The Department of Labor’s long-awaited final fiduciary rule “ensures that putting clients first is no longer a marketing slogan, it’s the law,” Labor Secretary Thomas Perez told reporters on an early April call to announce completion of DOL’s rule to amend the definition of fiduciary on retirement advice.
“With the finalization of this rule, we are putting in place a fundamental protection into the American retirement landscape,” Perez said on April 5, the day before the rule was released. “A consumer’s best interest must now come before an advisor’s financial interest. This is a huge win for the middle class.”
After nearly six years of reworking the rule based on extensive and “invaluable” public feedback from consumer groups and stakeholders, Perez told reporters that DOL has “streamlined” and clarified its conflict of interest rule — including the controversial Best Interest Contract Exemption (BICE), the disclosure provisions, proprietary products and treatment of products like annuities, as well as commissions.
“We listened, we learned, we adjusted,” he said, “and you’ll find that in the final rule.”
As part of the overhaul, DOL has also lengthened the compliance timeline under the rule to one year from the original eight months, Perez said, and “phased in the implementation so firms will have until Jan. 1, 2018,” to come into full compliance.
The final rule and exemptions adopt a “phased” implementation approach. One year after the rule’s publication, in April 2017, the “broader definition of fiduciary will take effect, but to take advantage of the BIC exemption, firms will only be required to comply with more limited conditions, including acknowledging their fiduciary status, adhering to the best interest standard and making basic disclosures of conflicts of interest,” DOL stated in a fact sheet detailing some of the final rule’s changes.
The other requirements of the exemption will only go into full effect on Jan. 1, 2018.
Now that the rule is completed, DOL’s focus is “shifting to working collaboratively with all stakeholders to ensure compliance,” Perez said, adding that over the next 18 months, DOL “will be fanning out to address questions, concerns and help facilitate compliance.”
Perez, along with White House National Economic Council Director Jeffrey Zients, Sen. Elizabeth Warren, D-Mass., and other lawmakers publicly announced the final rule at an event at the Center for American Progress in Washington on April 6. The rule appeared on public inspection at the Federal Register later that day.
Zients noted on the media call that a little over a year ago, President Barack Obama “called for action to crack down on conflicts of interest in retirement advice, which costs American families billions of dollars every year.” With the release, he continued, “we’ve reached a major milestone — the Department of Labor has finalized crucial protections for middle class Americans’ retirement savings.”
Zients noted that DOL’s final rule “incorporates feedback, helps to streamline and clarify the proposal, to minimize the compliance burden and ensure continued access to good advice, while at the same time maintaining an enforceable best interest standard.”
These new rules, he continued, “will level the playing field so that retirement advisors will compete based on the quality of advice that they give.”
He acknowledged, however, that “powerful interests” remain aligned against DOL, “insisting that the only good rule is no rule at all.”
Zients repeated a message that the president delivered last year: “If your business model rests on bilking hardworking Americans out of their retirement money, then you shouldn’t be in business.”
The president, he said, “will continue to fight to protect this new rule.”
Under the final rule, any individual receiving compensation for making investment recommendations that are individualized or specifically directed to a particular plan sponsor running a retirement plan (e.g., an employer with a retirement plan), plan participant or IRA owner for consideration in making a retirement investment decision is a fiduciary.
The rule also clarifies what “does and does not constitute fiduciary advice” and includes examples of communication that would not rise to the level of a recommendation and thus would not be considered advice. Specifically, it states that “education is not included in the definition of retirement investment advice so advisors and plan sponsors can continue to provide general education on retirement saving without triggering fiduciary duties.”
Further, the final rule defines a variety of investment education activities that fall short of fiduciary conduct, and makes clear that advisors do not act as fiduciaries merely by recommending that a customer hire them to render advisory or asset management services.
Perez explained some changes made to the Best Interest Contract Exemption.
“We were asked to adjust the mechanics of the contract,” Perez said. “Companies said that they would have to put a contract in front of potential customers the minute they walked in the door or the minute they got on the phone, so we addressed that.”
”Now,” he continued, “the contract can be completed at the same time as the other paperwork you fill out when you open an account. So for instance, if you go to four companies to shop around on how to invest your $100,000 that you’ve saved and you choose the second company that you met with, then when you execute the paperwork to establish that relationship, it’s then and only then that you execute the contract, and that contract can be as simple as a sheet of paper or another paragraph attached to one of the other documents that you are signing.”
