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New DOL Fiduciary Rule Generates Heated Debate

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The comment period on the Labor Department’s fiduciary rule to align with the Securities and Exchange Commission’s Regulation Best Interest ended on Aug. 8. A good smattering of the comments called for Labor to amend the rule. That’s unlikely.

Just days before the comment period expired, Labor denied a request by lawmakers to hold a hearing or extend the comment period on its new fiduciary prohibited transaction exemption aligning with Reg BI.

But then in a reversal, Labor said on Aug. 21 that it would hold hearings on its fiduciary rule on Sept. 3 and, if necessary, Sept. 4.

In a July letter, Sen. Patty Murray, D-Wash., ranking member on the Health, Education, Labor and Pensions Committee, asked Jeanne Klinefelter Wilson, acting head of Labor’s Employee Benefits Security Administration, to hold public hearings as Labor did in 2015 when it was seeking feedback on the previous fiduciary rule vacated by the U.S. Court of Appeals for the 5th Circuit.

In response, Joe Wheeler, deputy assistant secretary for Labor, told Murray in early August that Labor “believes that a public hearing is unnecessary” for the proposed class exemption, as it’s “much narrower in scope” than the vacated fiduciary rule.

“I’m incredibly frustrated that the Trump administration is charging ahead so recklessly with a proposal that could lead to retirement savers losing billions of dollars a year due to conflicted advice,” Murray said in an email statement.

The proposed prohibited transaction exemption had a 30-day comment period, which lawmakers and industry groups argued was far too short considering the rule’s complexity.

Final Rule on ‘Five-Part Test’

Labor’s package also included a final rule reinstating the 1975 fiduciary five-part test under the Employee Retirement Income Security Act. Unlike with the proposed fiduciary transaction exemption, or PTE, there was “no opportunity for comment” on the final rule, Barbara Roper, director of investor protection for the Consumer Federation of America, told me in early August.

There was “no consideration of whether it should be amended. The preamble [to the rule] includes a discussion of how it [the final rule] will be interpreted by the Department, but the rule is final,” she explained.

Roper and Micah Hauptman, financial services counsel at the consumer group, maintained in their comment letter to Labor that “we know from past experience that the 1975 regulatory definition of fiduciary investment advice, with its five-part test, is easily gamed by financial firms that like to market themselves as trusted advisers while avoiding any fiduciary obligations to their clients.”

By reinstating “that deeply flawed definition, the Department is ensuring that these firms, as well as their employees and agents, will only be investment advice fiduciaries when they choose to be,” they explained.

“Many if not most rollover recommendations, and virtually all of those involving rollovers into non-securities, will get a regulatory free pass as a result of the Department’s decision to reinstate this outdated, loophole-filled definition,” Roper and Hauptman said.

Labor should withdraw its fiduciary rule package as it allows for conflicted investment advice and gives most rollover recommendations a “regulatory free pass,” Roper said in the comment letter.

The Public Investors Advocate Bar Association, a group of lawyers who represent investors in disputes with the securities industry, urged Labor in a comment letter “to adopt a new regulation, which would eliminate the need to satisfy a five-part test before someone providing investment advice would be deemed a fiduciary.”

Said PIABA: “There should be no need to establish that investment advice has been given on a regular basis, or pursuant to a mutual agreement that the advice will serve as the primary basis for the investment decision. Any individual providing investment advice to a retirement investor for a fee should be deemed an Investment Advice Fiduciary and held to the highest fiduciary standards.”

Democratic Lawmakers Weigh In

Murray and Rep. Bobby Scott, D-Va., chairman of the House Education and Labor Committee, along with House Financial Services Chairwoman Maxine Waters, D-Calif., and Sen. Kamala Harris, D-Calif., Democratic presidential candidate Joe Biden’s VP pick, agreed in a comment letter to Labor that reinstating the 1975 five-part test under the Employee Retirement Income Security Act will allow “unscrupulous” advisors to provide conflicted advice.

“The five-part test from 1975 has not kept pace with the changed retirement services landscape,” the lawmakers told Labor Secretary Eugene Scalia. “It was promulgated prior to the existence to 401(k) plans and widespread investments in IRAs. Defined contribution (DC) plans have largely replaced traditional defined benefit (DB) pensions as the primary retirement plans offered by employers.”

The five-part test, the lawmakers continued, “has loopholes that can easily be exploited, particularly because every prong must be met for an advisor to be deemed as providing fiduciary investment advice. For instance, only advice that is furnished on a ‘regular basis’ is considered fiduciary investment advice. As a result, one-time recommendations — no matter how consequential — will be exempted.”

Labor, the lawmakers concluded, should “immediately withdraw” both the final rule reinstating the ERISA five-part test and its prohibited transaction exemption to align the SEC’s Reg BI and “star over with a focus on the best interests of workers and retirees.”

However, Kent Mason, an attorney with Davis & Harman in Washington, argued in his comment letter that Labor’s rewrite of the five-part test for determining fiduciary status in its final rule “would effectively reinstate the 2016 fiduciary rule” that was vacated by an appeals court, “and thus severely harm the ability of millions of Americans to access investment assistance.”

In brief, Mason wrote, the preamble to the proposed exemption attempts to “effectively eliminate three core parts of the five-part test — the mutual understanding, primary basis, and regular basis tests, and thus effectively reinstate the invalidated 2016 fiduciary definition.”

Moreover, he continued, the final rule “purports to be interpreting present law, these changes would be fully retroactive for all past years back to the 1970s.”

Because the final rule’s changes would effectively resurrect the 2016 fiduciary definition, “they are in stark violation” of the Fifth Circuit decision that voided the 2016 definition of a fiduciary and reinstated the original five-part test,” Mason wrote.

Also, the final five-part test rule violates the Administrative Procedure Act as well as President Donald Trump’s 2017 Fiduciary Duty Rule Memorandum as well as the regulatory policies and instructions announced in at least three executive orders issued by the Trump administration.

“For these reasons, and because the preamble language is flatly inconsistent with the language of the regulation, it is clear that the preamble language is invalid and will only create confusion,” Mason wrote.

But Roper challenged Mason’s assertion. “The discussion in the [rule’s] preamble doesn’t begin to reinstate the 2016 definition,” she told me in an email message. “The 2016 definition included all rollover recommendations, for example, and this [final rule] does not,” she said.

The final rule “also doesn’t eliminate three prongs of the five-part test. All the preamble does is suggest that the Department might not interpret the five-part test in exactly the same way it did in the past, while making clear that there are still plenty of loopholes firms can use to evade their fiduciary obligations.” Roper explained.

Democratic presidential candidate Joe Biden likely would torpedo Reg BI — as well as the Labor Department’s new fiduciary rule to align with Reg BI — if elected president, according to his draft party platform.

“Democrats believe that when workers are saving for retirement, the financial advisors they consult should be legally obligated to put their client’s best interests first,” the draft party platform, released in late July, states under the banner Guaranteeing a Secure and Dignified Retirement.

Democrats, the plan said, “will take immediate action to reverse the Trump Administration’s regulations allowing financial advisors to prioritize their self-interest over their clients’ financial well-being,” the draft report states in what appears to be a reference to Reg BI.

In taking “immediate action,” Brad Campbell, former head of Labor’s Employee Benefits Security Administration, who’s now a partner at FaegreDrinker in Washington, said a Biden administration may try to “change” Reg BI and potentially “revive” Labor’s 2016 fiduciary rule that was vacated by the appeals court.

Washington Bureau Chief Melanie Waddell can be reached at [email protected].