Are There Boogeymen in the New Fiduciary Proposal?

Nevin E. Adams, JD

Like many of you, I have spent a fair amount of time over the past couple of weeks reading and analyzing the impact and import of the new fiduciary rule proposal—not to mention the legal pundits who seek to tell us what they think it means, or might mean, regardless of what the proposal actually says.

At a high level, it seems to me (and several well-regarded ERISA attorneys) that retirement plan advisors who are today operating under the auspices of PTE 2020-02 should have little to worry about under the new proposal. Indeed, the biggest controversies around the proposed rule seem to be extending the reach of PTE 2020-02 to organizations and entities that hadn’t previously had to adhere to those requirements. 

But if you’re already doing so—and surely if you’re a retirement plan advisor you are—there’s little of concern in the proposal. In fact, you might well draw comfort from the possibility that entities and advisors that have competed with you for rollover business would have to adhere to the same rules and disclosures that are now part of your business, painful though it may have been to adopt them at the time. Of no small consequence is that recommendations to plan sponsors regarding which investments to include in 401(k) and other employer-sponsored plans—advice that is not subject to the SEC’s Regulation Best Interest and right now is not required to be in the customer’s best interest—would be.

Make no mistake, this is a new and considerably revised proposal. One that appears to not only have acknowledged the things that led a federal district court to vacate the 2016 rule—but to actively address and remedy those missteps. 

That said, rumors abound, and some law firms (certainly those that represent the interests of those who would be newly subject to new regulations) have, to my read anyway, been inclined to see plenty of clouds in the silver linings—and to characterize the new proposal as basically being a resurrection of the old one (to that end, the Halloween unveiling made for plenty of “zombie” references)—in the process imagining things that aren’t actually “there.” 

Perhaps the most pernicious is one that they admit isn’t there—but argue it might be; the so-called “private right of action”—which means simply that individuals would be able to sue on their own for a breach of the law. The concerns harken back to comments made during the controversy concerning the 2016 rule that the fiduciary rule was not only opening a new door for litigation, but that the Labor Department was perhaps even counting on it.     

Now, on this, and other points in the new proposal, the DOL acknowledges both the issues raised in the vacating of the rule by the Fifth Circuit, and the deliberate steps they’ve taken to avoid those issues in the new proposal. “The 2016 Rulemaking was significantly different than the current rulemaking,” the DOL explains in the preamble to the proposed rule, “in that it imposed a fiduciary obligation on virtually all investment recommendations specifically directed to retirement investors, imposed demanding contract and warranty requirements in the IRA market, which gave investors a direct cause of action against firms and advisers for breach of the Impartial Conduct Standards, and represented a significant break from the then-existing regulatory baseline.”

To be sure, there is already a cause of action for fiduciary breaches under ERISA for recommendations to plans and participants—and there’s no question that while under a recent decision in a Florida district court, rollover recommendations are not considered fiduciary recommendations under current law—but will be under the proposed rule.

That said, in considering this latest proposal, one notable DC law firm says, for example that the proposal includes “strong enforcement mechanisms, including provisions that give the DOL oversight and authority over firms’ individual retirement account (IRA) business and (although DOL claims otherwise[1]) a potential private right of action.” That’s right—even though the Labor Department specifically says otherwise, this law firm has chosen to read between the lines and see the potential for something the DOL explicitly denies. 

In fact, the Labor Department clearly states in a footnote in the preamble of the proposed rule that (the underline is mine, for emphasis) “Unlike the PTEs that were a part of the 2016 Rulemaking, these PTEs do not, and the amendments would not, include required contracts or warranties that the Fifth Circuit objected to.”  

The footnote goes on to explain that “these prohibited transaction exemptions also do not exempt a party from status as a fiduciary, and therefore, the proposals do not affect the scope of the regulatory definition of an investment advice fiduciary. Rather, the exemption proposals involve an exercise of the statutory authority afforded to the Department by Congress to grant administrative relief from the strict prohibited transaction provisions in Title I and Title II of ERISA for beneficial transactions involving plans and IRAs.”

Now, the standard of care for “conflicted” recommendations to plans, participants and IRAs is the Best Interest Standard—a combination of the prudent man rule and duty of loyalty. If the “conflicted” recommendation isn’t in the best interest of a retirement investor, the protection of the prohibited transaction exemption (PTE) is lost and the advisor isn’t permitted to be legally compensated. That said, the best interest standard in the PTE isn’t actionable.

Another critical “boogeyman” that proposal critics claim to have seen there is an undermining of the ability to enforce arbitration clauses as a precursor to litigation. I say “conjured” because—unlike a controversial provision in the 2016 rule that barred the use of the Best Interest Contract Exemption (BIC) if advisory contracts included an arbitration requirement—there is no mention or reference to that in the current proposal.        

There’s plenty still to analyze and evaluate in this new proposal—and arguably not as much time to do so as we might prefer. Here’s hoping most of that time and energy is spent on the things that are actually in the proposal instead of imaginary “monsters” that aren’t. 

Footnote

[1] Their exact words.