Publication:      401(k) Advisor

Volume/Issue:  Volume 24, No. 5, May 2017

The Fiduciary Regulations:  What a Fine Mess You Have Gotten Us Into, Ollie

Ilene H. Ferenczy

The DOL has delayed the applicability date of the new fiduciary conflict of interest regulation and the related prohibited transaction exemptions (collectively, the “Regulation”) from April 10 to June 9.  The purpose of the delay is to permit the DOL to engage in the study of the Regulation, as directed by the Trump Administration, to ensure that the regulations do not cause more harm than good, without requiring plans to comply with the Regulation in the interim.

The current segment of our story began when the Trump Administration issued a Presidential Memorandum on February 2, 2017, asking the DOL to engage in further study to determine whether the Regulation:

• Will likely harm investors due to reduced access to retirement savings offerings, products, information, or advice;
• Will cause dislocation and disruptions in the retirement services industry that will affect investors; and
• Will cause in increase in litigation or fees.

If the answer to any of these three questions is “yes,” the Administration will consider the next steps, which may involve revoking or modifying the Regulation.

All this is what many have been hoping for and, in fact, many have been trying in vain to litigate to achieve.  However, at this stage in the proceedings, one needs to look at the industry and wonder:  is this what we really want?

The Landscape Has Changed …

One need only look around in the financial industry to realize that there has been a change in the way retirement plans and their advisors are doing business.  People are now questioning whether a plan should be advised by someone who is not admitting to be a fiduciary.  Plan sponsors must ask themselves why they would consider hiring an advisor who is not a fiduciary and, as such, is not required to have the participants’ best interests at heart.  How can legal counsel advise a plan sponsor that it is not a risk to employ a nonfiduciary for this purpose, when it most likely tees up a plaintiff’s lawyer’s question:  Why did you decide to hire an advisor who was not subject to the fiduciary obligation to put your participants first?

At the very least, a plan sponsor must be able to articulate a reasonable response to that question to avoid being considered to have breached his or her fiduciary obligations to the plan and the participants.  And, if the response is that a fiduciary advisor was too expensive, the plan sponsor better have data – perhaps in the form of an RFP response from nonfiduciary and fiduciary advisors – to demonstrate that this claim is true.

There Was Some Good Stuff in the Regs and Their Aftermath

Upon further reflection, the DOL assured us that the “Frost Model,” whereby a level fee advisor offsets commissions or revenue sharing against the level fee, continues to avoid a self-dealing prohibited transaction.  This provides an advisor with an easy means by which to avoid having to comply with the complications of the full Best Interest Contract Exemption (BICE).  This “easy means” evaporates if there are proprietary funds involved, or if the financial institution behind the advisor is not receiving a level fee in relation to the investments.  But, it has been the mainstay of fiduciary advisor compensation, particularly in the Registered Investment Advisor (RIA) world, for a long time.

Losing the Regulation may mean that we lose BICE Lite, as the variation on the level fee BICE that applies to distribution and rollover advice has been called.  Under this shortcut exemption, a level fee fiduciary can give advice to a participant or beneficiary about distributions and rollovers, including the advice to roll their benefits over to an IRA on which the advisor will continue to provide services, without self-dealing.  This is a huge advancement on the pre-Regulation structure, particularly when it is coupled with the level field that was created when the Regulation made an advisor who is not in any way related to the plan a fiduciary with regard to the distribution and rollover advice.  By making anyone advising a participant regarding distributions and rollovers a fiduciary, and by providing a reasonable means by which someone can advise the participant without having to give away the business as part of that advice, the Regulation produces a healthy balance that would likely be very successful at protecting the participants from harm.  Further, it would hold all advisors to the participants to a higher standard of care, something that is very much needed.

On the Other Hand, Some Parts of the Regulation Were Not So Helpful

The part of the Regulation that truly threatens the relationships among plan service providers, to the detriment of the plan sponsors and participants, is the ridiculous rule that someone recommending a financial advisor is a fiduciary if s/he gets paid … with very little guidance as to what constitutes payment, or any limitation on the time frame or the breadth of that fiduciary status.  This provision, if left as is, would prevent most third party administrators (TPAs), lawyers, and accountants from directing their clients to qualified advisors.  The fear is not that the advice, in and of itself, is held to a standard that exceeds that of a normal recommendation.  Service providers who know who the good advisors are can probably give that advice without fear that it would be found wanting.  It is the risk of co-fiduciary liability under ERISA that, in this setting, has a chilling effect.  Suppose a TPA refers a client to a financial advisor (and receives some form of compensation for this advice, be it a finder’s fee, a “thank-you” lunch, or even a cross-referral).  If that TPA finds out sometime later that the client has engaged in a fiduciary breach – such as failing to deposit salary deferrals – the TPA can be held equally liable for that breach unless the TPA takes remedial action to help the plan.  How much later can this happen and invoke liability to the TPA?  No one knows.  What if the TPA resigns as fiduciary immediately after the recommendation to the advisor, but continues to provide nonfiduciary TPA services?  Does that cut off co-fiduciary liability?  No one knows.

So, Here We Are, With One Foot in the Regulation, and One Foot Out …

In summary, as the DOL and the Administration figure their way out of this muck, we in the industry should be careful what we wish. Perhaps full repeal or revocation of the Regulation is not what we really want for ourselves and our clients.  While the Regulation remains problematic for some reasons, it has redeeming characteristics that we may want to retain.