Risks Lurk in DOL Rule Exemption for ‘Clean Shares’

Industry officials see the Labor Department moving forward in proposing a new, streamlined exemption for “clean shares” as part of its revised fiduciary rule, but warn that risks lie ahead in how Labor crafts such an exemption.

If Labor issues “too broad” a definition of clean shares, “the rule will bless conflicted payments in cases where they might be a problem,” said Aron Szapiro, director of policy research at Morningstar, during a Friday panel discussion at the Consumer Federation of America’s financial services conference in Washington. If the definition is “too narrow,” the rule could “stifle innovation.”

As it stands now, Szapiro added, the kind of innovation that DOL hoped would occur in promulgating its fiduciary rule “is flourishing.”

Paul Roye, senior counsel for Capital Research and Management Company — which is the investment advisor for the American Funds — who spoke on the panel with Szapiro, opined that Labor “is going to fashion an exemption around clean shares” in any revised rule.

However, Roye, a former director of the Securities and Exchange Commission’s Division of Investment Management, stated, “it’s very easy to say ‘clean share’ exemption, but then you get into some of the issues … of what is ‘clean’?”

Labor, through such an exemption, could end up “making decisions for investors and dictating winners and losers,” Roye added. When regulators “try to decide what’s best for investors, that stifles innovation and in my view is bad policy.”

Labor announced Monday the official 18-month delay of its fiduciary rule’s prohibited transaction exemptions. Micah Hauptman, the Consumer Federation’s financial services counsel, who moderated the panel, stated that while the fiduciary rule “partially took effect” on June 9, the Labor Department, in delaying the exemptions, is “really stopping the rule from coming into effect.”

It’s “widely expected that DOL will revise or repeal the rule” in the interim, Hauptman added.

Clean Shares

Clean shares — which first came via T shares (or “transactional” shares) and then share class Z, or “clean” shares — were developed to allow level commissions that the broker could charge directly to the customer.

Szapiro noted in a recent Morningstar blog post that, as he’s warned regulators, there’s “promise and peril” in embracing clean shares.