The DOL Changes the Game

Change the Game

Published July 2015

Synopsis: The US Department of Labor (DOL) released a proposal for comment in April regarding the standard of care for advice in retirement accounts. 

The proposal raises the standard from simple suitability to the much more stringent fiduciary standard. The change will have a profound impact on how advice is delivered for investment and insurance professionals. How will these changes likely impact you, and will the public see a difference?


In April of 2015, the US Department of Labor proposed a change to rule 29 CFR parts 2509 and 2510 under the Employee Benefits Security Administration to redefine who should meet the fiduciary standard when providing investment advice to a retirement plan or its participants or beneficiaries. If adopted, the proposal would treat persons who provide investment advice or recommendations to an employee benefit plan, plan fiduciary, plan participant or beneficiary, IRA, or IRA owner as fiduciaries under ERISA and the Code in a wider array of advice relationships than the existing ERISA and Code regulations, which would be replaced. How serious an impact the proposed rules will have is hotly debated. Some industry sources have expressed that the rules will bring an end to advice to small retirement savers while many consumer advocates believe that the proposed rule is too weak and will have little impact on the industry and the conflicts of interest that currently exist.

History and the Reasons We Need a New Standard 

In 1974 the United States adopted the Employee Retirement Income Security Act (ERISA) in an effort to insure that corporations would manage retirement trusts for the benefit of the employees who would depend on those trusts in old age. At the time most retirement savings occurred in the form of a defined benefit pension plan. Because the investment decisions in these trusts were primarily made by more sophisticated investors (the plan's administrators) the law focused on the responsibilities of those plan administrators. The increased responsibility caused many corporations to move away from traditional pension plans and towards defined contribution plans, especially the 401(k) plan, where most of the investment decisions are shifted to the plan's members. ERISA also introduced the Individual Retirement Account (IRA) which provided for significant portability of defined contribution plans increasing their acceptance among consumers. Within an IRA, the entirety of the investment decision falls upon the individual investor.

The protections for retirement savers in ERISA were considered sufficient in 1974. As more and more savers have turned to savings vehicles outside of the defined benefit pension plan, the Department of Labor has become concerned that much of the investment advice provided to retirement savers is not provided in an environment governed by a fiduciary standard. In 2010, the DOL proposed a set of standards raising the standard of care for investment advice for ERISA accounts to a fiduciary standard. Though the DOL stated that they expected the final rule to include exemptions, there were no exemptions were in the initial proposal. The feedback was overwhelming negative as many firms saw the rule as preventing their current business model completely. In addition to not including exemptions there was no study performed on the potential impact on the consumer. Under pressure from industry groups, and with little support from other regulators, the Department withdrew the proposal and went back to work.

This time the DOL included other regulators in the discussion, most prominently the SEC, and performed research on the costs of imposing a new rule as well as the potential savings to the consumer. Now some two and a half years later they introduced a new proposal.

The New Proposal 

The new rule "clarifies and rationalizes the definition of fiduciary investment advice." Specifically the rule states:

Under the definition, a person renders investment advice by (1) providing investment or investment management recommendations or appraisals to an employee benefit plan, a plan fiduciary, participant or beneficiary, or an IRA owner or fiduciary, and (2) either (a) acknowledging the fiduciary nature of the advice, or (b) acting pursuant to an agreement, arrangement, or understanding with the advice recipient that the advice is individualized to, or specifically directed to, the recipient for consideration in making investment or management decisions regarding plan assets. When such advice is provided for a fee or other compensation, direct or indirect, the person giving the advice is a fiduciary. 

Though the rule runs several thousand words and contains several exemptions these few words above are the core of the rule. The definition names an advice provider a fiduciary when providing investment advice to plan participants, beneficiaries, IRA owners, and their fiduciaries. This greatly expands the number of financial professionals that would be expected to meet a fiduciary standard.

What does it mean to be a fiduciary? 

The short definition is that a fiduciary must act in the best interest of a third party. Under the rule the third party is the plan participant or IRA owner in addition to plan administrators. Acting in the best interest of that third party means that fiduciaries are required to put the interests of the third party before their own.

Currently, unless provided by registered investment advisers or their representatives, most advice on retirement investing is provided under the less stringent Suitability Standard. Under the suitability standard the person giving the advice is required to make recommendations that are aligned with the customer's needs and objectives, and associated costs must be fair and reasonable.  Though certainly not a lax standard, suitability allows for there to be greater conflicts of interest, and in no way requires the provider of advice to "act in the best interest" of the consumer. The adoption of a universal fiduciary standard for all advice on retirement accounts will require significant adjustments to the marketing and sales processes for many in the financial services industry.

