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According to Department of Labor Secretary Perez, DOL has received over 330,000 comments on its fiduciary regulation proposal. The DOL website shows 2,631 public comments. In August, DOL held four days of hearings, at which opponents and supporters of the proposal presented their views.
In this article we provide an update on the current status of the proposal and consider what changes may be made to it.
On July 29, 2015, a bipartisan (although primarily Republican) group of Congressman asked DOL to “re-propose this rule to ensure that it achieves its stated goal of protecting Americans saving for retirement.” In response, DOL Secretary Perez was emphatic that DOL intended to proceed with finalization of the rule. In his (August 7, 2015) letter in response, he stated:
This high level of interest and contribution to the process is indicative of a shift in attitude over the past few years – a recognition of the growing problem of conflicted advice, a desire to create a level playing field, agreement on the simple premise of putting the client’s best interest first, and a “get to yes” attitude that will lead to a meaningful and workable rule. For these reasons, we will move forward towards issuing a Final Rule that balances the input we have received.
It’s clear the Administration intends to complete this project before leaving office in January 2017. And, based on Secretary Perez’s letter, it’s pretty clear that whatever changes DOL will make will be at the margins, that DOL is committed to the basic structure and policies of the original proposal. The next steps for DOL are to (1) sort through the comments it has received, (2) determine which ones require a change to the proposal or, failing that, an explanation for why no change will be made, and then (3) publish a final rule.
We have provided a detailed review of the proposed rule in our articles DOL re-proposes rules redefining ERISA ‘fiduciary’, The DOL fiduciary proposal: investment education vs. advice and DOL proposed redefinition of ERISA fiduciary – Best Interest PTE. We tried to boil down the issues of critical importance to plan sponsors in our article DOL’s fiduciary proposal: significance for plan sponsors. Summarizing:
For sponsors of any size, the seller’s carve out will allow the continued provision of advice by providers to sponsors.
While the proposal will limit the amount of advice and education that may be provided to participants, defaults (e.g., to a target date fund) will mitigate that effect while participants are in the plan.
The critical ‘advice gap’ that will result from the proposal will come at termination/retirement: the new rule would significantly limit the amount of coaching that terminating/retiring participants will get (e.g., to not take a distribution but rather to leave retirement savings ‘in the system’).
Many of the issues that the original (2010) proposal raised for sponsor staff (e.g., plan investment committee staff) have been dealt with, although there are still some problems at the margins.
There were several letters from members of Congress to Secretary Perez on the proposal. We found the most interesting to be an August 7, 2015 letter to Secretary Perez from eight Democratic Senators (Ron Wyden (D-OR), Debbie Stabenow (D-MI), Robert Menendez (D-NJ), Tom Carper (D-DE), Ben Cardin (D-MD), Michael Bennet (D-CO), Bob Casey (D-PA) and Mark Warner (D-VA)), asking for certain clarifications and changes to DOL’s proposal.
That letter, signed by some key, senior Democrat retirement policymakers, may give a clue to some of the areas where DOL may see issues with its proposal and may be open to changes. We’ll be referring to it several times in this article, so we’ll call it the ‘Democrat Senators’ Letter.’
In the rest of this article we are going to consider some of the substantive issues that DOL may reconsider. We begin with what we believe (see above) will be the key issue for plan sponsors: what sorts of education or advice may be given to terminating participants under the new rule.
Under the new rule, will anyone be able to recommend to a terminating participant that she leave her money in the system? Let’s begin with a description of the problem.
The language of the proposal is very broad. Fiduciary advice would generally include:
[A] recommendation to take a distribution of benefits or a recommendation as to the investment of securities or other property to be rolled over or otherwise distributed from the plan or IRA.
