On June 21, 2018, the United States Court of Appeals for the Fifth Circuit based in New Orleans confirmed its decision to vacate the Department of Labor’s (DOL) fiduciary rule, known as the “Definition of the Term ‘Fiduciary’; Conflict of Interest Rule -- Retirement Investment Advice” (the Rule). Published in the Federal Registrar in its final form on April 8, 2016, the Rule was scheduled to be phased in from April 10, 2017, through January 1, 2018. The Department of Justice’s decision not to petition the Supreme Court further indicated the finality of the Rule.
In general, the Rule was controversial because it expanded the concept of a fiduciary for purposes of the Employee Retirement Income Security Act of 1974 (ERISA) beyond the traditional special relationship of confidence and trust — including situations in which the relationship was simply that of a salesperson and customer. Further, the decision from the Court concluded that the Rule constituted “unreasonableness” and that the DOL’s implementation of it constituted an “arbitrary and capricious exercise of administrative power” — as it provided interpretive authority over IRAs and broker-dealers, which was viewed by the Court and other critics as an encroachment on areas where the Securities Exchange Commission (SEC) is responsible for oversight.
Specifically, the Rule expanded the “investment advice fiduciary” definition under ERISA to demand that retirement advisors act in the best interest of their clients and put their clients’ interest ahead of their own. Many viewed the definition as overbroad and convoluted, turning commonplace interactions into fiduciary relationships and minimizing the exchange of information between individuals saving for retirement and no-cost resources such as call centers, walk-in centers and websites.
The standard of fiduciary is a much higher level of accountability than the current standard of suitability required of brokers, financial planners and insurance agents who work with retirement plan accounts. The suitability standard provides that as long as an investment recommendation meets a client’s defined need and objective, it is deemed appropriate. Under a fiduciary standard, financial professionals are legally obligated to put their client’s best interests first, rather than simply finding “suitable investments.” Many believe the Rule would have eliminated many commission structures, such as upfront sales loads and 12b-1 program platforms throughout the industry.
The regulation to the Rule was met with opposition from many financial investment professionals, as being held to a suitability standard rather than a fiduciary standard is more preferential due to legal concerns. Many expressed that the fiduciary rulemaking consequently would cause dislocations and disruption within the financial services industry, and would limit the ability of retirement savers to obtain the guidance, products and services necessary to meet retirement goals. Additional costs to comply with the Rule were expected and considered to be disproportionately tough on smaller, independent broker-dealers and registered investment advisory firms who typically do not have the expertise to meet the additional compliance requirements.
Even several larger institutions sold their brokerage operations or shut down their offering of certain commission-paying retirement options in reaction to the Rule, as they continued to justify assuming the potential risk and liability for certain accounts, including the substantial threat of unwarranted litigation.
The SEC is looking at alternatives to address this growing concern from the investor perspective on the regulatory front. While it is not clear how the current ruling will impact the SEC Chairman’s Jay Clayton’s position on the matter, it appears that there is a coordinated effort to develop consistent standards that apply to retirement and non-retirement accounts. There are clear advantages to this approach, which will preserve investor choice and access to advice.
Please contact a member of your service team, or contact Lori Novak at lnovak@cohencpa.com for further discussion.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.