United States

The fiduciary rule: A new opportunity awaits


For many Americans, the prospect of retiring with adequate savings has become a question fraught with insecurity and doubt. The impact of the 2008 financial crisis, compounded by pre-existing conditions of stagnant wages and rising costs, have affected the ability to stash away a nest egg for retirement.

The fiduciary rule (the Rule) proposed by of the U.S. Department of Labor (DOL) had an implementation date beginning June 9, 2017. The intent of the Rule was to protect retirement customers from financial advisor conflicts of interest and to enforce a fiduciary standard upon those providing investment advice to retirement plan accounts and other similar type accounts.

The Rule implementation and impediments

The Rule was designed to be phased in with the delayed implementation date beginning June 9, 2017, and ending Jan. 1, 2018.  Financial institutions were expected to comply with standards of conduct, reasonable compensation standards, and provide disclosures, address identified conflicts of interest, and maintain supervisory logs and records that provide evidence of exemptions to the Rule.

The new presidential administration halted the phase 1 rollout and delayed a second part of the Rule until 2019, which among other things, would have let consumers bring class-action suits against firms that violated their fiduciary duties.  On March 15, 2018, the 5th U.S. Circuit Court of Appeals issued a ruling stating, “Transforming sales pitches into the recommendations of a trusted adviser mixes apples and oranges. Therefore, the rule should not apply to brokers. By using this logic, the DOL should ban brokers entirely from this sphere or, alternatively, it could create a vacuum where anything goes and anyone can play. Neither is desirable.”  The court further noted that “in adopting the Fiduciary Rule, it [DOL] acted arbitrarily and capriciously.”  The appeals court effectively argued against the Rule and vacated the previous court’s decision to uphold the law.

Currently, the viability of the Rule is in question, and the DOL is required to take some action to either request a rehearing of the case in the 5th Circuit, appeal to the Supreme Court and continue to advance the Rule, allow the vacated Rule to stand without further action, or effectively go through a process to withdraw the Rule.

The evolution of the 2016 Rule

The Employee Benefits Security Administration, a division of the DOL, is responsible for administering and enforcing the fiduciary, reporting and disclosure provisions of Title I of the Employee Retirement Income Security Act of 1974 (ERISA).  ERISA was enacted to address public concerns that funds of private pension plans were being mismanaged and abused. Private pension funds are retirement plans to which individuals contribute from their earnings and in return, expect the payment of pension funds after retirement. During the time when ERISA was first enacted, the retirement landscape was very different than it is today. At that time, most plans were defined benefit pension plans where employees and earners contributed to the plan which was then professionally managed. The retirement benefit was defined both by the length of time at a place of employment and the level of one’s salary and contribution to the plan. The risk of investment performance was carried by the plan sponsor, not plan participants.

In today’s retirement landscape, there has been a marked shift away from defined benefit pension plans to defined contribution plans, such as 401(k) plans. But these plans also shift the investment risk for saving for retirement to plan participants because most 401(k) plans give participants responsibility for selecting their own investments. With many more people concerned about retirement and now faced with the responsibility of conducting sound investment management practices over their own retirement portfolios, many individuals have turned to the financial services industry to assist in the management of their retirement assets. With financial products such as individual retirement accounts (IRAs), simplified employee pension (SEP), Roth IRAs (Roth IRA), and a host of other plans covered by section 4975 of the Internal Revenue Code, individuals face a complex set of choices to make about how to manage retirement plans and other plan assets. It became increasingly important for participants to obtain high-quality investment advice.

ERISA established a standard of care for investment advisers and those giving investment advice related to retirement accounts. The standard of care included a definition of the responsibility of investment advisers as fiduciaries and came with a five-part test to determine whether the adviser was, in fact, a fiduciary.  In order to meet the ERISA fiduciary standard, all parts of the test were required to be met. The adviser must: 1) make investment recommendations; 2) on a regular basis; 3) upon a mutual understanding between client and adviser that the advice; 4) will serve as the primary basis for investment decisions; and 5) will be individualized to the particular needs of the retirement plan. These services could be provided for a fee which included any compensation to the fiduciary, his or her employer, or affiliates. Retirement fee services increased in number and form, and a number of investment adviser compensation models were constructed to award investment advisers for their services to the client and to the firms for which they worked.

It is with this backdrop of the DOL’s shared responsibility for administering ERISA and for providing safeguard standards for employers and employees, increasing complex retirement products and services, and the financial crises that the current-day Rule emerged.  Officially known as Definition of the Term “Fiduciary”; Conflict of Interest Rule-Retirement Investment Advice (81 FR 20945), the Rule reflected DOL’s desire to update the fiduciary definition. In particular, the DOL wanted to protect retirement plan participants who may be encouraged to roll over their retirement plan accounts into potentially higher-priced investment products or services.

