Death of DOL Fiduciary Rule Raises Question: Do You Know Your Fiduciary Ecosystem?

August 28, 2018

The on-again, off-again legal deathwatch of a stronger fiduciary rule by the U.S. Department of Labor that captivated investment advisors and lawyers for the past two years is finally being laid to rest.

The rule, which implemented a higher standard for investment advice on retirement accounts, took effect in 2016 but was thrown out by a U.S. District Court judge in the Northern District of Texas earlier this year

To the casual observer, the DOL rule may have seemed like shades of gray: Advisors must act in their client’s “best interest” instead of simply recommending investments that are “suitable.”

But the rule put more legal teeth in the obligations and responsibilities of advisors, and some professionals in the field had already begun changing policies or practices.

Bank of America’s Merrill Lynch brokerage arm was one of the leaders, banning broker commissions on retirement accounts the firm manages in favor of a new model that charges fees based on a percentage of assets. Merrill Lynch conducted a media campaign touting how its new compensation policy better aligns its interests with those of its clients.

In June, Merrill Lynch said it might reverse the ban, in part because the 1 percent fee on assets is sometimes more expensive than a traditional commission would have been, which prompted some clients to leave, The Wall Street Journal reported.

“While we’ll remain a standard-bearer on [the fee] front, we’d be remiss if we didn’t consider additional flexibility and choice we can provide to clients,” Andy Sieg, head of Merrill Lynch wealth management, told The Wall Street Journal.

Some critics have noted that it’s hard for advisors to tell clients that they’re reverting back to a lesser standard in the wake of the demise of the DOL rule.

Who’s Your Fiduciary?

Although it has died, the DOL case is prompting executives and people who serve in a fiduciary capacity on their company’s retirement plan committee to reflect on their investment advisor ecosystem.

Who exactly has fiduciary responsibility, and why does it matter?

The ultimate fiduciary is the plan sponsor, which is usually the company itself.

Trustees of a plan, such as the senior executives on the committee that oversees a plan and makes decisions about investments, also have complete fiduciary responsibility.

Many people serving in that capacity don’t fully understand their responsibilities and potential legal exposure.

“We’ll sit in with a committee and it’ll be our first official meeting, and we’ll have someone intimately involved in the plan say something like ‘Well, I’m not a fiduciary…,’” says Anne Tyler Hall, Owner and Principal Attorney at Hall Benefits Law, which specializes in ERISA and fiduciary legal solutions.

Other people assume all financial advisors and brokers have the same level of fiduciary responsibility, but that’s not the case.

Brokers and financial advisors aren’t necessarily fiduciaries.

Certain advisors, such as those holding registered investment advisor (RIA) designation, are by definition co-fiduciaries and have full fiduciary responsibility and a legal obligation to do what’s in the best interest of the client. Financial advisors, such as brokers, are typically not acting as a co-fiduciary. Brokers have a suitability standard; meaning they have a duty to recommend investments or providers that are suitable for their client, but they do not need to ensure their recommendations are in the client’s best interest.

Some financial advisors might not have specialized certification on ERISA law or concentrated experience with retirement plans. While that might have been OK for them to run a company’s retirement account when it was small and had just a couple dozen employees, there may come a time when that company’s needs mature and outgrow the advisor’s capabilities.

The company’s committee must consider these factors and may need to take the initiative to switch to an advisor who specializes in retirement accounts and has fiduciary responsibility, which is a best practice.

In short, if you have any discretion over how the plan is run or where the money is invested, you’re a fiduciary, says Hall.

Another often misunderstood element is insurance. Companies should have two kinds: a fidelity bond (which protects the money in the plan) and fiduciary liability insurance (which protects the people who run the plan).

Some companies don’t have any liability insurance at all, which exposes their employees who oversee the plan to personal risk that they may not be aware of.

Making sure that people with a fiduciary role fully understand what that entails is paramount, and companies should have robust policies and procedures in place to ensure they’re following best practices, which an attorney or registered investment advisor can guide them through.

“What we stress is education, and building this fiduciary legal compliance foundation,” Hall said.

What is a Conflict of Interest?

One goal of the DOL rule was to minimize potential conflicts of interest and incentivize brokers to recommend products and investment strategies that better reflected the best interests of their clients.

For example, under the suitability threshold, an advisor could be debating between two investment products that are similar, but one pays him a higher commission and so he recommends that one because he has something to gain.

Both are “suitable” but one pays more to the advisor. Is that an inherent conflict of interest?

Another scenario is the hefty upfront commission advisors earn when they convince a company to move its plan from custodian to another, which can be 1 percent or more. The retirement plan is often charged an advisor fee of roughly 50 basis points to cover that commission, and companies are seldom aware that their plans are paying such large fees to simply move money to a new asset manager. Is that a conflict of interest?

The answer is complex and nuanced, and it’s often hard to identify things in the gray area that might be problematic.

The DOL fiduciary rule, which was opposed by the U.S. Chamber of Commerce and supported by the AARP and many groups that represent small investors, would have required more disclosure of such situations to the client and perhaps different choices by advisors.

SEC’s Turn

In April, the Securities and Exchange Commission stepped in and proposed a new rule of its own that would require broker-dealers to act in the “best interest” of retail clients on any securities transaction or investment strategy involving securities.

The SEC proposal relies heavily on disclosure of potential financial conflicts of interest, mitigation of conflicts that exist and the exercise of “reasonable diligence, care, skill and prudence” when selling products and conducting transactions to ensure they are in the client’s best interest.

However, as Forbes noted, the SEC proposal doesn’t explicitly define what “best interest” means for brokers.

The commission has the 1,000-page set of proposals open for public comment through August 7.

In Summary

The strike down of the DOL fiduciary rule is prompting many executives, retirement committee members and others with fiduciary responsibility to take a closer look at their investment advisor ecosystem.

It’s critical to fully understand fiduciary duties and best practices that can mitigate liability risk, and also carefully consider potential conflicts of interest that may exist.

A proposal by the SEC aims to accomplish what the DOL rule was intended to do, which is put greater responsibility on brokers to put the client’s “best interest” above their own interests.

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