He added: “You don’t have to do a thing with any of the other companies that you dealt with.”
The final rule also voids a list of approved assets eligible under the BIC exemption. “We got a lot of feedback that folks didn’t like the list of assets, so in the final rule that list is gone,” Perez said.
As for presenting the BICE to existing clients, “firms can now send a simple email or letter — which does not require the entry of a contract — […] to address the issue of the existing customers,” Perez stated.
Fred Reish, a partner in Drinker Biddle & Reath’s employee benefits and executive compensation practice group, said the “biggest surprise” is the extension of the compliance requirements. “The final rules allow a year before compliance is required. Even then, compliance with the [BICE] is simplified until the full requirements take effect on Jan. 1, 2018, over a year and a half from now.”
Also, the compliance requirements for BICE have been “greatly simplified” under the final rule, Reish added. “That includes the timing of the execution of the contract — point of sale — and the elimination of the most burdensome financial disclosures.”
Perez stated on the call that DOL “eliminated the one-, five- and 10-year projections of the point of sale disclosure as well as the annual disclosure, and streamlined other disclosures.”
That being said, “the basic structure of the regulatory package has not changed,” Reish added. “The definition of fiduciary is still encompassing and the exemptions are still needed. Those changes are nothing short of revolutionary for advice to IRAs.”
Rule Will ‘Survive Lawsuits’
DOL is confident that the rule will survive legal challenges, the two top architects of the rulemaking said in early April.
“Every rule we take, people threaten us with litigation,” Perez told reporters on the sidelines of the Center for American Progress event where he announced the rule. “We had a very lengthy and deliberate process, and what people see when they review the rule is that we listened and made changes. I’m confident in what we’ve done on the policy front, and I’m confident that we will survive any legal challenge.”
Perez also said that he believed the number of opponents to the rule would actually shrink over the course of the compliance timeline.
“The volume of opponents I think is going to shrink because they are on the wrong side of the debate and are on the wrong side of history, on the wrong side of the American people, and are on the wrong side of Main Street,” Perez said.
Phyllis Borzi, assistant secretary of Labor for DOL’s Employee Benefits Security Administration, agreed in comments to reporters that DOL is “confident that we have put together a rule that will survive legal challenges.” However, she said, “people have a right to” challenge the rule in the courts. “That’s the American way.”
Borzi, who has been the main architect of the rule but turned over public statements about the rulemaking to Perez over the past couple of years, said she knew getting the rule finalized “was going to be a difficult haul.” But, she said, “it was the right thing to do.”
Added Borzi: “Whatever the slings and arrows we took along the way, this is worth it. But we’re not finished.”
After six years of working to get the rule completed, Borzi said that DOL will now turn to helping firms comply with the rule. “The process is just beginning because there will be lots and lots of questions that will come,” she said. “My staff is prepared to help people comply; compliance is going to be the mode that we’re going to be in from now on.”
DOL extended the compliance deadline from eight months to one year “to balance the need to get the protections in place as soon as possible with the practicalities of how long it would take people to implement this” rule, Borzi said.
She added that under the new rule, “people will have to create new policies and procedures, new compensation arrangements perhaps, develop new products.”
Indeed, Rep. John Delaney, D-Md., stated in comments at the event that with DOL’s final rule, “the private economy will embrace the standard because they have to, and many of them have been doing that already, and they will innovate around providing solutions that meet the standard and make customers happy and are low cost.”
Delaney said he sees two events unfolding: “The existing players […] will adopt this rule, make changes to their business models as needed, and they’ll work hard to keep every one of their customers because one of the biggest costs that financial services companies have are what’s called customer acquisition — meaning the money they spend for customers,” he said. “So why in the world would any of the companies stop serving any of these customers that they’ve invested a huge amount of money in? I just don’t buy into this idea that they’ll stop serving these customers.”
Second, Delaney said, “we’re also going to see new innovation.” Right now, “there are people in conference rooms with white boards, entrepreneurs and investors charting out new businesses to build to provide this level of service.”
