The Institute for the Fiduciary Standard applauds the Department of Labor’s historic effort to update ERISA after 40 years. The transformative changes in the markets, investing and the employer-employee relationship since 1974 call out for major reform. The independent and credible research that quantifies the costs to investors in higher fees and lower quality investments, due to antiquated rules, is compelling.
DOL’s bold leadership in acknowledging and articulating the gravity of the problem, proposing bold rule-making, and listening to and then challenging opponents of the rule to get around the table and help improve the rule is to be applauded.
The redraft’s BICE—Best Interest Contract Exemption—fundamentally re-engineers ERISA’s foundation by allowing many previously prohibited compensation arrangements. As DOL states, the BICE seeks to:
“Preserve beneficial business models by taking a standards-based approach that will broadly permit firms to continue to reply on common fee practices as long as they are willing to adhere to basic standards aimed at ensuring their advice is in the best interest of their customers.”
DOL sets out the standards’ requirements. The firm and the broker/advisor must
“Contractually acknowledge fiduciary status, commit to adhering to basic standards of impartial conduct, adopt policies and procedures reasonably designed to minimize the harmful impacts of conflicts of interest, and disclose basic information on their conflicts of interest and the cost of their advice. Central to the exemption … (is) to meet fundamental obligations of fair dealing and fiduciary conduct to give advice that is in the customer’s best interest; avoid misleading statements; receive no more than reasonable compensation; and apply with applicable state and federal laws governing advice.”
In other words, the firm and the broker/advisor are asked to do what most investors believe their broker/advisor already does, or should do, today. Or, more significantly, what a broker/advisor implies doing in meeting a best interest standard.
What are they asked to do?
To promise in writing to do what’s right.
Charge reasonable fees.
Follow policies to manage conflicts, give impartial advice and tell the truth.
Disclose conflicts and all fees the investor pays and the firm receives, and follow state and federal laws.
It’s Common Sense: Conflicts Cause Harm
In sum these practices seek to apply the fiduciary duty of loyalty and reflect the corollary enduring principle that is the very focus of the DOL proposed rule. This principle has been so completely woven into law and ethics and culture, and so often expounded on by jurists throughout history, that it is today considered a given, not needing explanation.
It is simple common sense to investors and virtually irrefutable to academics and regulators. The principle: conflicts are inherently harmful.
One researcher terms conflicts, “A cancer on objectivity,” and a former SEC senior staff official calls them, “Viruses that threaten the organization’s well-being … and if not eliminated or neutralized even the simplest virus is a mortal threat to the body…”
DOL’s Strategy Presents Opportunities and Risks
The main opportunity is that firms currently associated with opacity and conflicted advice may change their practices and meet the ERISA best interest standard. The main risk is firms will agree to meet the best interest standard and hold themselves out as such.
However, they won’t materially change their practices and, instead, will present voluminous legal arguments to explain why their current practices are best practices.
DOL has addressed the fiduciary rule with conviction, persistence and humility all too rare in Washington today. The agency proposed and withdrew and then re-proposed a rule. DOL acknowledged shortcomings in its first proposal, seeks improvements in the current proposal and has repeatedly invited the industry to offer more suggestions.
Meanwhile, industry participants who have publicly engaged on fiduciary rulemaking, almost without exception, do not acknowledge the existence of any “problem” that is associated with the industry. Instead, industry participants turn logic upside down and argue that conflicted advice benefits investors and fiduciary duties harm investors.
Industry “logic” is captured in its high-decibel angst over the common-sense duties – an agreement promising to do right, to tell the truth, to give impartial advice, charge reasonable fees and disclose conflicts, etc. – in the BICE. Such “logic” has been called “Orwellian” by one (Republican-appointed) jurist, Judge Paul A. Crotty.
The Institute offers four recommendations to strengthen BICE:
- DOL should continue listening to industry suggestions aimed at lowering firms’ costs without weakening the BICE requirements.
- DOL should provide greater specificity to the definition of “reasonable fees.”
- DOL should spell out the steps required of broker-advisors to overcome and neutralize or mitigate a material conflict.
- Finally, DOL should underscore its conviction that conflicts are corrosive and reduce them. DOL should require a level fee compensation arrangement as a condition of the BICE.