FAQ: The Department of Labor Fiduciary Proposal

Where does the Department of Labor get the authority to regulate advisors?
The Employee Retirement Investment Security Act of 1974 (ERISA) sets minimum standards for pension plans in private industry. For example, if an employer maintains a qualified retirement savings plan, ERISA specifies when an employee must be allowed to become a participant, how long they have to work before they become vested in their pension, how long a participant can be away from their job before it might affect their benefit, etc. ERISA also establishes the standards of conduct for fiduciary advisors assisting both employers and plan participants with respect to the plans and the participant accounts.  Although Individual Retirement Accounts (IRAs) are not “plans” under ERISA, the DOL has authority with respect to the definition of fiduciary and prohibited transactions for IRAs so these rules are applicable to IRAs as well.
Do DOL regulations under ERISA apply only to retirement plan advisors?
Yes. Securities outside of qualified retirement plans, as well as the advisors who provide them, do not fall under ERISA. They are regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). However, SEC and FINRA regulations do also apply to advisors who provide securities within qualified retirement plans.
What does ERISA say about retirement plan advisors’ fiduciary standard of conduct?
ERISA requires advisors who provide “investment advice” to serve as fiduciaries to their clients, meaning that they must act with prudence and loyalty, diversify client assets and follow plan documents. 
A financial professional satisfying the duty of prudence acts “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” (ERISA 404(a)(1)(B)). 
A duty of loyalty requires that advisors act solely in the interests of the participants for the “exclusive purpose” of providing benefits and defraying costs. ERISA currently prohibits fiduciaries from completing transactions that involve conflicts of interest, unless they disclose the conflicts and operate under the oversight of an independent fiduciary. 
What constitutes providing “investment advice,” according to the DOL? 
Under current ERISA rules, a broker-dealer  becomes a fiduciary providing investment advice ONLY if he or she satisfies a five-prong test. An broker-dealer is a fiduciary if he or she: 
1) provides advice,
2) on a regular basis,
3) pursuant to a mutual agreement or understanding
4) that the advice is the primary basis for an investment decision,
5) and if the advice is individualized based on the particular needs of the plan or participant. 
If any one of the five parts of the test is not met, the broker-dealer is not considered to be providing investment advice and therefore is not deemed a fiduciary. Anyone with discretionary authority is always a fiduciary under both ERISA and SEC rules.
A broker-dealer making trades at the direction of a plan sponsor, investment advisor or plan participant is not considered as providing “investment advice,” under current rules. Nor is it considered “investment advice” to provide general education about asset allocations or types of investments. 
What value does the broker-dealer provide if not “investment advice” under ERISA?
The registered representative of a broker-dealer can provide general guidance to consumers about their retirement investments, including investments in IRAs, 401(k) accounts, and other assets invested to produce retiree income. A registered representative can also transact trades at the direction of a plan fiduciary. Broker-dealers and registered representatives are subject to SEC and FINRA rules, which require advisors to deal fairly with clients, make suitable recommendations, execute the best trades and disclose conflicts of interest.
Financial professionals generally are compensated under one of two business models. A majority of transactions fall into the broker-dealer model, in which compensation is paid from the product provider to the broker-dealer and registered representatives, and not by the consumer. In other transactions, a buyer, typically one with more sophisticated investment strategies who has significant assets, may prefer to engage an advisor under a fee-based arrangement and pay the advisor directly.
For many, especially those with small to medium-size accounts, consulting with a trusted advisor using the broker-dealer model is more cost efficient, more accessible and preferable to a fee-based arrangement. Fee-based arrangements often have minimum account requirements, making them inaccessible to small account holders. Ninety eight percent of all IRAs with $25,000 or less in assets are serviced under the broker-dealer model.
If broker-dealers and registered representatives do not currently fall under DOL regulation, does that mean they are unregulated?
Certainly not. A broker dealer is always subject to SEC and FINRA rules, which require advisors to deal fairly with clients, make suitable recommendations, execute the best trades and disclose conflicts of interest.
Suitability, as enforced by FINRA, is a very robust standard. Registered reps must comply with regulations covering nearly every aspect of their businesses, from how they communicate with clients to how they interact with senior citizens, from how they advertise to how they keep and maintain records. The suitability standard is governed by no fewer than six FINRA rules and more than a dozen Regulatory Notices and Notices to Members. It requires registered reps to compile and regularly update detailed investor profiles for each client. Registered reps must get to know their clients and have a strong understanding of their clients' needs and interests.

Registered reps face near constant scrutiny and annual compliance reviews by their broker-dealers. The broker-dealers, in turn, are subject to detailed FINRA examinations approximately once every two years.
What are the consequences for an advisor who breaches fiduciary duty?
The consequences of a claim of breach of fiduciary duty are significant.  The financial professional has the burden of proof that he or she has not violated the duty if a complaint is made.  If a breach is determined, the financial professional is personally liable for any losses to the plan or participant account, and must return any profits arising from the breach. 
What’s wrong with requiring advisors to act with prudence and loyalty? I already do that for my clients.
Of course you already act with prudence and loyalty. However, DOL fiduciaries are not permitted to have any conflicts of interest, even if disclosed, so receipt of commissions or other third party compensation is prohibited (if the amount of commission varies by product and/or provider).  Retirement savers therefore lose the ability to choose how they engage their professional advisors. For many, paying out of pocket for financial advice may be too costly.  Paying an asset management fee may conflict with FINRA’s suitability rules, in that accounts with minimal trades or transactions are better served under the broker-dealer model.
How would the DOL proposal change the current situation?
It will take some time to read and analyze the regulation before we can determine its impact on NAIFA members and the families they serve in preparing for retirement.

According to the DOL’s summary of the proposed regulations, fiduciaries must provide impartial advice in their clients’ best interests - and cannot accept payments creating a conflict of interest – unless they satisfy one of two, possibly three, exemptions.

The exemptions are lengthy and will require careful reading. Generally, the advisor and the client would be required to enter into a written contract that has specific provisions, including that all advice be in the best interests of the client, that conflicts be clearly disclosed, and that procedures be in place to encourage advisors to make recommendations in the clients best interests.

There are new enforcement provisions that also need analysis to determine if the end result will be that consumers have less access or choice in engaging financial professionals to help them plan for retirement.
What impact does the proposed regulation have on retirement savers access to advice?
By effectively requiring all plans and participants to use a fee-only compensation model, the proposed rule significantly reduces consumer choice. Fee-based arrangements often have minimum account requirements, making them inaccessible to small account holders. Ninety eight percent of all IRAs with $25,000 or less in assets are serviced under the broker-dealer model.
What should NAIFA members do now?
We are urging NAIFA members and their colleagues who would be affect by the DOL rule to do two things:
  1. Email or call your member of Congress to tell him or her that it is important that the DOL fiduciary rule does not make it harder or more expensive for lower- and middle-income Americans to invest in retirement plans. Also, consider attending the NAIFA Congressional Conference May 19-20 in Washington, D.C. to speak with your member of Congress in person.
  2. Watch your email in-box, www.naifa.org, and the NAIFA Blog for future updates on the rule and calls for comments or further action.
  • Posted April 15, 2015 IN
  • Comments (1)

Good to see the impact of the department of labor's proposal laid out like this. It answers a lot of questions I had and even tells us how normal people can help with this issue that will affect us all. Thanks for sharing.
4/21/2015 11:50:00 AM