DOL Expected to Push Ahead with Expanded Fiduciary DefinitionAs most practitioners in the employment and securities arenas are well aware, the Department of Labor (“DOL” or “Department”) and Securities and Exchange Commission (“SEC”) have been pushing forward at a quick pace as they consider fiduciary issues. In October 2010, DOL issued its proposal to expand the definition of fiduciary and held two-day hearings earlier this year in March to gather input from the industry. For its part, in compliance with the Dodd-Frank Act, the SEC issued a report completed by its staff in January recommending that the agency adopt a “uniform fiduciary standard” for broker-dealers and investment advisers. Both the DOL’s and SEC’s work have gained widespread attention, with the DOL receiving over 250 comment letters1 to date on its proposal and the SEC receiving over 2,000 comments2 last year as its staff worked on the January report. As a quick recap, the DOL is seeking to eliminate the long-standing five-part test for defining “investment advice for a fee” under ERISA and determining fiduciary status of an advisor to retirement plans. Under its proposal, the DOL would create a regulation that more closely aligns with ERISA’s statutory language and defines a fiduciary as a person who provides investment advice to plans for a fee or other compensation. Key components of the five-part test that would be eliminated include requirements that: (1) the advice be given on a regular basis (2) serve as a primary basis for plan investment decisions; and (3) be given pursuant to a mutual agreement/understanding between the advisor and plan or participant. However, advice must continue to be individualized to the needs of the plan to fall within the definition of “investment advice for a fee” and, thus, convey fiduciary status. In addition to these changes, the proposal would include in the definition of fiduciary advice appraisals and fairness opinions rendered in connection with plan investment decisions and specifically would supersede Advisory Opinion 76-65A, which created an exception for appraisals of employer stock for purchases by employee stock ownership plans (“ESOPs”). It would also include advice and recommendations as to the “management of securities,” a component which commenters believe the DOL should further clarify. In addition to changes to the DOL rules, regulations pursuant to Section 4975(e) of the Internal Revenue Code would change in a parallel fashion, bringing advice related to individual retirement accounts (“IRAs”) under the proposal. While it is unclear how current exemptions (such as prohibited transaction exemptions) will continue to apply and be administered by DOL, the proposal contains key exceptions, including a so-called seller’s exception, an investment education exception, and a platform provider’s exception. In general, the DOL proposal has sparked a lot of controversy and received a strong reaction in comments. Two aspects of the proposal that received the most criticism are the proposals to: (1) expand the definition of fiduciary to include valuation services, which would have a profound effect on ESOP valuations, and (2) create a corresponding change to rules under IRC Section 4975(e), thereby affecting the status of service providers operating in the IRA space. With regard to ESOPs, industry commenters claim that the proposal could reduce the number of qualified valuation firms servicing ESOPs due to greater costs associated with providing valuation services as a result of increased regulation.3 Therefore, commenters have asked DOL to delay consideration of the issue by removing the reference to ESOPs from the proposal or, in the alternative, revising the proposal to require that an independent fiduciary verify valuations or appraisals provided by valuation firms. With regard to IRAs, industry commenters have made similar arguments that consumers’ access to advice related to investments in IRAs will become limiteddue to greater costs caused by increased regulation.4 While the strong reaction to the DOL’s proposal has given the Department’s staff some pause as it carefully considers a final rule, it appears that the DOL does not think it is necessary to delay its rule. Interestingly, while most regulatory initiatives are initiated as the result of policymakers observing trends in the market, in the case of the DOL’s fiduciary definition proposal, investigators and enforcement staff found the definition of fiduciary to be unworkable in trying to prevent and sanction misconduct by advisors whom plans and participants often view as acting in a fiduciary capacity. Therefore, investigators approached policymakers seeking a solution to make it simpler to determine the fiduciary status of advisors in order to reduce conflicts and promote greater transparency and accountability. For this reason alone, it seems clear that the DOL is intent on moving forward with its proposal and implementing a system that allows the Department to provide greater fiduciary protections for plans and participants. For those following the DOL’s proposal, it is just as important to be aware of the SEC’s work in the fiduciary arena. Since issuing its proposal, the DOL has been sitting in the spotlight and experiencing