DOL Fiduciary Rule: What’s Old Is New Again

At this point, the entire financial services industry and much of the investing public has heard about and commented extensively on the new Department of Labor fiduciary rule. Even Englishman-cum-New Yorker John Oliver has opined on the rule, excoriating Americans who dare to engage in our peculiar colonial indulgence of governmental participation via legal challenges of suspect laws. After such a condemnation, we have been led to believe that all of Wall Street is to be in fear of this new rule and is obliged to change its ways, and right quick. Perhaps some quarters of the Street might tremble before the rule, but for much of the financial services industry, the rule is nothing new.

If you’ve ever been a fiduciary for your clients, because as a professional you know that it’s in the best interest of the client, you’ve already lived with the rule. If you believe in the core tenets of putting your clients first, you’ve already lived with the rule. If you’ve ever been involved with institutional clients like pensions or Taft-Hartley plans, you’ve already lived with the rule. Mr. Oliver, this new rule is not new to the industry; it’s just new to the talk show circuit. 

Of course, many well-meaning financial services professionals disapprove of the rule, while regulators adore the rule. How have the financial industry and its own regulators framed the point of this rule so badly and so poisoned its acceptance? Between the DOL putting out questionable figures on what Wall Street apparently steals from retirement accounts, to trade industries stepping into a public relations mess they never intended to be in, the industry is creating confusion for clients and hardening both sides of the debate. What all sides need to understand is that the worst foul so far committed by the DOL and the industry trade organizations is not being clear to the investing public: A large portion of the financial services industry has been living under this rule since the 1970s.

Turns out, many industry practitioners have been doing right by their clients under a fiduciary rule for over 40 years. Rare is the financial professional who has never worked with an ERISA-covered account. The Employee Retirement Income Security Act has been law since 1974 and contains a strong fiduciary standard that is binding all professionals who work with ERISA-covered accounts.

The new rule is a thousand-page document that muddies the waters of what should be a fairly simple and admirable goal, expanding the definition of “Covered Accounts” under ERISA to include individual retirement accounts (and maybe some other investing vehicles). Why is it important to start with ERISA? ERISA is the only federal act that truly defines the fiduciary standard. Sure, there are two mentions of “fiduciary” in the 40 Act (Investment Company Act of 1940), and every state has a different definition. But ERISA defines who is a fiduciary and how a fiduciary is to act toward clients. Not clarifying the starting point is where the industry proponents and detractors have equally missed the forest for the trees. 

Under the new rule, a fiduciary is any person who provides investment advice to a retirement investor for a fee or other compensation (direct or indirect). This seems fairly simple, doesn’t it? The duties of a fiduciary, defined by ERISA, are equally direct:

  1. Loyalty – Actions of a fiduciary must be solely in the interest of the participants and beneficiaries.
  2. Documentation – Agreements and Investment Policy Statement must be in writing.
  3. Prudence – A fiduciary must act with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character with like aims.
  4. Diversification – Investments must be diversified to minimize the risk of large losses.
  5. Reasonable Plan Expenses – It is necessary to create a process to assess if fees and expenses are reasonable.

Applying the ERISA fiduciary standard to all retirement accounts might seem like a good idea, but this isn’t what happened. Unfortunately, the DOL butchered fundamental ERISA tenets with the Best Interest Contract Exemption, leaving the new rule a mediocre hollow version of the real thing. If the definition and duties of a fiduciary are so direct, why did the DOL need a thousand-page document to require what was for 40 years uncontroversial? As with anything ordered by politicians and written by policy wonks, the devil is in the details. 

What is the greatest sin a fiduciary can commit? Conflict. Unlike the 40 Act, where conflicts are acceptable (but frowned upon) as long as they are disclosed, under ERISA, conflicts are intolerable. For example, a financial professional cannot charge a commission in an ERISA-covered account, because ERISA requires compensation to be in the form of a level fee to prevent the inherent conflict of recommending transactions merely to generate commissions. Under the new rule, however, a financial professional can charge a commission or other form of variable compensation under the Best Interest Contract Exemption. Under BICE, as long as an advisor signs an agreement acknowledging a conflict but contractually promises to do what’s in the best interest of the client, a financial professional can manage a client’s money just as in the past with no repercussions.

And that is why this whole concept of a DOL fiduciary rule is both ridiculous and tragic; everyone lost sight of what should have been the goal. Under Oliver’s providential rule that will save us from the greedy financial professional, clients may still be mistreated by a ne’er-do-well financial professional as long as they promise that they are not a ne’er-do-well. The DOL is receiving accolades for abandoning a functioning concept that has been in place for 42 years and for caving to industry pressure.

Amidst all these points, the greatest disappointment is that clients are now being led to distrust true advisors who have been acting in a fiduciary capacity for many years and who must now defend how they manage their clients’ assets.

Matthew Reynolds is the Chief Operating and Compliance Officer at Chicago-based financial services firm Noyes and its subsidiary David A. Noyes & Company.  

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