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Is the DOL’s New Proposal Really a New Broker Standard?

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Henry Gondorff (played by Paul Newman) in the 1973 classic movie “The Sting”:

“You have to keep the con even after you take his money; he can’t know you took him.” 

As I painfully make my way through the long document that comprises the Department of Labor’s much anticipated (or dreaded) proposed rule changes for brokers that work with clients who have IRAs, the sentence that keeps running through my mind is: “We’ve been had.”

By “we,” I refer to those of us who had hoped the DOL would raise the level of protections for IRA investors to the same fiduciary standard that currently protects participants in 401(k) and other retirement plans. Instead, what we got is a collection of “new” standards” so riddled with exemptions and loopholes that it makes one wonder whether the fix was in from the beginning. 

Consider this hypothetical scenario:  Suppose you and a group of your competitors derived a substantial portion of your annual profits from the sales of heavily loaded investment products into IRAs, often while helping clients roll over their existing retirement plans.

And, again, hypothetically, suppose your industry and federal regulators were under considerable pressure from consumer and advisor groups, as well as the media, to increase protections of your IRA clients to the level of other retirement plan participants. What would you do? 

Would you simply oppose any new consumer protections, and pressure lawmakers into joining you in stonewalling them? You could; but that would make your industry look “anti-investor” and could eventually hurt the business you were trying to protect. And, of course, it would be hard to maintain your block of politicians in the face of increasing public support for the new rules.

Or you could work behind the scenes to pressure the DOL to abandon its efforts. But even if you succeeded, you’d once again end up making yourselves and the DOL look bad.

Instead, suppose you got your high-priced strategists together and devised a better plan: One that quieted the consumer advocates and industry critics, while enabling you to get on with business as usual. What would that look like?

To start, you’d keep caterwauling about how unfair and anti-consumer any new standards would be. You might even get the White House to issue a statement about the need for new regulations, so you could wail about how unfair that was, too.

Meanwhile, behind the scenes, you and your political supporters might pressure the DOL to make “minor” changes to its proposed new regs, which would result in very little changes in the way you currently do business. Then, when those new proposals came out, you’d continue to gnash your collective teeth about how they spelled the end of the brokerage industry, yadda, yadda.

Finally, when they are adopted, the DOL looks good, the White House looks good, your politicians look good, and you just keep on doing business as usual. Ka-ching!

Far-fetched? Probably, which I would have thought, too, if I hadn’t read the Institute for the Fiduciary Standard’s new while paper, “Conflicts of Interests and the Duty of Loyalty at the Securities and Exchange Commission,” by Knut Rostad, president of the Institute. (See Melanie Waddell’s “SEC’s Ability to Deliver True Fiduciary Standard in Doubt: Report,” and my upcoming May column in Investment Advisor).

In his paper, Rostad chronicles the SEC’s gradual but steady replacement of the key fiduciary principle of “acting in the client’s best interest” with simply disclosure of conflicts, under its own legal theory that a client’s receipt of disclosure (even if they don’t read it) is sufficient evidence of the client’s best interest. 

Rostad argues that the SEC is conducting a massive erosion of investor protections. And if you can survive the brain damage of reading through the DOL’s new proposal, you’ll find the lowered standards at work in it as well: equating disclosure with the client’s best interest.

The DOL gives us a clue to what it’s really up to when it writes: “The Department has also sought to preserve beneficial business models for delivery of investment advice by separately proposing new exemptions from ERISA’s prohibited transaction rules that would broadly permit firms to continue common fee and compensation practices, as long as they are willing to adhere to basic standards aimed at ensuring that their advice is in the best interest of their customers.”

For those of you have followed the fiduciary debate over the past half decade, you’ll recognize the use of the term “preserving business models” to mean “not forcing sales people to really act in the best interests of their clients.” Yet to maintain the appearance of a fiduciary-like standard, the DOL has added “…ensuring that their advice is in the best interest of their customers.” (But also note they didn’t say “investors” or even “clients.”) 

However, the DOL proposal does provide ample clues for us to understand what they mean by customers’ “best interests.” For instance: “The Department is proposing a new exemption (the “Best Interest Contract Exemption”) that would provide conditional relief for common compensation, such as commissions and revenue sharing, that an adviser and the adviser’s employing firm might receive in connection with investment advice to retail retirement investors…the exemption requires the firm and the adviser to contractually acknowledge fiduciary status, commit to adhere to basic standards of impartial conduct, adopt policies and procedures reasonably designed to minimize the harmful impact of conflicts of interest, and disclose basic information on their conflicts of interest and on the cost of their advice.” 

I’m not a lawyer, but to me, this sounds a lot like the “broker exemption” to the ’40 Act, which currently allows retail brokers to give financial advice without being subject to RIA standards. Even worse, it has replaced the duty to avoid conflicts with disclosure (just as Rostad revealed about the SEC). Worst of all, if accepted as written, it would greatly increase the “cover” for brokers to claim they are client fiduciaries, while legally having to meet a much lower standard—and while squaring the brokerage industry with consumer advocates and the media.

I don’t really know if the DOL’s proposal is part of a brokerage industry grand scheme. But it sure is interesting how all the pieces fit neatly together, isn’t it? It’s enough to make Henry Gondorff proud.