Shifting focus is in brokers' best interests

Brokers lost a round in their battle against being held to a fiduciary standard last week when the Department of Labor proposed a new regulation defining who must act in their clients' best interests. The Office of Management and Budget has approved the proposal, which would apply to anyone providing advice to retirement plan sponsors or individuals regarding IRA or 401(k) investments.It now enters a 75-day comment period, after which the DOL will hold a public hearing. After the comments and hearing the DOL could modify the proposal before it proposes a final rule — but a fiduciary standard for brokers is one big step closer. The brokerage industry has a choice to make: Continue to battle against being held to a fiduciary standard, expending much time and effort and facing long odds — or spend the time and effort revamping the business model to accommodate the new regulation. Acceptance would seem to be the better option at this point, as the DOL appears to have accommodated some of the industry's key concerns. For example, brokers providing advice on retirement investments will still be able to receive compensation via commission. The new regulation, if adopted, would treat as a fiduciary under the Employee Retirement Income Security Act anyone who provides investment advice or recommendations to an employee benefit plan, plan fiduciary, plan participant or beneficiary, individual retirement account or IRA owner. The DOL's proposed regulation states that “ERISA safeguards plan participants by imposing trust law standards of care and undivided loyalty on plan fiduciaries, and by holding fiduciaries accountable when they breach those obligations. In addition, fiduciaries are not permitted to engage in "prohibited transactions,' which pose special dangers to the security of retirement ... plans because of fiduciaries' conflicts of interest.”

NOT OBLIGED

The DOL proposal notes that under regulations issued in 1975, many investment professionals have no obligation to adhere to ERISA's fiduciary standards and may operate with conflicts of interest they need not disclose, may give non-prudent or disloyal advice, and steer plans and IRA owners to investments based on their own — rather than their customers' — financial interests. The department said it believed that because of the growth of participant-directed retirement plans and IRAs, “and the need of such plans and IRA owners to seek out and rely on sophisticated financial advisers to make critical investment decisions in an increasingly complex financial marketplace,” the 1975 regulatory definition of a fiduciary had to be revisited. The DOL said it sought to preserve beneficial business models for the delivery of investment advice by proposing new exemptions from ERISA's prohibited-transaction rules. These would broadly permit firms to continue common fee and compensation practices such as commissions and revenue sharing. To obtain the benefits of these exemptions, firms and advisers would be required to “contractually acknowledge fiduciary status, commit to adhere to basic standards of impartial conduct ... and disclose basic information on their conflicts of interest and on the cost of their advice.

PUTTING IT IN WRITING

“Central to the exemption is the adviser and firm's agreement ... to give advice that is in the customers' best interest; avoid misleading statements; receive no more than reasonable compensation; and comply with applicable federal and state laws governing advice.” The “best interest contract” that firms and advisers would sign with clients to obtain many of the proposed exemptions seems to be a reasonable requirement for allowing the industry to maintain its current compensation practices. After all, most in the industry claim they already are looking out for their clients' best interests under current regulations. If that is true, they should not fear putting it in writing. The DOL says if clients feel the “best interest contract” has been breached, they could take legal action. A number of other proposed exemptions should ease industry concerns; for example, allowing advisers to sell some debt securities to plans and IRAs from their inventories. The Department of Labor seems to have made a real effort to address the concerns of the brokerage industry and to ensure it can still provide investment advice to the middle class, while at the same time protecting middle-class investors from conflicted advice and high, hidden costs. The industry should respond positively, perhaps seeking a few clarifications and minor tweaks, but no longer seeking to kill the fiduciary standard. The next step will be to see that the fiduciary standard the Securities and Exchange Commission is supposed to develop does not conflict with the DOL rule. That's where the industry's energy should be directed now.