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Fiduciary rule may be neutered by new DoL proposal, critics say

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With its contentious fiduciary rule only partially in effect, the Department of Labor is pressing ahead with a new proposal to add exemptions to the regulation that business groups say could relieve compliance burdens but that critics contend will effectively neuter the rule.

In its formal call for an 18-month delay of the best-interest contract exemption and other controversial parts of the rule this week, the Labor Department indicated that it is finalizing a proposal for a new exemption likely to focus on certain classes of mutual fund shares ― a central source of the conflicts the original fiduciary regulation was intended to address.

In a Federal Register filing, the department announced that it "anticipates it will propose in the near future a new and more streamlined class exemption built in large part on recent innovations in the financial services industry."

This likely refers to so-called "clean shares" of mutual funds that would be free of the sales incentives and other features that can create conflicts of interest for brokers and advisors.

In a July request for information, the Labor Department noted that some firms had begun developing clean shares as a potential "long-term solution to the problem of mitigating conflicts of interest with respect to mutual funds."

The department cited an SEC definition of clean shares as "a class of shares of a mutual fund without any front-end load, deferred sales charge, or other asset-based fee for sales or distributions."

"I think the pathway is set and now they've given themselves more time to get to the goal line, which is removing any meaningful enforcement," says Knut Rostad, president of the Institute for the Fiduciary Standard.

How a clean shares exemption could fit in with the broader fiduciary rule remains unclear, but consumer advocates who have argued for legally binding provisions requiring retirement advisors to act in the their clients' best interest are wary.

"Our bottom line has always been there needs to be a legally enforceable best interest standard at all times, and firms need to rein in incentives that encourage and reward harmful advice," says Micah Hauptman, financial services counsel at the Consumer Federation of America. "We don't see why the agency would need to create another exemption when the BIC already accomplishes that."

A Labor Department spokesman declined to comment on what a clean shares exemption might look like, saying that "it would be premature to make any statements about the substance of any streamlined class exemption."

Hauptman suggests that the clean shares exemption could resemble the level-fee exemption included in the original rule, a provision that would allow many fee-only advisors to evade the contractual and disclosure provisions of the BIC.

Susan Conrad, director of retirement plan advisors at Plancorp, a St. Louis-based RIA, sees a clean share exemption and, potentially, others as effectively superseding the BIC.

"[T]he new avenue is to put in parallel exemptions," Conrad says. "The idea is that if we can't get the old ones off the books, we can just let them die on the vine ― because the new ones will cover every prohibited transaction the old ones did. The new, streamlined exemptions would just be the easier route for advisors."

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In the meantime, the department says that it has yet to complete the review of the fiduciary rule that President Trump ordered in February. Any potential changes that arise from that evaluation, or the proposal for a clean shares exemption, wouldn't be able to take effect before the original applicability date of Jan. 1, 2018, the department said in its argument for the 18-month delay. That extra time would also allow the Labor Department to further engage with the SEC in a broader effort to harmonize fiduciary standards.

While the department favors the 18-month timetable for pushing back the rule, it is also asking for comments on alternative ways to structure the delay, such as setting the applicability date 12 months following the conclusion of the reexamination that the White House ordered.

The Labor Department spokesman says that the agency will collect and review the comments on the proposed delay, with a final decision likely to be made by year's end.

"We generally do not speculate on when decisions would be made on final rules, although we are sensitive to the need for a decision in this case in advance of the current transition period ending on January 1, 2018," the spokesman says.

Many of the business groups that have argued against the fiduciary rule hailed the proposed delay, saying they hoped it would produce a streamlined rule for best-interest retirement advice and allow for closer coordination with the SEC and other regulators.

But advocates for the rule like Hauptman and Knut Rostad, president of the Institute for the Fiduciary Standard, see the delay as a sign that the process is cooked, with the inevitable result being a defanged fiduciary standard that strips away the strong enforcement provisions of the original rule.

"I think how this plays out is that the BIC is watered down and weakened to the point of being ineffective, in a nutshell," Rostad says. "I think the pathway is set and now they've given themselves more time to get to the goal line, which is removing any meaningful enforcement."

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