The Preamble to the proposal explains: “recommendations to take distributions (and thereby withdraw assets from existing plan or IRA investments or roll over into a plan or IRA) or to entrust plan or IRA assets to particular money managers, advisers, or investments would fall within the scope of covered advice.” (Emphasis added.) On the other hand, “one does not act as a fiduciary merely by providing participants with information about plan or IRA distribution options, including the consequences associated with the available types of benefit distributions.”
So, it appears that under the rule as proposed, a person (e.g., a call center operator or investment adviser) could describe the choices a terminating participant might make but could not ‘recommend’ any particular choice. Those choices (generally) are: (Plan A) leave the money in the terminating participant’s current plan or roll it over into a plan of her new employer; (Plan B) roll the money into an IRA; or (Plan C) take a cash distribution.
It’s clear that DOL wants to prevent a conflicted advisor (that is, an advisor affiliated with specific IRA funds/fund managers) from recommending that a participant take a rollover distribution to the affiliated IRA. DOL clearly views Plan A (either leaving assets in the plan or transferring them to a new employer) as better options. Leaving assets in the plan is, however, often not an option; many sponsors prefer that a terminating participant take a distribution (and sever ties with the plan). Transferring to a new plan is, typically, a very awkward process (see our article Recent studies on rollovers identify emerging issues).
In these (typical) circumstances, Plan B is the (hoped for) alternative: that the participant roll over plan assets to an IRA. Given DOL’s (and participant advocates’) negative view of ‘conflicted’ IRAs, one assumes that the (that is, DOL’s and participant advocates’) hope is that the participant will roll over assets to an un-conflicted IRA, pursuant to advice from an independent, un-conflicted advisor.
Under the proposal, however, that approach hits a snag if (as is typically the case) the independent advisor gets a bigger fee as a result of the IRA rollover. A number of commenters have made this point. The Democrat Senators’ Letter raises this issue in the context of a level fee adviser advising both plan participants and IRA holders:
The proposed rule generally encourages conflict-free compensation arrangements. However, under the guidance, plan advisers who receive level compensation from a retirement plan, and would receive level compensation for investment advice provided to an IRA rollover from a retirement plan, would be discouraged from working with plan participants on rollovers. The problem arises because the level of compensation received from the IRA would usually be higher than that received from the plan if the adviser concludes that he will need to provide a higher level of service for the IRA. This situation would subject the adviser to the same difficult BIC exemption requirements faced by Variable fee advisers …. We ask that this situation be addressed in a way that provides a level playing field for all advisers, regardless of whether they have a relationship to the plan and regardless of the fee structure they use.
We would note that a similar problem would arise if an independent level fee adviser who was not being compensated for advising the participant as a participant but would be compensated (on a level fee basis) for advising the participant as an IRA holder.
This seems like a problem that DOL would want to solve. Because under Plan C the money leaves the retirement system. How DOL will solve it – how it will distinguish between conflicts involving affiliated advisers and conflicts involving ‘level fee’ advisers – is unclear.
At the risk of being repetitive, what is at stake here is whether anyone will be able to encourage/coach a terminating participant to leave her money in the system – either by not taking a distribution or by rolling her distribution into an IRA. One industry group, in its comments, suggested that if that is not allowed, then “[a]ccording to a comprehensive study by former government economists, this would result in $20 billion to $32 billion more in annual leakage from retirement plans.”
A related issue is, if recommendations (by anyone) to a participant about distributions are fiduciary advice, does the proposed Best Interest Contract exemption (BIC) cover those recommendations? As discussed below, most industry commentators view the BIC, as currently formulated, as unusable. Assuming the usability issues can be fixed (which seems unlikely), the BIC is read by many as covering only advice about investments and not advice about distributions. There seems to be broad support (including, e.g., from participant advocate groups) for clarification that the BIC does extend to distribution advice.
We discuss the BIC at length in our article DOL proposed redefinition of ERISA fiduciary – Best Interest PTE.
