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DOL Moves Industry Closer to Harmonization

DOL Moves Industry Closer to Harmonization

The Department of Labor proposal is seen as a first step toward an industry standard.


Although the brokerages opposed the Department of Labor moving first on the definition of a fiduciary responsibility, the agency’s proposal may represent the first step in a harmonized fiduciary standard by maintaining flexibility of business models.

“The first thing that came to mind reading the proposal was a big ‘h’ for harmonization, in the sense that the industry was crying out for the Department of Labor to talk with the Securities and Exchange Commission,” says Duane Thompson, president of Potomac Strategies and senior policy analyst at fi360. “It looks like they not only talked, but there was some bleeding over of some of the Advisors Act fiduciary standard into the Department of Labor’s thinking.”

Ron Rhoades, president of ScholarFi and a professor of financial planning at Alfred State, says the DOL’s proposal can “absolutely” be categorized as a first step toward a workable uniform fiduciary. He hopes the SEC will take some cues from the DOL rule when it begins to formulate its uniform fiduciary standard, which Chair Mary Jo White has given the green light. “The DOL proposal distinguishes ‘sales’ from ‘advice,’ which SEC has been reluctant to do in the past,” he says. With the DOL pursuing this rule, the SEC now has a black eye for its long-standing failure to protect investors by applying the fiduciary standard to “advice” much more broadly, he adds.

“Given that DOL has moved away from the ‘sole interests’ ERISA standard to a ‘best interests’ standard (using its exceptive relief authority), there really isn't [any] reason the rules can't be nearly identical,” Rhoades says.

But Fred Reish, a securities lawyer with Drinker Biddle & Reath, cautions that while the SEC and DOL are coordinating, they can only go so far in harmonization. “Each agency has to write regulations consistent with the governing statutes, and the statutes take different approaches,” he says. But where possible, the rules will be written to work together.

The public got its first look on April 14 at the DOL’s long-awaited proposed fiduciary rule for advisors to retirement accounts. The proposal included several exemptions designed, Secretary of the Department of Labor Thomas Perez said, to protect investors while providing flexibility to financial advisors.

The exemptions allow advisors to receive common types of payment for services, including commissions, revenue-sharing and 12b-1 fees. “The rule is intended to provide guardrails but not straightjackets,” said Perez.

The biggest change may be the "best interest contract exemption." Instead of a five-part test to determine if an advisor is properly acting as a fiduciary under ERISA, it would require advisors and firms who want to receive certain types of compensation to "formally commit" to clients that they will put their best interests first, Perez said.

Under the contract, advisors and firms basically must agree to act in the best interests of clients and adopt policies that attempt to mitigate and disclose any unavoidable conflicts, says Timothy D. Hauser, the deputy assistant secretary for program operations of the Employee Benefits Security Administration.

“I was surprised, I thought the Department would stick to its guns,” Thompson says. “But it looks like the Department of Labor is moving away from simply prohibiting conflict, and allowing conflicts as long as there’s meaningful disclosure.”

An example of this harmonization and move toward disclosure is the DOL’s principal transaction exemption in the proposal, he adds. In 2007, the SEC created a temporary rule for principal transactions of broker/dealers who are registered as investment advisors, allowing b/ds to sell higher-quality fixed-income securities out of inventory.

Similarly, under the DOL’s proposal, advisors would be able to recommend similar products to plan participants and IRA accounts under a principal, if the advisor discloses it. The advisor would also have to obtain two price quotes from unaffiliated counterparts for the same or a similar security, and the transaction would have to occur at a price at least as favorable to the plan or IRA as the quotes.

“This wasn’t just pro forma discussions over Starbucks,” Thompson says. “It certainly looks, smells and tastes like the 40 Act fiduciary standard, like it’s moving in that direction.”

Cost Analysis

The DOL estimates the implementation costs could total between $2.4 billion and $5.7 billion over the next 10 years. But looking just at the brokerage space, the agency is estimating it would only cost between approximately $195,000 and $900,000 in start-up costs and between $80,000 and $360,000 for ongoing costs.

The agency drew its cost analysis from a report submitted by the Securities Industry and Financial Markets Association in response to the SEC’s request for information. The industry group surveyed 18 of its members (12 large b/ds and six regional b/ds), who estimated it would cost between $5 and $6 million to implement and between $1 and $2 million in annual maintenance.

But Kent A. Mason, a partner with Davis & Harman, says the DOL’ s proposal is seeking extremely detailed data from those advisors and brokerages using the exemptions. For example, it requires information on all direct and indirect pay an advisor’s company receives on asset sold in the last year. “That’s basically a phonebook,” he says. “The cost to build the systems to produce this data is going to be staggering amounts of money.”

The shift to a principles-based approach could also prove costly to the industry in the long run. “This is going to cause a fair amount of heartburn on Wall Street and in the broker/dealer community in terms of a principles-based approach,” Thompson says.

The customer will now have more tools to enforce that contract, Hauser says. Under the proposal, IRA account holders would have the right to sue the advisor and the firm in a lawsuit for breach of contract, according to an alert issued by the Wagner Law Group.

“That may be the way the fiduciary standard is clarified,” Thompson says. “The courts were in some ways the final arbiter of what Congress wanted when they wrote ERISA, and it looks like they’re going to play an even bigger role under a principles-based fiduciary approach. So if there is a grey area, the courts are going to shape it.”

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