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DoL overhauls retirement rules. Here’s what advisors need to know

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The Department of Labor’s proposal to replace the vacated fiduciary rule is set to upend standards governing retirement advice.

Again.

Like its Obama-era predecessor, the department’s proposal is already facing intense criticism for its allegedly permissive attitude toward conflicts of interests and a hasty rulemaking process. Even Secretary of Labor Eugene Scalia, who as a private attorney led the legal challenge that vacated the fiduciary rule, has become a target of criticism.

"The idea that he wouldn’t see any need to recuse himself, I think, tells you in its own way pretty much everything you need to know about this rule,” says Barbara Roper, director of investor protection for the Consumer Federation of America, adding, “I am sure Secretary Scalia’s former clients are very happy with him.”

If enacted, the agency’s regulation would alter the standards governing investment advice that advisors and brokers provide to retirement investors.

If enacted as currently written, the Labor Department’s proposal would reaffirm and clarify a five-part test for determining when an advisor is a fiduciary with regard to retirement advice. It would also change exemptions advisors could take, including with regard to IRA rollovers.

Here are five key takeaways about the proposal and the rulemaking process.

Regulatory alignment

The Labor Department says its proposal would align with the SEC’s controversial Regulation Best Interest. Indeed, according to the department’s website, the proposed regulation “is designed to promote fiduciary investment advice that meets the best interest standard.”

That’s a problem in the eyes of critics like Roper, who ask: How does one promote fiduciary advice that meets a non-fiduciary standard?

“It was the stated goal of the SEC not to disrupt the brokerage business model. And it is the goal of the DoL, basing its standard on that of the SEC, to allow more leeway for conflicts of interests than would have been allowed under ERISA,” she says, referring to the 1974 law that empowers the Labor Department to oversee retirement accounts.

The department’s announcement follows two other major regulatory changes: permitting private equity funds in 401(k)s and the proposed exclusion of ESG from retirement plans.

Scalia criticized ESG in a statement last month, saying that: “Private employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan.”

Enforcement

The Labor Department’s proposal, like the SEC rule with which it aligns, is reliant upon disclosure.

For example, CEOs — or equivalent officers — would be required to provide an annual certification ensuring they have complied with the exemption and that they avoided prohibited transactions.

The proposal says compensation for advice on rollovers is permitted, and that compensation must be reasonable and conflicts must be mitigated.

But it’s not entirely clear how the disclosure requirements will be enforced, experts say. That enforcement component is critical to how effective the regulation will be, says Jasmin Sethi, associate director of policy research at investment research firm Morningstar.

“Will they say disclosure is enough or will they say you have to change your practices here? That kind of thing will really determine what kind of protections there are for investors,” Sethi says.

Both Reg BI and the Labor Department proposal leave a lot to the imagination when it comes to how they will be enforced, says Sethi. “There is a lot of vagueness in the language.”

One thing the proposal is clear about: Clients will not have a private right of action, something they did have under the Obama-era rule.

Secretary of Labor Eugene Scalia said retirement plans aren’t for “furthering social goals or policy objectives that are not in the financial interest of the plan.”
June 25

Conflicts of interest

The proposal would reaffirm a five-part test for determining who is a fiduciary, something the Obama administration tried to replace. Critics charge that the second step in the test — that investment advice be given on a regular basis — combined with other aspects of the rule are too permissive of conflicts of interest, akin to a Get Out of Jail Free card when it comes to conflicts of interest.

“I think it’s reasonable to think that most rollover recommendations won’t be covered since they won’t be considered advice on a regular basis,” Roper says.

But David Kaleda, an attorney representing broker-dealers, insurance companies and benefit plan service providers at Groom Law Group, disagrees. He says the department would be expanding its definition of fiduciary advice under the proposal.

For example, Kaleda says, rolling over a retirement plan to an IRA, or one IRA to another IRA, would be considered giving investment advice under the proposal.

“They're taking the position that they're clarifying what investment advice is under the law that's been in existence since the late seventies,” he says.

At the same time, the proposal’s exemption would make it easier for fiduciaries to receive commissions than under the current code — even though a “number of exemptions” already make it possible, Kaleda says.

“I would not say that, under current law, a fiduciary cannot receive commissions — it may be hard to do because you have to meet these exemption requirements and other guidance,” he says. “What the DoL is really doing is it's providing some way — another way — to get there that's not quite as prescriptive as their current exemption regime.”

Too hasty, and bad timing?

As with other regulatory proposals, the department’s rulemaking has a comment period. But at 30 days in length, it’s considerably shorter than the 75 days that the Obama administration allowed for the fiduciary rule (the government also extended that comment period by 15 days and hosted three-and-a-half days of public hearings).

“It’s extremely short,” says Marlon Paz, head of law firm Mayer Brown’s Broker-Dealer Regulation & Compliance practice. “This is part and parcel of the rush to get this thing through.”

Paz says the 30 days is not an appropriate amount of time to provide thoughtful insights and feedback even without taking into account that the department’s announcement also coincides with a pandemic, economic upheaval and the implementation of Reg BI.

“Regulation Best Interest just started,” Paz says. “Can we let that play out a little bit to see how it does?”

A lot can be learned from how the SEC enforces the newly enacted Reg BI and how firms implement it, Paz says. But that kind of analysis will not be available within 30 days.

“Whatever camp you are in, you need more time to comment. We need that because that’s how we get to better rulemaking,” he says.

Other experts made similar observations about the hasty timeline. “We are scrambling to process and understand this,” Morningstar’s Sethi says.

Will this rule last?

The Trump administration’s comment period has likely been shortened to get the rule on the books before the presidential election, critics say. Yet that very haste may open the government up to legal challenges down the road, critics and experts say. Even with its longer comment period, the Obama-era fiduciary rule faced five lawsuits and was ultimately vacated by a federal appeals court.

The rulemaking’s aggressive schedule “would open them to questions about the adequacy of the rulemaking,” says Roper.

Another factor to consider: Should former Vice President Joe Biden win the presidential election in November, his administration would have several options to either revise or redo both the Labor Department rule and SEC’s Reg BI, thus starting the process anew.

“[A] change in political administration could upend both the DoL rule and the SEC fiduciary rule,” Cipperman Compliance Services says. “Like soft dollars and 12b-1 fees, this debate may never end.”

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