The following is an edited version of testimony given July 26 by Phyllis C. Borzi, assistant secretary of labor in charge of the Employee Benefits Security Administration, before the House Education and the Workforce Subcommittee on Health, Employment, Labor and Pensions
The following is an edited version of testimony given July 26 by Phyllis C. Borzi, assistant secretary of labor in charge of the Employee Benefits Security Administration, before the House Education and the Workforce Subcommittee on Health, Employment, Labor and Pensions.
The Employee Benefits Security Administration is committed to pursuing policies that encourage retirement savings and promote retirement security for American workers.
A key part of EBSA's job is establishing policies that safeguard the money that workers and employers set aside for workers' retirement. There are about 48,000 private-sector defined-benefit plans that hold about $2.6 trillion in assets.
In addition, there are nearly 670,000 private-sector 401(k) and other defined-contribution-account plans that hold about $3.9 trillion in assets. Individual retirement accounts hold an additional $4.7 trillion. In fact, nearly 50 million households own some type of IRA. That number represents more than 40% of the households in the United States.
Americans' retirement security depends in large measure on the sound investment of this money. While some investment decisions are made by large professional money managers, today most are made by individual workers who must manage their own 401(k) accounts and IRAs. To guide their decisions, workers often rely on advice from trusted experts.
The Employee Retirement Income Security Act of 1974 expressly provides that a person paid to provide investment advice with respect to assets of a private-sector employee benefit plan is a plan fiduciary. The Internal Revenue Code has the same provision regarding investment advisers to IRAs. ERISA and the tax code prohibit both employee benefit plan and IRA fiduciaries from engaging in a variety of transactions, including self-dealing — when a fiduciary puts his or her own financial interests first — unless the relevant transaction is authorized by an exemption contained in law or issued administratively by the Department of Labor. In the case of an employee benefit plan, but not an IRA, under ERISA a fiduciary also owes a duty of prudence and exclusive loyalty to plan participants, and is personally liable for any losses that result from a breach of such duty. This has been the law since ERISA was enacted.
DEVIL IN THE DETAILS
The law on its face is simple enough: Advisers should put their clients' interests first. But, as always, the devil is in the details — in this case, in the question of what constitutes paid investment advice. The department's current initiative will amend a flawed 35-year-old rule under which advice about investments is not considered to be “investment advice” merely because, for example, the advice was only given once, or because the adviser disavows any understanding that the advice would serve as a primary basis for the investment decision.
Investors such as pension fund managers and workers contemplating investing through an IRA should be able to trust their advisers and rely on the impartiality of their investment advice. That is the promise written into law in 1974. The department's initiative sets out to fulfill this promise for America's current and future retirees. It is imperative that good, impartial investment advice be accessible and affordable to plan sponsors, and especially to the workers who need it most.
The department's October 2010 proposed amendment to its fiduciary rule represented its approach to accomplishing these goals. The proposal has prompted a large volume of comments and a vigorous debate. The department is committed to developing and issuing a clear and effective rule that takes full and proper account of all stakeholder views and ensures that investment advisers can never profit from hidden or inappropriate conflicts of interest.
In enacting ERISA, Congress established a number of provisions governing investment advice to private-sector employee benefit plans and IRAs. Under ERISA and the tax code, any person paid directly or indirectly to provide investment advice to a plan or IRA is a fiduciary.
Substantially identical provisions in ERISA and the tax code prohibit fiduciaries from engaging in a variety of transactions, including those that result in self-dealing, unless they fall within the terms of an exemption from the general prohibition. The relevant ERISA provisions apply to private-sector employee benefit plans, and the related tax code provisions apply to both plans and IRAs. In either case, fiduciaries who engage in prohibited transactions are subject to excise taxes. ERISA and the tax code each provide the same statutory exemptions from the general prohibition against self-dealing. The secretary of labor is authorized to issue additional exemptions.
ERISA additionally subjects fiduciaries who advise private-sector employee benefit plans to certain duties, including a duty of undivided loyalty to the interests of plan participants and a duty to act prudently when giving advice. Fiduciaries face personal liability for any losses arising from breaches of such duties. ERISA authorizes both participants and the department to sue fiduciaries to recover such losses. These ERISA provisions, however, generally do not extend to fiduciaries who advise IRAs.