This change may be even more pronounced for the banking and insurance industry. These providers have often operated outside of the suitability standard, with disclosure and care requirements varying between the states. A big change in the new proposal is that the recommendation to move funds from one custodian to another may now be considered fiduciary investment advice even if no specific investment is recommended.

Who is not a fiduciary? 

In order to not overly burden firms and create an environment that continues to serve the small investor a number of exemptions to the rule are included in the proposal. Most of the listed exemptions are aimed at advice provided to a plan's fiduciaries (generally the plan's administrators). Because most plan administrators have a higher level of investment sophistication, the DOL is less concerned about providing additional protections to them.

There are still a few exemptions that apply to advice provided to the retail retirement investor. Below are three important exemptions.

1. Best Interest Contract Exemption 

The best interest contract exemption allows firms to continue to set their own compensation practices so long as they, among other things, commit to putting their client's best interest first and disclose any conflicts that may prevent them from doing so. Common forms of compensation, such as commissions, revenue sharing, and 12b-1 fees, are permitted under this exemption, whether paid by the client or a third party such as a mutual fund. This exemption is available to advisers to IRA savers, individual plan participants, and small plans. To qualify for the new best interest contract exemption, the firm and individual adviser providing retirement investment advice must enter into a contract with its clients that:

  • Commits the firm and the individual adviser to providing advice in the client's best interest.
  • Warrants that the firm has adopted policies and procedures designed to mitigate conflicts of interest.
  • Clearly and prominently discloses any conflicts of interest, like backdoor payments or hidden fees often buried in fine print that might prevent the adviser from providing advice in the client's best interest.  

2. ESOP Valuations and Fairness Opinions

Advice as to the value of securities in a plan provided to help an investor determine when, and how, to dispose of an asset may be exempt to the degree to which the information provided is analytical and factual. This would apply primarily to ESOP plans.

3. Investor Education 

The DOL FAQ states, "The financial services industry plays an important role in providing retirement and investment education to workers and retirees. The new proposal aims to provide greater clarity in the line between education and advice, so that advisers and plan sponsors can continue to provide general education on retirement saving without triggering fiduciary responsibilities. As an example, education could consist of general information about the mix of investments (e.g. stocks and bonds) someone should have based on their age, income, and other circumstances, while suggestions about the specific stocks, bonds, or funds that should constitute that mix would constitute advice. We believe this greater clarity on the distinction between education and advice will facilitate the provision of education, not inhibit it."

So What's the Difference? 

The first point when considering these rules is that it is almost certain that there will be changes before final adoption. As happened in 2010 this proposal may not be adopted at all. Even if they are adopted as they are written how they impact you or your firm is dependent on how much you and your firm employ non-fiduciary investment advice in your marketing and sales efforts.

Analysis of the proposal varies widely. Generally consumer advocate oriented groups are pleased, but are expressing concern that the "best interest contract exemption" is too broad. They note that simple disclosures are not a particularly effective tool currently and are skeptical that these requirements will be sufficient protection for the average retirement investor. On the opposite side are industry groups (the Securities Industry and Financial Markets Association, SIFMA, in particular) who have expressed that the adoption of these rules is so onerous that many firms will walk away from providing any advice to the small and middle market investor. So far, most of the larger broker/dealer firms are not forwarding an opinion, while some insurance companies have expressed concerns similar to SIFMA. The DOL seeks input; a link is provided below if you would like to participate.

It is likely that a more universal fiduciary standard applying to all investment advice will follow the DOL rule. Consideration of such a rule was included in the Dodd-Frank Act, though little progress has been made. When the DOL succeeds in introducing this new standard the efforts to develop a more universal standard will accelerate.

If you are a financial professional, or lead a financial services firm, it is important that you know what these rules will mean to your practice. Regulators having been moving toward adopting a fiduciary standard for investment advice for a number of years and under leadership of both political parties. It is more a question of when, not if, these rules, or some variation of them are adopted. The best advice is to begin to adapt your practices (or your firm's culture) now for what is coming in the future.

James Heitman is an instructor at Kaplan. The views expressed in this article are solely those of the author and do not represent the view of Kaplan University.

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