Jean Strickland—As President Barack Obama has noted, the Department of Labor’s (“DOL’s”) new fiduciary rule intended to recognize the shift of retirement funds from employer-controlled pension plans to present-day employee-driven 401k and IRA accounts. It will do this by updating the Employee Retirement Income Security Act of 1974 (“ERISA”) to ensure that financial advisers act in their customers’ “best interest” relative to these accounts. A central requirement of the new rule—known as the Best Interest Contract (“BIC”) Exemption—requires that firms execute a BIC with customers when they provide commission-based pay to the financial professionals making investment recommendations.
Currently, investors seeking guidance with their retirement funds may invest with financial professionals under either of two standards—a “suitability” standard or a “fiduciary” standard. The suitability standard allows brokers to put their own interests ahead of customers’ interests. For example, brokers may receive greater compensation from selling certain products over others, which creates a conflict of interest. The new rule would require all who render investment advice for retirement accounts to adhere to a fiduciary standard.
So, why should there be any dispute about acting in the customer’s best interest?
The answer in short: The industry’s reduced profits.
However, the industry has raised interesting legal arguments in its efforts to obtain an injunction and a court order vacating the rule and its exemptions. On June 1, 2016, industry trade associations filed a lawsuit in opposition to the rule. The lawsuit alleges, among other things, that the DOL exceeded its authority. Specifically, the trade associations claim that: 1) the DOL did not have authority to promulgate the rule because Congress specifically vested this authority with the U.S. Securities and Exchange Commission (“SEC”) through the Dodd-Frank Act and 2) the DOL created a private right of action through its BIC Exemption, which only Congress can create.
Other interesting legal arguments include a claim that the DOL disregarded Congress’ direction in the Federal Arbitration Act by prohibiting class action waivers in arbitration agreements. Additionally, the lawsuit alleges that the rule violates existing statutory text in ERISA with an overly broad definition of “fiduciary” that wrongly encompasses sales activities. Further, the trade associations claim that the overly broad definition of “fiduciary” burdens and restricts financial institutions’ and financial professionals’ speech more than is necessary to serve the public interest thus violating the First Amendment. “The U.S. District Court for the Northern District of Texas . . . is scheduled to hear a consolidated lawsuit against the Department of Labor’s fiduciary rule on November 17, 2016.”
Meanwhile, as a result of the rule, Merrill Lynch announced this month “that it would no longer give retirement savers the option of paying a commission for trades after April 10th, when the new fiduciary regulation takes effect.” Other institutions may follow. A consequence of this shift is that retirement accounts may become more predominantly fee-based arrangements rather than commission-based arrangements moving forward. However, unless one is receiving advice for “trading” versus “investing” one’s retirement funds, this seems like a lesser concern relative to solving the conflict of interest issue inherent in many commission-based arrangements.
Safeguarding nest eggs from excessive risk-taking and compensation schemes that enrich financial professionals at retirees’ expense is a worthy goal. All would be better served by the industry making helpful suggestions for how regulators could best accomplish a transition to a fiduciary standard that puts the customers’ interests first.
