Final Fiduciary Regs Pack Less Than Hurricane-Force Punch

I’ve never directly experienced a hurricane.  But on Tuesday April 5^th, the day before the Department of Labor (DOL) officially issued its final fiduciary regulations, I found myself imagining what it would be like to stand on a coastal beach and watch an approaching vortex of hurricane-force wind and surf about to make landfall; right where I stood.  Sometimes a fertile imagination can be too much of a good thing.

Fortunately, the final rule and accompanying prohibited transaction exemptions issued by DOL appear to be less disruptive and destructive than many thought they would be, compared to the 2015 proposed rule and exemptions.  Whether this came about through inherent reasonableness within the DOL (did I really say that?), or out of fear of lawsuit or possible congressional action, is unclear, and matters little.  DOL did move the “burden” needle considerably.  Some have gone so far as to say that DOL “caved” to the pressure of opponents, and modified their guidance to the point that it lacks sufficient teeth.  I think that’s an overstatement.  But the fact that both proponents and opponents of the guidance have quibbles with the final product may be an indication that DOL found a palatable – if not applause-worthy – middle ground. DOL appears to have listened to the many written comments and the public testimony given between the April 2015 release of the proposed rule and the close of the final comment period last September.  I’ll share some examples, most of them positive.

Apart from actual content, many worried about having adequate time to adapt to the guidance after it was issued as final.  As the saying goes: “timing is everything.”  Based on the 2015 proposed regulations, many expected that compliance would be required within eight months of issuance.  Happily, that is not the case.  Although EBSA has made the guidance technically “effective” 60 days after publishing in the Federal Register, or June 8, 2016, there is a much longer period before having to actually operate within the confines of the final rule and accompanying exemptions.  As of April 10, 2017, investment firms and advisors will be governed by the conduct and disclosure rules.  A transition period from that date to January 1, 2018, will apply to a central pillar of the guidance, the best interest contract, or BIC.

The BIC creates a contractual agreement between advisors and their firms and the recipients of investment guidance.  Without going into its fine points here, it is an agreement that contractually places the interests of the investor above those of the compensated advisor, chiefly when advisor compensation may vary based on investments chosen.  A signed contract was intended to enforce placing the investor’s interests first.  Under the proposed rule this applied to ERISA plans and to IRAs and non-ERISA plans, as well.  In any situation where compensation might vary depending on investments chosen, or in distribution, rollover or transfer advising situations, the purpose of a signed contract was to enforce impartiality and fiduciary behavior.  Happily, ERISA plans were excluded under the final guidance from the need for a signed contract, DOL recognizing that ERISA already provides statutory remedies for fiduciary misbehavior.  IRAs and non-ERISA plans do not have this legal recourse, so the signed contract approach of BIC was intended to provide just such an enforceable remedy.  But the principles of the BIC, including the disclosure of potential conflicts, and procedures to safeguard against investor harm, apply in all these cases.

There are several additional changes to BIC that will simplify compliance for those firms that will use it and must meet its requirements.  Essentially any investment can be offered if the principles of BIC are met, rather than the limited investment types identified in the proposed rule.  In those cases where a signed BIC document must be executed, such as in an IRA rollover situation, contract execution can be part of an account opening process, rather than before the very first syllable of an advising communication! Existing advisory clients for whom a BIC arrangement should be in place can be handled on a negative-consent basis, without the need for a new “please sign this” interaction. Also, the need for initial one, five and 10-year projections, and annual disclosures, were removed as BIC requirements, significantly reducing the administrative and record-retention burden of the BIC as initially proposed.

Another favorable step back from the proposed rule concerns advising situations where the recipient can be expected to have enough investing expertise to recognize the difference between a sales pitch and impartial, “best interest” advising.  In the proposed rule it was termed a “carve-out,” an activity that would not be considered investment advice.  If an advisor was making investment recommendations to an ERISA plan covering 100 or more eligible participants, or a plan with $100 million or more in assets, it would be presumed that the plan representative receiving the recommendations would take them at face value, as an informed fiduciary would.  Under the final rule the 100 participant element has been discarded, and the asset threshold reduced to $50 million, allowing this exclusion to apply to many more plans. 

Great concern with the proposed rule stemmed from the stance on investment education and educational materials.  While the proposal recognized the value and non-advice nature of information on general investment and asset allocation principles, it had prohibited the mention of actual investments available in a retirement plan.  The final rule reverses this and allows an asset allocation model to include actual plan investments, but these must be official designated investment alternatives (DIAs) within the plan.  Unfortunately, there may be other investments in a plan that would be advantageous for a participant or beneficiary, but these cannot be modeled.  Worse, asset allocation modeling for an IRA investor may not include actual investments, on the grounds that there is no independent fiduciary to review and select investment choices that could or should be included in such modeling.  This is a genuine missed opportunity, and a potential handicap for IRA investors

It is worthy of mention that Health Savings Accounts (HSAs) and Coverdell Education Savings Accounts (ESAs) are covered by this guidance to the same extent that IRAs are.  There has been little mention of this in either the media or in the guidance itself.  The statutory tracing rules take us there, and advisors should be aware of this, inasmuch as some investors who are maxing-out in other savings vehicles are also saving in HSAs, with little intention of spending down the accounts in the near-term.  These investors are availing themselves of more sophisticated investments when their balances warrant it. 

More could be said about specific provisions of the final fiduciary rule and its associated exemptions.  But the point to be made here is that proposed guidance that appeared potentially unworkable, may – when all is said and done – have been transformed into a final fiduciary framework the industry can possibly live with.  More to come on this industry changing topic.