In prepared testimony to the Department of Labor's (DOL) leadership and staff, American Retirement Association (ARA) CEO Brian Graff highlighted “the significant regulatory gap” regarding plan-level advice on Dec. 12.
Graff’s comments—made in support of the DOL’s latest attempt to modernize the 1975 regulatory definition of investment advice—came on the first day of a public hearing hosted by the department titled “Retirement Security Rule: Definition of an Investment Advice Fiduciary.”
Explaining that small business retirement plans are often sold and not bought due to business owner time constraints, there is no ongoing advice relationship, “and the ‘regular basis’ prong of the 1975 five-part test is not satisfied.”
He also noted that the SEC’s Regulation Best Interest (Reg BI) and the NAIC’s Model Rule cover individual investors, not those in retirement plans, resulting in a regulatory gap the DOL’s proposed Retirement Security Rule would close.
“Investment advice given to small business plan sponsors is also not protected by SEC’s Regulation Best Interest because ‘plan-level’ advice is considered ‘institutional advice,’ even if we are talking about an unsophisticated small business owner with just two employees,” Graff said, before adding that the SEC told the ARA it believed such advice belonged within DOL’s jurisdiction.
He re-emphasized that under the current federal and state regulatory framework, most small business owners trying to offer a retirement plan to their employees are often provided no regulatory protection from the advice they receive regarding plan investment options.
Advice given to plan sponsors under the proposed regulation would ensure it’s subject to the same fiduciary regulatory standard regardless of whether it’s given once or as part of an ongoing relationship. It would also be retirement plan investment (mutual funds, insurance products, CITs, CDs, commodities, even cryptocurrency) and distribution/compensation model (commission) neutral.
In keeping with the season, Graff pointed to “one significant proposed change to PTE 2020-02 that appears to be inconsistent with the department’s stated position of being a business model and product neutral,” which he called the naughty list.
The list contained business and compensation models presumed to violate a retirement investor’s best interest, including appraisals, performance and personnel actions, bonuses, and differential compensation.
“The inclusion of this proscriptive ‘naughty’ list would seem wholly inconsistent with the department’s general embracing of a principles-based fiduciary standard,” Graff said. “We strenuously recommend that the final exemption return to the previous language in the current exemption, which relies on a principles-based approach to policies and procedures.”
He concluded by reiterating the ARA’s “general support for the Department’s longstanding effort to modernize the 1975 regulatory definition of investment advice …We believe it is critical to the interests of plan sponsors and participants that the fundamental changes in the 1975 regulatory definition of investment advice be allowed, after almost fifty years, to finally move forward.”
Brian Graff’s Full DOL Testimony Included Below
Thank you, Assistant Secretary Gomez, Deputy Assistant Secretaries Khawar and Hauser, and the rest of EBSA staff for this opportunity to testify on behalf of the American Retirement Association on the proposed retirement security regulation. The mission of the ARA has always been to expand and strengthen the employer-based retirement plan system. Consistent with this mission, ARA embraced the enactment of ERISA almost fifty years ago in 1974 because it included a principles-based fiduciary standard designed to protect the interests of both plan sponsors and participants. From the outset, we would like to voice our support for the Department’s longstanding efforts to modernize the 1975 regulatory definition of investment advice, leading to fiduciary responsibility under ERISA, particularly as it applies to advice to retirement plan sponsors with respect to plan investments.
It is well recognized that the gateway for working Americans to achieve a comfortable retirement is having access to a workplace retirement plan. Moderate income workers are fifteen times more likely to save for retirement when covered by an employer-based retirement plan than on their own in an IRA. The advent of automatic enrollment has made the connection between retirement plan coverage and positive retirement outcomes even stronger.
The retirement plan coverage gap tends to be greater among small business employers and this has contributed to savings inequity among communities of color where employment disproportionately skews to smaller businesses. Access to a workplace retirement plan is by far the best way to address savings inequity and the American Retirement Association remains committed to the goal of expanding retirement plan coverage, particularly by smaller businesses.
The good news is that progress is being made. The overwhelmingly bipartisan legislation SECURE 2.0 contained numerous provisions to expand small business retirement plan coverage. Legislative efforts with similar policy objectives have also been spearheaded in now fifteen states. As an example, data from one state has shown an over 50 percent increase in 401(k) plan coverage with the smallest businesses showing the biggest increase. Over the next five to seven years, it is estimated that hundreds of thousands of new small business retirement plans will be created.
This is indeed good news, but it also highlights a significant regulatory gap respecting advice to plan sponsors regarding plan investments. It is often said that small business retirement plans are “sold” not “bought” because small business owners are too busy running their businesses.
“Selling” a small business retirement plan, including the specific investment options offered to participants, is not “investment advice” under the current 1975 regulation because, as is often the case with smaller plans, there is no ongoing advice relationship and the “regular basis’ prong of the 1975 five-part test is not satisfied. Practically, this means that when most small business retirement plans are “sold” the advice given is NOT subject to ERISA’s fiduciary standard of care.