REGULATORY TEST
In 1975, the department issued a five-part regulatory test defining “investment advice” that gave a very narrow meaning to this term. The regulation significantly narrowed the plain language of the statute as enacted, so that today, much of what plainly is advice about investments is not treated as such under ERISA, and the person paid to render that advice is not treated as a fiduciary. Under the regulation, a person is a fiduciary under ERISA and/or the tax code with respect to their advice only if they make recommendations on investing in, purchasing or selling securities or other property, or give advice as to their value; [give advice] on a regular basis; [the arrangement is] pursuant to a mutual understanding that the advice; will serve as a primary basis for investment decision; and will be individualized to the particular needs of the plan.
An investment adviser is not treated as a fiduciary unless each of the five elements of this test is satisfied for each instance of advice. For example, if a plan hires an investment professional on a one-time basis for advice on a large, complex investment, the adviser has no fiduciary obligation to the plan under ERISA because the advice is not given on a “regular basis,” as the regulation requires. Similarly, individualized paid advice to a worker nearing retirement on the purchase of an annuity is not provided on a regular basis. Thus, the adviser is not a fiduciary even though the advice may concern the investment of a worker's entire IRA or 401(k) account balance.
The narrowness of the existing regulation opened the door to serious problems, and [subsequent] changes in the market have allowed these problems to proliferate and intensify. The variety and complexity of financial products have increased, widening the information gap between advisers and their clients, and increasing the need for expert advice. Consolidation in the financial industry and innovations in products and compensation practices have multiplied opportunities for self-dealing and made fee arrangements less transparent to consumers and regulators. At the same time, the burden of managing retirement savings has shifted dramatically from large private-pension-fund managers to individual 401(k) plan participants and IRA holders, many with low levels of financial literacy. These trends could not have been foreseen when the existing regulation was issued in 1975.
The narrowness of the regulation has harmed some plans, participants and IRA holders. Research has linked adviser conflicts with underperformance. [Securities and Exchange Commission] reviews of certain financial sales practices may also reflect these influences. Finally, EBSA's own enforcement experience has demonstrated specific negative effects of conflicted investment advice.
It is worth noting that none of this research evidence necessarily demonstrates abuse. On the contrary, it seems to suggest that conflicts may color advice in some instances from honest advisers without their even realizing it. But whether deliberate or inadvertent, the result where conflicts exist is often the same — adviser conflicts are a threat to retirement security. Academic research suggests this and experience bears it out.
Under ERISA, a loss remedy is available only from plan fiduciaries. As a result, under the current regulatory structure, neither the secretary of labor nor plan participants can hold the appraiser directly accountable for disloyal or imprudent advice about the purchase price, no matter how critical that advice was to the transaction. The sole recourse available to the secretary and plan participants is against the trustee who relied on the advice, rather than against the professional financial expert who rendered the valuation opinion that formed the necessary basis for the transaction.
Consequently, the department believes there is a need to re-examine the types of advisory relationships that should give rise to fiduciary status on the part of those providing investment advice services. The 1975 regulation contains technicalities and loopholes that allow advisers to easily dodge fiduciary status. Plan fiduciaries, participants and IRA holders are entitled to receive impartial investment advice when they hire an adviser.
On Oct. 22, 2010, the department published a proposed regulation defining when a person is considered to be a fiduciary by reason of giving investment advice for a fee with respect to assets of an employee benefit plan or IRA. The proposal amends the current 1975 regulation that may inappropriately limit the circumstances that give rise to fiduciary status on the part of the investment adviser. The proposed rule takes into account significant changes in both the financial industry and the expectations of plan fiduciaries, participants and IRA holders who receive investment advice. In particular, it is designed to protect participants from conflicts of interest and self-dealing by correcting some of the current rule's more problematic limitations and providing a clearer understanding of when persons providing such advice are subject to ERISA's fiduciary standards, and to protect IRA holders from self-dealing by investment advisers.