pressure from the brokerage industry and Congress to which it is not accustomed.5 Through letters and testimony, several commenters have attempted to pressure the DOL into delaying its work on expanding the fiduciary definition so that final rules can be coordinated with the SEC, which has indicated that it will start penning a proposal later this summer. An SEC rule would have particular implications for broker-dealers, who are likely to be treated as fiduciary advisors for the first time under federal securities laws when providing personalized investment advice to retail investors. It is unclear, however, whether and how a new SEC rule would impact broker-dealers advising retirement plan clients – an arrangement that is usually done on a non-fiduciary basis. Thus, a looming question is how the SEC’s proposal for fiduciary rules will affect and/or interplay with DOL rules. The outcome is hard to predict given the SEC has yet to even write and issue a proposed rule, while the DOL has moved at a much quicker pace to propose and implement rules that promote greater transparency and accountability in the fiduciary space. There has been some indication that the SEC and Financial Industry Regulatory Authority (“FINRA”) will seek to implement new disclosure requirements related to conflicts of interest.6 Consequently, several investment service providers could find themselves subject to two sets of fiduciary rules. Assistant Secretary of Labor Phyllis Borzi and DOL staff made it clear during the DOL’s March hearings that the Department has been coordinating its rulemaking efforts with the SEC, and the agencies do not intend to create conflicting standards.7 However, she also strongly noted that entities regularly are subject to multiple laws with differing requirements. Moreover, ERISA and Dodd-Frank are two very different statutes with different purposes and structures, and while DOL is seeking to coordinate its work with the SEC, Borzi does not believe that DOL should defer to the SEC or subrogate DOL regulations to SEC rules in any way. As a consequence, the Department cannot guarantee that service providers, such as broker-dealers, will be subject to a single fiduciary standard of care under ERISA and the federal securities laws. While there is some uncertainty what a final DOL regulation will look like, service providers should be prepared for definite changes. Phyllis Borzi has indicated that the final rule is expected to be submitted to the Office of Management and Budget by September and finalized by year end. One likely scenario would be for the DOL to delay corresponding changes to rules under the Internal Revenue Code so that advisory services related to IRAs are not yet affected by a final rule. This would allay many of the concerns asserted by the brokerage community and allow the DOL to pull its final rule farther away from the public spotlight. The DOL, however, will likely move forward with its proposal to replace the decades old five-part test in order to give its investigators the tools they need to protect plans and participants. Thus, advisors can expect to be subject to a functional test that looks to their status,8 how they hold themselves out, and the nature of their advice to determine fiduciary status. Moreover, appraisers and valuation firms should expect to also be pulled into the fiduciary space, as valuation activities are an area that has concerned investigators for quite some time. It should be noted, however, that during the March hearings the Department appeared to be sympathetic to concerns of valuation firms and willing to make some adjustments to the final rule. And finally, those service providers who will seek to avail themselves of one of the exceptions to the new proposal to offer non-fiduciary services should be preparing to provide clear disclosures to plans of their status and the nature of their services in order to ensure that plans and regulators do not view them as providing fiduciary services. By: Kristina Fausti, kristina@fi360.com, Director of Legal and Regulatory Affairs, Fiduciary 360 |
1Available at http://www.dol.gov/ebsa/regs/cmt-1210-AB32.html.
2Available at http://www.sec.gov/comments/4-606/4-606.shtml.
3 See, e.g., Comment Letter from Anthony A. Guthrie, President & Managing Principal, and Lance T. Studdard, Vice President, Reliance Trust Company, available at http://www.dol.gov/ebsa/pdf/1210-AB32-084.pdf.
4 See, e.g., Comment Letter from Terry K. Headley, President, National Association of Insurance and Financial Advisors, available at http://www.dol.gov/ebsa/pdf/1210-AB32-PH042.pdf.
5 Since issuing its proposal, in addition to the many comment letters, DOL has received letters from ranking Republican members of House and Senate committees, the New Democratic Coalition, and Senators John Kerry (D-MA) and Jeanne Shaheen (D-NH), expressing concern over the Department’s proposal.
6 See FINRA Regulatory Notice 10-54, available at http://www.finra.org/Industry/Regulation/Notices/2010/P122362.
7 Transcripts of DOL’s March 1-2, 2011 hearings are available at http://www.dol.gov/ebsa/regs/cmt-1210-AB32.html.
8 For example, whether they are an “investment adviser” under the Investment Advisers Act of 1940 or act as a fiduciary in another capacity. |
