The Department of Labor (“DOL”) announced that it is extending the “investment advice fiduciary” definition in the “Employee Retirement Income Security Act” (“ERISA”) which will bind all financial professionals who provide retirement planning and advice to a fiduciary. A fiduciary is a level of obligation that requires “fiduciaries” to place the interests of their clients above their own. It also exposes people who are “fiduciaries” to additional causes of action if they fail to place their client’s interests above their own.
The expansion of the rule is a significant victory for consumers however there are more than a few financial and investment professionals who argue the rule is unnecessary and will increase costs on consumers.
Fiduciary Rule Explained
A fiduciary is a person who holds a legal or ethical relationship of trust to another person or people. For example, lawyers owe fiduciary duties to their clients; trustees owe a fiduciary duty to the trust and the beneficiaries of the trust, conservators, legal guardians, business partners who fiduciary duties to one another, boards of directors to their corporations, and teachers and students.
The purpose of the fiduciary rule was to emphasize that some jobs or relationships necessarily entail that other people will depend on them for their advice, knowledge, and experience. Those relationships are inherently unequal therefore the fiduciary duty arose to ensure that, despite the unequal relationship, the fiduciary wouldn’t place their interests above their clients.
The fiduciary duty is the highest standard of care to which a person or entity can be bound. The fiduciary is expected to exhibit extreme loyalty to the principal (the person to whom the duty is owed), to the point that the fiduciary must lose their own money in order to assure the solvency of their client. Furthermore, the fiduciary duty prohibits people bound by the duty from entering into conflicts of interest or failing to disclose a conflict to the principal.
A conflict of interest means that the fiduciary has competing goals or obligations that distract from her fiduciary obligation. For example, if a lawyer is representing two clients and evidence is uncovered that one of the clients may have a claim against the other, the lawyer is required by fiduciary and professional obligation to disclose the conflict to the clients.
Controversy Regarding the Rule
The rule was originally promulgated by the Obama Administration and was set to be phased on April 10, 2017. However, on February 3, 2017, after the Trump Administration assumed control of the government, the White House issued a memorandum that instructed the DOL to conduct an “economic and legal analysis” of the fiduciary rule’s impact and to delay the implementation of the rule by 180 days. However, by March 20, 2017, the DOL issued its Bulletin clarifying that the delay would only be for 60 days.
The DOL reopened the rule for public comment and received overwhelming support in favor of the rule and intense opposition to the delay of its implementation. Some industry heavyweights, including major asset managers, oppose the rule and favored delay. However, despite the opposition, the Secretary Alexander Acosta (the head of the DOL) announced that delay of implementation would be inappropriate, contradicting the White House memorandum.
Several lawsuits have been filed to oppose the rule, including a joint suit filed by the U.S. Chambers of Commerce, the Securities Industry, and Financial Markets Association, and the Financial Services Roundtable. Many brokers argue that the new rules will prohibit commissions which will force them to raise their hourly rates which could price many people out of their services.
Outline of New Rule
The rule requires investment and financial advisors to:
- Place their clients’ interests above their own.
- Disclose potential conflicts of interest, for example, if the advisor receives a commission for selling the client a particular product.
- Disclose all fees and commissions to clients.
The rule was expanded to include financial advisors who provide ongoing advice and those who are making one-off recommendations or solicitations (so people who are trying to pitch their services to a client). The fiduciary obligation is a far higher duty than the old suitability rule which only required financial advisors to provide advice that meets the client’s needs and objectives.
The rule also specifically lists plans that are protected by the rule including:
- Defined contribution plans such as 403(b) (government retirement plans), employee stock ownership, 401(k)s, and Simplified Employee Pensions (“SEPs”);
- Defined-benefit plans (i.e. pensions); and
- Individual Retirement Accounts.
However, the rule doesn’t cover every situation in which a financial advisor gives information to a client. For instance, if a customer calls a financial advisor asking about a particular product or if a financial advisor gives general investment advice based on a person’s income or age (but not advice that is individualized to that person’s goals).