Industry advocates generally describe the BIC as unusable as proposed. According to the Investment Company Institute, “That exemption [the BIC] as currently drafted is quite useless because of the multitude of ambiguous and impractical conditions to which it is subject.” The Democrat Senators’ Letter explains the issue at length:
[W]e recommend that the Department critically examine the BIC exemption to ensure that it is operational. If from a practical perspective financial professionals cannot use the exemption, we worry about the impact that may have on small businesses and moderate income savers. For example, it may be very difficult for service providers to show that their own compensation is reasonable without guidelines and safe harbors to follow. Furthermore, the disclosure requirements seem excessive. … As you know, it’s a balance when it comes to participant and investor disclosures. Investors need appropriate information to make informed decisions. However, if too much information is provided, it gets ignored. Unfortunately, it appears to us that these disclosure requirements will overwhelm participants and investors. We also think it will be very difficult for financial institutions to comply with these requirements. Therefore, we urge the Department to revisit the BIC exemption disclosure requirements. We also encourage you to “piggyback” off of relevant rules from your own guidance and that of other regulators that are currently in place and that serve the intended purpose.
Some participant advocates dismiss this concern. Alicia H. Munnell and Anthony Webb of the Center for Retirement Research at Boston College say that the assertion that the financial services industry will not use the BIC is “simply not credible. We are being asked to believe that the terms of the BIC exemption are so onerous that the industry will choose to walk away from $1.7 trillion of assets and perhaps $17 billion of revenue rather than comply with them. … No real evidence exists to support [this claim].”
Given how central the restrictions and disclosure requirements in the BIC are to DOL’s overall concept, our current view is that DOL will not make the sorts of changes the Democrat Senators are urging. It may, however, make some changes at the margin, including:
Clarifying that the BIC covers advice concerning distributions.
Allowing use of the BIC for advice to sponsors of plans with less than 100 participants that allow participant choice.
Relaxing the signed contract requirement. According to the Democrat Senators Letter, “We also hear frequently that many are concerned that under the proposed rules, investment advisers must obtain a signed contract before providing investment recommendations. … [W]e have heard informally that this was not the intent of the Department and we appreciate your openness to making the contract requirement more workable, including consideration of the creation of an enforceable commitment without requiring a signed, written contract.”
Covering options. Under the proposal options are excluded from the ‘investments’ covered by the BIC.
Some of the other elements of the proposal that may be ‘in play’ include:
Possible narrowing of the platform providers carve out. Several participant advocate groups argued for a narrowing of the platform providers’ carve out. According to the Pension Rights Center: “marketers of investment platforms can limit the investment options from which a fiduciary may choose and may be influenced by the payments they will receive from the vendors of the investment products available on the platform. We thus believe the broad carve-out may permit conflicts that should be controlled. We suggest eliminating this carve-out and substituting a prohibited transaction exemption that requires disclosure and mitigation of conflicts.”
Allowing investment education identifying funds. Many commenters, and not just industry advocates, suggested a broadening of the carve out for investment education. The Democrat Senators’ Letter suggested that educators be allowed to identify funds: “the new rule [with respect to investment education] restricts the identification of specific products or investments …. We find that to be a troubling result because for most investors and participants, specific examples are extremely helpful. … [I]f instead, the financial professional was required to name a few funds as examples, subject to certain standards, that seems more like investment education and not advice. … [W]e hope that the Department will look to find middle ground in this area.”
Relaxing the rules for small businesses. Many commenters (and, again, not just industry advocates) suggested loosening the rules for small businesses. The proposal does not provide a seller’s carve out for advice to sponsors of plans with less than 100 participants. And the BIC does not apply to sponsors of participant choice plans. The Democrat Senators’ Letter states, “The reality is that retirement plans for small businesses are sold, not bought – and it is important that any rule take this factor into account. We appreciate the Department’s willingness to critically examine your proposed rule to ensure that it does not result in fewer new small plans being created and it allows financial professionals the ability to help small businesses set up plans and select investment options.”
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We will continue to follow these issues.