Investment advice given to small business plan sponsors is also NOT protected by SEC’s Regulation Best Interest because “plan-level” advice is considered “institutional advice” even if we are talking about an unsophisticated small business owner with just two employees. In fact, when Reg BI was being developed the ARA asked the SEC Commissioners to consider applying it to advice to small business retirement plans and we were told that they believed such advice properly belonged within DOL’s jurisdiction.
Similarly, although the NAIC Model Rule has increased protections for individual purchasers of annuities in over half the states so far it again does NOT apply to the purchase of annuity-based retirement plans by small business owners. Thus, under the current federal and state regulatory framework, most small business owners doing the right thing and trying to offer a retirement plan for their employees are often provided zero—let me repeat zero—regulatory protection with respect to the advice given to them regarding plan investment options.
As we look to increase small business retirement plan coverage it is critical we address this regulatory gap. The 1975 regulatory definition of investment advice is ill-suited for advice to plan sponsors with respect to participant-directed 401(k) plans that didn’t even exist in 1975. Under ERISA, a small business owner is subject themself to ERISA’s fiduciary standard when selecting a provider of plan investment options.
Since a plan sponsor is making decisions on behalf of participants, ARA believes it is absolutely essential, as provided in the Department’s proposed rule, that such a fiduciary plan sponsor be able to rely on the fact that their investment advisor will be subject to the same fiduciary standard of care regardless of whether such advice is just once or on a “regular basis.”
Both SEC Reg BI and the NAIC Model Rule provide investor protections to individuals on a transactional basis whether or not there is an ongoing advice relationship on a so-called “regular basis.” It is simply nonsensical to give an unsophisticated small business owner who is arguably making a more consequential set of investment decisions on behalf of his or her employees LESS investor protection than that same small business owner would likely get with respect to investment advice received on his or her own personal investments.
ARA feels strongly that small business owners looking to provide a retirement plan for their employees should never be left without any regulatory protections when getting advice with respect to plan investment options.
The ARA as a matter of policy believes that all retirement plan regulations should be business model and product neutral. The proposed regulation will ensure that advice given to plan sponsors will be subject to the same fiduciary standard of care regardless of whether the advice is given once or as part of an ongoing relationship. It will also provide for the same fiduciary standard of care regardless of the retirement plan investments being considered be they mutual funds, insurance products, CITs, CDs, commodities, or even cryptocurrency.
We also support the stated intent of the proposal to be distribution and compensation model neutral. ARA feels strongly that commission-based compensation must continue to be permitted. We appreciate the recognition in the proposal that commission-based compensation for advice may in many cases be in the best interest of plan sponsors and participants. In fact, the allowance of commission-based compensation is critically necessary with respect to small business retirement plans as it can reduce out-of-pocket costs to the small business owner who might not otherwise be able to afford the plan. The same can be said regarding proprietary investment products and we appreciate the Department’s recognition that their use in retirement plans can also be consistent with ERISA’s fiduciary standard.
Of course, we recognize that with a broad rule like this the details matter. We supported PTE 2020-02 when it was originally proposed, and we generally think it has been working well in protecting plan sponsors and participants.
We frankly have some concerns about some of the proposed changes, such as the substantial changes to the disclosures required, and question whether the benefits of some of these changes outweigh the likely costs. We will be outlining these concerns in more detail in our written comments.
We would like to highlight one significant proposed change to PTE 2020-02 that appears to be inconsistent with the Department’s stated position of being business model and product neutral. Proposed changes to the policies and procedures required under PTE 2020-02, Section II(c), would now include a proscriptive list of business and compensation models that are presumed to be in violation of a retirement investor’s best interest. These include appraisals, performance and personnel actions, bonuses, and importantly differential compensation. Given the season, we are referring to this as the “naughty list.”
The inclusion of this proscriptive “naughty” list would seem to be wholly inconsistent with the Department’s general embracing of a principles-based fiduciary standard. If this list is included in the final exemption, it will absolutely interfere with existing business and compensation models by creating a clear negative presumption against all these forms of compensation.
For example, there are numerous examples of when differential compensation may be entirely appropriate and in the best interests of plan sponsors and participants because such differential compensation relates to specialized investment options offering different levels of services or features. Such common options to plan sponsors and participants would now be chilled as a consequence of this negative presumption. We strenuously recommend that the final exemption return to the previous language in the current exemption which relies on a principles-based approach to policies and procedures.
That said, we do want to reiterate our general support for the Department’s longstanding effort to modernize the 1975 regulatory definition of investment advice. In this regard, we strongly support the Department’s suggestion that when finalized the regulation be structured so as to be severable in case a court determines that portions of the final regulatory package, and in particular the changes to the existing prohibited transactions exemptions, should be vacated. We believe it is critical to the interests of plan sponsors and participants that the fundamental changes in the 1975 regulatory definition of investment advice be allowed, after almost fifty years, to finally move forward.
Thank you for the opportunity to testify today. We look forward to continuing the dialogue on this important topic, and I am happy to take any questions.
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