DOL's rule would add a lot of fiduciaries into the mix

Advisors who make one-off recommendations to 401(k) plans and participants may face a new reality under the latest fiduciary rule proposed by the Department of Labor: They will be fiduciaries, whether they like it or not.

Tuesday, the agency proposed a rule that would again redefine “fiduciary” under the Employee Retirement Income Security Act. It also proposed amendments to several prohibited transaction exemptions, which could have far-reaching consequences for IRA rollovers and the products that advisors and brokers suggest.

A pillar of the proposed rule is making virtually anyone who recommends investments to a 401(k) plan a fiduciary, which the Biden administration said is necessary to close a loophole in the Securities and Exchange Commission’s Regulation Best Interest.

“Advice to plan sponsors fall outside of Reg BI, because plan sponsors are not retail investors,” said Jason Roberts, CEO of the Pension Resource Institute.

That has meant that in some cases 401(k) plans receive investment advice that is conflicted, with brokers making one-time recommendations for products that give them hefty commissions. Generally, that's something that affects very small retirement plans, as larger, most established plans work with RIAs that serve in a fiduciary capacity. The effect of conflicted investment advice recommendations in small retirement plans was a theme that the White House noted in its announcement of the proposed rule, which is the latest effort of the administration to attack “junk fees” in various industries.

WHO'S COVERED?

Given that the proposed rule and prohibited transaction amendments total about 800 pages of text, there are nuances and consequences that may not be clear for days or even weeks.

It’s important to note that even as the rule is positioned as something that will make more people fiduciaries, the amendments will affect those who are already working in a fiduciary capacity, said Steve Rabitz, co-chair of Dechert's employment benefits and executive compensation practice.

“My reaction to that is, ‘not so quickly,’” Rabitz said. “There are significant potential changes to a number of the exemptions that people rely on, even while they’re acting as fiduciaries.”

For example, an exemption that has been in place since 1977 that allows investment fiduciaries to recommend open-end mutual funds sponsored by an affiliate may no longer apply, unless the advisor has full investment discretion, he noted. And, similar to a question raised by the 2016 version of the DOL fiduciary rule, there are questions about the use of model portfolios, he said.

SUPPORTERS AND OPPONENTS

Overall the proposed rule and amendments could see support from advisors focused on retirement plans and opposition from the insurance industry. The latter is because the DOL has proposed to make one-time recommendations for IRA rollovers fiduciary advice— and insurance brokers who sell annuities aren't covered by the consumer fiduciary protections under ERISA.

The founder and chairman of one of the big retirement advisor RIAs, Randy Long of SageView, said the new iteration of fiduciary standards has been a long time coming.

“It’s a step in the right direction to provide clarity on operating in the best interest of the consumer or the participant,” Long said. “It is good. It will bring some compensation down and benefit the participant … I think there were inherent conflicts in the industry in the ways in which advisors were being paid. This goes a long way to create a fiduciary standard of care, which is positive for Americans overall.”

TAKING THE FIVE-PART TEST APART

A big part of the fiduciary definition change is amending a 1975 rule that established a five-part test to determine whether advice triggered fiduciary duty to a client.

The proposed rule takes aim at the “regular basis” aspect of that test, changing that requirement to include one-time advice provided by those who regularly makes investment recommendations in their course of their business.

“Without fiduciary status, the advice provider is free to disregard ERISA’s duties of prudence and loyalty and to engage in self-dealing transactions that would otherwise be flatly prohibited … because of the dangers they pose to plans and plan participants,” the DOL wrote in an announcement of the proposed rule.

That one-time advice would apply to rollover recommendations, an aspect that was heavily contested in an earlier version of the rule finalized during the Obama administration. That 2016 regulation was ultimately vacated in federal court and replaced by a looser Trump administration rule that required advisors to disclose their fiduciary status and conflicts of interest as well as follow impartial-conduct standards.

“That term ‘regular basis’ is in there, but it doesn’t say that the actual advice at issue is regular,” Roberts said.

Although the DOL in 2016 had replaced the 1975 five-part test in its fiduciary rule, the agency effectively reinstated the test in 2020. When it did so, for the first time it offered an interpretation of what the test meant, and that in turn pulled more advisors into the fiduciary fold, Rabitz said.

“You’re living in a world where it’s already been expanded, and some people have come to live with fiduciary advice status,” he said. “It begs the question, what’s really going on? And what’s the [DOL’s] motivation?”

Fiduciary status is a tricky thing for anyone selling a product, he noted. They have to rely on prohibited transaction exemptions, the conditions of which are not easy to meet and are highly punitive if violated, he said.

“The DOL is in a conundrum, because they really want to pick up rollovers,” he said. “But they really can’t unless they get acrobatic in their interpretation.”

SCALE OF THE PROBLEM?

Ten years ago, when a version of the fiduciary rule was developed, it was likely much more common for 401(k)s and participants to receive conflicted investment advice, Roberts said.

There have been several forces that have made the business change, not just regulatory ones — the ongoing threat of class-action litigation has made big 401(k) sponsors much more conscious of the investments and services their plans include. And it was almost certainly more common a decade ago for plans to be sold by advisors who didn’t specialize in retirement — those professionals may, for example, have had a wealth management client who needed a 401(k) started.

But one-time sales are “still pervasive in the small, micro and startup market,” Roberts said, because that business is less scalable or profitable and more time-consuming than the larger-plan market. The advent of pooled employer plans, state-sponsored auto IRAs and other plans has improved things, but there is still unmet demand for small 401(k)s to receive conflict-free advice, he said.

WILL THIS TIME BE THE LAST TIME?

Versions of the fiduciary rule have been kicked around, proposed, finalized and reversed for more than 10 years. The goal during any administration is to make its iteration a lasting one, and the current one is no exception, though it has the benefit of a lot of hindsight.

“Sometimes when we hear from the DOL, we see a fact sheet and a proposed rule, but today was different,” Bonnie Treichel, chief solutions officer at Endeavor Retirement, said in an email. “We heard from President Biden, we saw a series of releases from the White House, a fact sheet from the EBSA … and the 277-page proposed rule.”

Clearly, the administration is focused on closing “loopholes” that allow junk fees, Treichel said. And annuity recommendations are a big piece of that, she noted.

The changes to the five-part fiduciary test are significant, she said.

“When compared to the 2016 rule, this definition is more narrowly tailored than the 2016 version of the rule,” she said. “You must imagine that the DOL carefully crafted this definition so that we don’t end up with a fifth version of the fiduciary rule.”