The controversy over the Rule

Oddly enough, the new Rule, which at its core wanted to ensure that investment advisers act in the best interest of their clients and free from conflicts of interest, was met with controversy.  The controversy stemmed from three major issues:

  1. The DOL changed the established definition under ERISA of fiduciary, the five-part test that accompanied it and the exemptions under the pre-existing rule.
  2. The DOL definition of fiduciary impacted how the Investment Adviser Act of 1940 also defined the fiduciary role of investment advisers. Investment advisers were historically governed by authorities such as the Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA), and not by the DOL.
  3. The rule challenged the fee structure and compensation models of investment advisers and potentially implied an inherent conflict of interest in the models, which many financial institutions rejected.

These three issues put the new Rule on a direct collision course with a newly elected presidential administration and political party.

Under the new Rule, a person will be considered an investment advice fiduciary if he or she provides a “recommendation” with respect to an investment, distribution or account management decision in a retirement account for a fee or other compensation. The primary question in establishing if there is fiduciary investment advice is whether a recommendation has been provided regarding the investment, distribution or account management of a retirement account.

A recommendation has been defined under paragraph (b)(1)  of the Rule as any communication that, based on its content, context and presentation, would be reasonably viewed as a suggestion that the advice recipient engaged in or refrained from taking a particular course of action. Fiduciary investment advice includes recommendations on the advisability of the purchase, sale or holding of investments, and recommendations as to the management of retirement accounts, including, for example, distribution and rollover decisions.

The new rule relates not only to traditional retirement accounts but also to health savings accounts and Coverdell Education Savings Accounts (pre-tax educations savings), as each of these requires the individual customer chooses their own investments or seeks professional advice.

Proponents of the rule stress that in today’s landscape, there is a plethora of advisers in the market place, including online schemes, that are not Registered Investment Advisors (RIAs) or investment adviser representatives (IARs) who target retirees and retirement accounts. These types of advisers are not obligated to act in the client’s best interest, and because of conflicts of interest such as commissions paid to sell certain products, might and do provide bad advice.

Potential investor and financial institution impacts

The Rule was originally seen as a huge investor savings program that would allow retirement savers and future planners the ability to save on fee services and invest more of their assets.  In reality, it turned out to be a mixed bag for investors.  Those investors routinely seeking simple advice or not requiring professional advice, found themselves in the controversial crosshairs of the Rule.  Some financial institutions began a push toward managed retirement accounts with fees.  Those investors with simple retirement accounts began to experience pressure to move 401(k)s and IRAs, and other such accounts into managed programs.

The Rule was also intended to protect investors from other investment schemes aimed at their retirement accounts.  For example, sales professionals from insurance companies have been singled out for targeting retirement savings for investment schemes or mutual funds.

On the other side, investment advisers, wealth managers, broker-dealers, retail banking institutions that have investment brokers on the branch floor, and other similar financial institutions were all impacted by the new fiduciary standard and the definition of investment advice and recommendation.  Compensation models, fees structures, supervisory controls and a host of other issues immediately became pressing, as well as the contemplation of the levels of the best interest contract (BIC) introduced by the Rule. Under the Rule, financial advisers are prohibited from receiving variable commissions when conducting transactions in client retirement accounts.  For these commissions to be allowable, the transaction in question would have to qualify for the BIC exemption.  The BIC exemptions apply only when the financial adviser provides nondiscretionary investment advice, and the client understands the nature of the guidance they are given.

Takeaway considerations for financial institutions

The long-haul effort of the DOL to propose and implement the Rule highlighted among other things, the deep held beliefs of consumer advocates that there was a fundamental flaw in the structure of investment advisory relationship for retirement accounts and other similar type accounts.  While the appeals court may have put forward an argument about the lack of authority of the DOL to re-define the fiduciary standards related to these and similar accounts as a primary reason for the current limbo status of the law, one cannot ignore that this issue raised significant awareness of investors and advisers alike.  On March 8, 2018, just prior to the 5th Circuit ruling, 11 state treasurers wrote letters to the chairman of the SEC to urge him to review the major components of the Rule and to prompt the SEC to devise its own version of the revised fiduciary standards and definitions as related to retirement investment and like accounts.

On April 18, 2018, the SEC released a set of proposals intended to limit brokers and investment advisers’ potential conflicts of interest for nonretirement and retirement accounts. The SEC’s proposal, known as the “best-interest proposal,” is subject to a 90-day comment period by the public and industry before being finalized. 

With the current status of the DOL rule and the proposed SEC rules on the table, financial institutions now have the opportunity to continue to court consumer confidence and self-assess their conduct standards, fiduciary standards, disclosures, compensation models, and supervisory and governance standards in the execution of their duties as financial advisers so that despite whatever new form the rule re-emerges, they will have already completed much of the compliance work.

RSM as a first-choice advisor

RSM has already contemplated the next steps for financial institutions that completed their gap assessment and implementation plans.  We remain ready to assist in the assessment and implementation processes that will inevitably continue given the newly proposed rules by the SEC.