Rep. Ann Wagner, R-Mo., who sponsored the Retail Investor Protection Act, bipartisan legislation passed in the House that would require the Securities and Exchange Commission, not DOL, to take the lead on crafting a fiduciary rule, said the day the rule was released that she was “working closely with House leadership and members of the Education and Workforce Committee on using the Congressional Review Act to stop [DOL's] ill-advised rule.” Less than two weeks later, she and two other Republican lawmakers introduced a joint resolution disapproving the rule, one day after Republican Sens. Johnny Isakson of Georgia, Lamar Alexander of Tennessee and Mike Enzi of Wyoming introduced a similar resolution.
Rule’s Effect on RIAs
In March, a prominent RIA chuckled when asked how he was preparing his wealth management firm for the DOL’s redefinition of fiduciary under ERISA. “I’m sick of hearing about this rule,” he said, suggesting that the rule would not affect his firm at all.
That feeling is understandable, since RIAs already have a fiduciary duty to put their clients’ interests ahead of their own, while the burden of complying with the rule will mostly be borne by advisors and their broker-dealer partners.
However, he may be wrong. For example, while advisors are used to dealing with the SEC as their regulator and examiner, the DOL has a different enforcement scheme, though advisors who consult on retirement plans may already be familiar with the DOL and the complicated rules of ERISA. RIAs are used to disclosing conflicts of interest through their Form ADV filed with the SEC or the states, but “that will not suffice for the DOL rule, which is focused not on disclosing conflicts but on prohibiting them,” Schwab’s Michael Townsend said late last year.
Townsend, Schwab’s vice president of legislative and regulatory affairs, said then that “layering on another set of regulators will require someone in the firm to understand them to potentially monitor and comply with.” RIAs will have to consider, for example, “what kind of information […] to provide to someone who is contemplating moving from a 401(k) to an IRA […], someone who may not yet be a client of yours but may be considering becoming a client.” Can the advisor recommend a 401(k) rollover into an IRA when the advisor’s management fee for the IRA exceeds the 401(k) plan’s fee or when the IRA doesn’t perform as well as the 401(k)?
In a Fidelity advisor survey released in March, 55% of RIAs surveyed said they expect the rule will increase the time they must spend on compliance. Tom Corra, COO of Fidelity Clearing & Custody, said in an interview then that “at a minimum,” advisors should expect to have “a conversation with clients” and increased recordkeeping costs.
A preliminary assessment of the DOL rule suggests some of those compliance worries may not be as big an issue as first thought. Skip Schweiss, managing director for retirement plan services and advisor advocacy for TD Ameritrade, listed several changes in the final rule of interest to RIAs.
He provided the caveat that “I have not yet read all of the 1,023 pages in the final regulations,” though he has “read the FAQs and the summary released” by the Department of Labor.
His first response is that DOL “retained the spirit of the rule — to raise the standards of care for retirement investors — but they also listened to a lot of the concerns that retirement advisors” and the industry had about the preliminary rule. “They struck a really nice balance,” he said.
Those sentiments were echoed by several advisors. Harold Evensky of the wealth management firm Evensky Katz Foldes and Texas Tech University said in an email that the DOL rule constituted a “major step toward a more secure and dignified retirement for millions.” David Savir, a former JPMorgan wealth manager turned RIA just this year at Element Pointe Advisors in Miami, said in a note that “the fiduciary rule is a very positive change for investors.”
Schweiss pointed out a benefit to investors. Since the DOL best interest standard is a “contractual obligation,” the rule “essentially takes mandatory arbitration out of these retirement accounts; investors’ rights are still retained.”
Finally, Schweiss said his early reading suggests the DOL has constructed a fiduciary process that’s “more principles-based” than rules-based.
Schweiss said dually registered RIAs “will be impacted more than the fee-only RIAs.” Are RIAs ready for the rule? “My sense is they’re not — there was an [erroneous] idea that it only applied to brokers and insurance agents.”
With such a complicated rule, this is one instance where being a broker-dealer rep might make it easier to comply. “Broker-dealer reps have a home office preparing” for the DOL rule, he pointed out, mentioning steps already taken by LPL and Raymond James. Those broker-dealers probably feel some relief since it appears, Schweiss said, that “if you’re living under the best interest contract, you can still recommend options, futures, forex and nontraded REITs.”
As for RIAs, Schweiss said that “if I were them, I’d be in touch with my securities lawyer or ERISA lawyer.”
— Read more of our coverage of the passing of this historic rule on the DOL Fiduciary Compliance homepage.