You are directed to examine the Fiduciary Duty Rule to determine whether it may adversely affect the ability of Americans to gain access to retirement information and financial advice. As part of this examination, you shall prepare an updated economic and legal analysis concerning the likely impact of the Fiduciary Duty Rule, which shall consider, among other things, the following:
(i) Whether the anticipated applicability of the Fiduciary Duty Rule has harmed or is likely to harm investors due to a reduction of Americans' access to certain retirement savings offerings, retirement product structures, retirement savings information, or related financial advice;
(ii) Whether the anticipated applicability of the Fiduciary Duty Rule has resulted in dislocations or disruptions within the retirement services industry that may adversely affect investors or retirees; and
(iii) Whether the Fiduciary Duty Rule is likely to cause an increase in litigation, and an increase in the prices that investors and retirees must pay to gain access to retirement services.
(b) If you make an affirmative determination as to any of the considerations identified in subsection (a), or if you conclude for any other reason after appropriate review that the Fiduciary Duty Rule is inconsistent with the priority identified earlier in this memorandum-then you shall publish for notice and comment a proposed rule rescinding or revising the Rule, as appropriate and as consistent with law.
Source: White House
“Faced with the sizable if uncertain legal and regulatory risks of assuming DoL fiduciary status vis-à-vis these fund shareholders, brokers are simply resigning from small accounts en masse,” he said. “Shareholders will lose the relationship they’ve depended upon, with none to take its place.”
The ICI is “calling upon the SEC to propose a harmonized best interest standard for broker-dealers that would enhance, rather than replace, existing suitability obligations,” Stevens added. “Only two bodies can lead the way on a unified best interest standard—the SEC and Congress. We hope the SEC will take the lead—but if it doesn’t, Congress should stand ready.”
The Labor Department should clarify that periodic distributions from retirement plans into insurance policies that were entered into prior to the applicability date of the rule should be exempt from the rule, wrote Sarah Ferman, senior government relations representative for the American Bankers Association.
“The ongoing premiums paid to agents in such cases do not constitute a new recommendation, but are based upon a transaction that occurred prior to the applicability of the rule,” she explained. Without this clarification, insurance agencies may be forced to resign as servicing agents on these policies and “policyholders would lose the benefit of the agent’s expertise.”
A letter signed by 51 organizations—including Americans for Financial Reform; DEMOS; NAACP; the National Employment Lawyers Association; the National Employment Law Project; and the Sargent Shriver National Center on Poverty Law—expressed strong support for the rule and opposition to eliminating or weakening it.
The letter cited statistics used when the rule was first developed. Among them: underperformance associated with conflicts of interest in the mutual funds segment alone is likely to cost IRA investors between $95 billion and $189 billion over the next 10 years and between $202 billion and $404 billion over the next 20 years.
“Unfortunately, the rules that have applied to retirement investment advice have made it too easy for unscrupulous advisers to line their own pockets at our expense,” the letter stated. “The nature of the lobbying that has taken place around the rule itself demonstrates that harm to investors is a specious excuse for overturning or weakening this rule.”
The letter argued against claims that firms will be exposed to excessive litigation cost. “For those who would flout these rule requirements, private litigation is the major means for the enforcement of the Best Interests Contract Exemption in the rule,” it says. “In the absence of a litigation option, it can no longer be assumed that the best interest commitment will be adhered to by investment advisers.”
The CFA Institute is a professional association that represents nearly 146,400 investment analysts, advisers, portfolio managers, and other investment professionals. “While we had hoped that the SEC would have taken the lead in creating a best-interest standard for all advice providers to retail investors, it has yet to do so and has not indicated an intent to do so soon,” it wrote. “Consequently, the rule that the Labor Department has put in place is, despite its flaws, a much-needed step in the right direction for retirement investors.”
Legal battles escalate
While the political process unfolds, lawsuits are seeking to secure more immediate relief for affected firms.
In June 2016, the U.S. Chamber of Commerce, Financial Services Institute, Financial Services Roundtable, and other business groups filed the first of several legal challenges. In February 2017, Judge Barbara Lynn of the United States District Court for the Northern District of Texas ruled against plaintiffs.
The latest wrinkle: On May 9, the Washington Legal Foundation—a public-interest law firm and policy center advocating for free-market principles—filed an amicus brief in support of the appellants in Chamber of Commerce, et al. v. Department of Labor, supporting efforts to reverse the Fifth Circuit ruling.
“Rather than increasing access to investment education and expanding consumer choice, the Fiduciary Rule will make it more difficult for America’s workers and retirees to receive quality advice about their investment options. This chilling effect comes at the expense of the First Amendment,” says Cory Andrews, WLF’s senior litigation counsel.
The brief focuses on the Labor Department’s “violation of the First Amendment by creating a rule that discriminates against speech based on its content and the identity of the speaker.” A content-based restriction on speech must meet strict scrutiny, it argues.
“The District Court circumvented proper application of strict scrutiny by holding that the appellants waived any First Amendment claims because they did not raise these issues during the rulemaking process,” the brief adds, arguing that “this harsh approach has been rejected in the past by both the Fifth Circuit and the U.S. Supreme Court.”