From the August 2012 issue of Investment Advisor • Subscribe!

Borzi on the Hot Seat, Again

Democratic lawmakers question DOL fiduciary rule on IRAs

Phyllis Borzi is once again feeling heat—this time from House Democrats—over her insistence on including individual retirement accounts (IRAs) in the Department of Labor’s reproposed fiduciary rule.

The latest complaint came in a late June letter from House Democrats to Borzi’s boss, Labor Secretary Hilda Solis. The lawmakers told Solis that their “core concern” is that the final proposal to redefine the term fiduciary in the context of providing investment advice under ERISA must ensure that “current access to investment information and education is at the very least preserved.”

In order to achieve this goal, the lawmakers said, it “is essential for the relevant federal agencies to coordinate their actions to arrive at a workable, consistent set of rules.” Unfortunately, the lawmakers voiced concerns that DOL may not be following this approach.

What’s more, the lawmakers said, DOL’s efforts and its data requests should be focused on what they called the “critical national need” for investment information and education. Instead, the department’s data requests from the industry on IRAs indicate that DOL may be headed in a direction that could “actually restrict access to investment education and information.”

The House Democrats, including Rep. Barney Frank, D-Mass., told Solis that they see a lack of “meaningful coordination” between the DOL’s Employee Benefits Security Administration (EBSA) and the SEC, despite the fact that the SEC is engaged in a “parallel” fiduciary project.

But Borzi said in a May interview with Investment Advisor that although there is a “primary commonality” between the SEC’s Dodd-Frank project to craft a rule to put brokers under a fiduciary mandate and EBSA’s fiduciary project, which is “to be more clear as to who is a fiduciary under [DOL and SEC’s] respective statutes,” it’s impossible for the two to come out with one fiduciary standard as the statutes they adhere to are “so very different.” She reiterated this in June at an industry conference by stating: “I will not promise anybody there will be a single fiduciary standard.” However, she added that compliance with EBSA’s fiduciary standard “won’t put you out of compliance with another [fiduciary] standard” such as the SEC’s.

She told me in the May interview that DOL and SEC over the years have had a strong record of collaboration but stressed “where it’s appropriate,” and that the SEC and DOL have been collaborating on the economic analysis as EBSA crafts its reproposal.

Blocking Advice for IRA Owners?

A huge sticking point has been EBSA’s data request from industry trade groups regarding what impact any conflicts of interest faced by brokers and advisors who advise on IRAs might have on IRA investors.

When EBSA released its original rule proposal on fiduciary duty under ERISA in October 2010, EBSA received comments suggesting that it had not adequately demonstrated or quantified the harm that can arise when investment advisors’ interests conflict with those of the IRA owners they advise.

I talked with three industry experts—Fred Reish, Brad Campbell and Kent Mason—about the lawmakers’ worries. They agreed that if IRAs are included in the redraft, as Borzi has insisted they will be, such account holders will be blocked from receiving advice.

Kent Mason, a partner at the law firm Davis & Harman—which represents the companies that participated in the Oliver Wyman study released to the DOL and the SEC in early April—reiterated the key point the study made: that 7 million IRAs “would be cut off from access to an investment professional” under EBSA’s proposal.

An Issue for Small Businesses

Besides the IRA issue, “there is a huge small business issue here,” Mason says. A critical issue that’s been largely overlooked, he argues, is that small businesses looking to offer a 401(k) plan for their workers would be prohibited from offering advice. Mason offers this example: Say you have a 12-employee hardware store that’s ready to offer a plan. The owners have a discussion with a financial institution that can provide 2,000 investment options to choose from—a number that Mason says is not unusual. The small business owner, however, wants to offer only about 15 to 20 investment options. “Today, there’s a lot of education that’s provided by the financial institution, such as ‘Here’s 15 or 20 options offered by similar businesses,’ or ‘Here’s some screening techniques you can use,’” to help the employer make an informed decision, Mason says.

Under the EBSA’s proposed regulation, argues Mason, that kind of help “would now be prohibited.”

So a small business like the hardware store, Mason says, would then be forced to make one of two choices: select the investments itself, subject to fiduciary liability; or find an independent expert, also subject to fiduciary liability.

Indeed, Fred Reish, partner and chair of the ERISA team at Drinker Biddle & Reath, says that small IRAs with, say, $25,000 or $50,000, “won’t receive individualized advice from RIAs who sign on as fiduciaries, because the annual fees are so small.”

For example, he says, “a 1% fee would be only $250 or $500 per year.” In those cases, he says, “commissions can provide higher compensation for services.”

Reish says that DOL should write rules that preserve current successful practices while also protecting plans, participants and IRA owners. To a degree, he says, that could be accomplished by requiring disclosures and by providing exceptions to the prohibited transaction rules.

Former EBSA head Brad Campbell, who’s now with Drinker Biddle’s Washington office, says that despite the numerous concerns that have been raised about DOL’s proposal “in the context of ERISA plans alone,” he agrees that extending the fiduciary rule to IRAs will present “lots of new problems,” and have the effect of making it much more difficult for people to get advice on IRAs.

He cites the fact that as it stands now, less than 20% of workers in 401(k) plans have access to advice. “That same problem would be significantly increased in the IRA marketplace,” Campbell says.

Presidential Politics and Purview

While Borzi has said she worries about investor protection as boomers roll over their retirement money from 401(k)s to IRAs (see sidebar above), Campbell says he doesn’t believe the IRA marketplace “is the wild, wild West that it’s being portrayed to be.” DOL is insisting that the IRA market is “a problem, and they need to do something about it, but it’s not clear DOL is the right agency, and it’s not clear their solution is the right solution.”

Indeed, Mason says that while DOL has the authority to write the rules that apply to IRAs, the Department has “no enforcement authority.” That is up to the Internal Revenue Service (IRS).

No doubt DOL will receive further objections to its inclusion of IRAs in its reproposal once it’s released, which Campbell predicts won’t come until after the presidential election in November.

DOL, he said, has not sent a rule proposal to the White House’s Office of Management and Budget within the last six months, something he called “an unusual dry spell” for the department. Even if Labor sent its reproposal to the White House today, he said, it usually takes three months for an approval.

If President Obama wins re-election, however, Campbell said DOL’s rule amending the definition of fiduciary under ERISA will quickly appear at OMB. If Obama does win a second term, Campbell predicts “we will see a renewed push for more aggressive regulation.”

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