The proposed regulation would modify the 1975 regulation by replacing the five-part test with a broader definition more in keeping with the statutory language and providing clear exceptions for conduct that should not result in fiduciary status. Under the proposal, the following types of advice and recommendations may result in fiduciary status: appraisals or fairness opinions concerning the value of securities or other property; recommendations as to the advisability of investing in, purchasing, holding or selling securities or other property; or recommendations as to the management of securities or other property. To be a fiduciary, a person engaging in one of these activities must receive a fee and also meet at least one of the following four conditions.
The person must represent to a plan, participant or beneficiary that the individual is acting as an ERISA fiduciary, already be an ERISA fiduciary to the plan by virtue of having any control over the management or disposition of plan assets or by having discretionary authority over the administration of the plan, be an investment adviser under the Investment Advisers Act of 1940, provide the advice pursuant to an agreement or understanding that the advice may be considered in connection with investment or management decisions with respect to plan assets and will be individualized to the needs of the plan.
At the same time, the proposed regulation recognizes that activities by certain persons should not result in fiduciary status. Specifically, these are persons who do not represent themselves to be ERISA fiduciaries and who make it clear to the plan that they are acting for a purchaser/seller on the opposite side of the transaction from the plan rather than providing impartial advice; persons who provide general financial/investment information, such as recommendations on asset allocation to 401(k) participants under existing departmental guidance on investment education; persons who market investment option platforms to 401(k) plan fiduciaries on a non-individualized basis and disclose in writing that they are not providing impartial advice; and appraisers who provide investment values to plans to use only for reporting their assets to the DOL and IRS.
HARMONIZATION
We have received many comments emphasizing the importance of harmonizing the department's proposed rule making with certain Securities and Exchange Commission and Commodity Futures Trading Commission rule-making activities under the Dodd-Frank Act, including activities related to SEC standards of care for providing investment advice and CFTC business conduct standards for swap dealers. There are concerns that inconsistent standards could negatively impact retirement savings by increasing costs and foreclosing investment options. Likewise, concerns have been raised about the adequacy of coordination between the department and other relevant agencies, including the SEC, Treasury Department and Internal Revenue Service, with respect to oversight of IRA products and services.
The [Labor] Department, Treasury Department, Internal Revenue Service, SEC and the CFTC are actively consulting with each other and coordinating our efforts. We are committed to ensuring that the regulated community has clear and sensible pathways to compliance. We are confident that these goals will be achieved.
The SEC is currently considering staff recommendations to establish uniform fiduciary duties under the securities laws for advisers and brokers. While the department and the SEC are committed to ensuring that any future fiduciary requirements applicable to investment advisers and broker-dealers under the applicable laws are properly harmonized, the department is also committed to upholding the separate federal protections that Congress established in 1974 for plans, plan participants and IRAs under ERISA and the tax code.
The department also plans to harmonize its fiduciary regulation with the CFTC's and SEC's proposed business conduct standards for swap dealers. The department does not seek to impose ERISA fiduciary obligations on persons who are merely counterparties to plans in arm's-length commercial transactions.
The department will continue to carefully study arguments put forth in commentary about the proposed rule change from stakeholders. We have, however, the following observations on some of the comments.
We did not propose to force brokers to eliminate commission-based fee arrangements, restructure all of their compensation as wrap fees or convert all brokerage IRAs to advisory accounts. Exemptions already on the books authorize brokers who provide fiduciary advice to be compensated by commission for trading the types of securities and funds that make up the large majority of IRA assets today. We will attempt to provide this clarification in a more formal manner as we proceed in this process.
The department is considering providing interpretive guidance to make this clear, as well as issuing additional exemptions. Such additional exemptions might cover, for example, revenue-sharing arrangements that are beneficial to plan participants and IRA holders, and/or so-called principal transactions, wherein a fiduciary adviser, rather than acting as an agent, itself buys an asset from or sells an asset to an advised IRA. Such exemptions would carry appropriate conditions to protect plan participants' and IRA holders' interests.
The department believes there is strong evidence that unmitigated conflicts cause substantial harm and therefore is confident that the proposed fiduciary regulation would combat such conflicts and thus deliver significant benefits to plan participants and IRA holders.
The tax code itself treats IRAs differently from other retail accounts, bestowing favorable tax treatment and prohibiting self-dealing by persons providing investment advice for a fee. In these respects ... IRAs are more like plans than like other retail accounts.
