So much ground has been traveled in the last seven years leading to our current “partial” implementation of the Department of Labor’s (DOL) fiduciary rule, we may have forgotten how it came about or we are bored to the point of tears in hearing it regurgitated. At the risk of the latter, let me paint a quick recap for you before opining on what the future might look like. What forces drove the steps down that path, what does this partial fiduciary rule actually do? Let’s handicap potential outcomes from here and regardless of the near-term outcome forecast what forces will continue to propel future legislation and regulation in the financial space.
Phyllis Borzi is often referred to as the architect of the rule. In the Obama administration, she was head of the Employee Benefits Security Administration, under the DOL, spearheading an effort to rectify alleged injustices to qualified retirement plans perpetrated by financial services industry via excessive fees and commissions resulting in poor and expensive client recommendations. She used an obscure Carter administration Executive Memorandum as the pretext. It reorganized responsibilities for supervising conduct of those advising ERISA plans from Treasury to DOL, and in the process mentioned IRAs, not contemplated by Congress in original ERISA legislation. Thomas Perez, the former DOL Secretary, then drove the rule across the finish line at the behest of the Obama administration. President Obama applied the finishing touches to armor the rule against future legislative action by making it applicable outside the 60-day Congressional Review Act, even though the rule wasn’t to be effective until long after he was out of office. Phone, pen and cunning. Some of the industry has fought this approach and the result every step of the way, including lawsuits. The incoming Trump administration threw some brakes on the freight train: issuing a memorandum in February 2017, directing the DOL to review the rule and “Prepare an analysis of the impact of the rule and rescind or revise it if:”
- the rule has harmed, or is likely to harm, investors due to reduced access to advice and other services;
- the rule has or will result in dislocations or disruptions that may adversely affect investors and retirees;
- it is likely to cause an increase in litigation and an increase in prices for retirement services.
The DOL granted a temporary delay until June 9, but then allowed some of the fiduciary requirement and compliance with Impartial Conduct Standards to go into force: fiduciary responsibility, reasonable compensation, disclosure of all material facts and compensation, and documentation. However, no BICE contract, no requirement to allow lawsuits, and no financial institution apparatus are required until January 1, 2018. In response, Borzi told Investment News in May of this year:
“Opponents of the rule are going to find it extremely difficult to successfully delay or substantially dilute the rule.” (http://www.investmentnews.com/article/20170522/FREE/170529989/phyllis-borzi-says-opponents-of-dol-fiduciary-rule-face-uphill-climb)
Another wrong call by Ms. Borzi. A further delay is nearly complete until July 1, 2019, with many predicting key elements of the rule will change. While this result is what neither proponents nor opponents wanted, I challenge you to find anyone who predicted this half-baked solution.
Where in the world are we now?
The result of the DOL’s labors has resulted in much uncertainty on all sides about the future of financial services distribution. What we do know is that we now have a “non-law law.” Admittedly, this has become fairly common, as Congress, in an increasingly complex and regulated world, seeks to write “blank-check” legislation for regulatory agencies to fill in and cash. This removes the citizens of the U.S. one step further from actually influencing what our laws are.
Via the “reasonable compensation” requirement for an advisor, the DOL has essentially instituted, with no direct congressional authorization, government price fixing, but without the certainty of an actual mandated price ceiling. Who knows what is reasonable by product type or between types; yet anyone can second guess it.
The DOL has destroyed consumers’ rights to various types of advice. No qualified money plan holder may receive and act on any type of advice unless a fiduciary complying with all of the DOL’s criteria is the one giving it. Hence, the free speech argument in the Chamber lawsuit. Commission-based sales are biased against. Robo-advice is favored.
The DOL has defined client Best Interest standard required of a fiduciary with either a circular argument or a business-destroying argument. It’s what someone exactly like you, Mr. or Mrs. Agent or Rep, would recommend if they were you and they were a charitable entity with no self-interest. Actually, it’s a higher standard than that since even most charities are in practice self-preserving, no matter their philosophy. They do not continually review their operations for termination if they believe another charity is doing good works more in the best interest of their recipients. These compulsory standards applied to IRAs outside of employer plans on a blanket basis across all products are unrealistic and unworkable. This will inevitably promote second guessing by clients, fueled by trial lawyer marketing. Investment Advisors who are already fiduciaries may want everyone to play on their field, but Congress never had that intent nor authorized the DOL to enact it.
The DOL has created a thicket of overlapping regulatory conflicts. They have overlaid regulation on top of FINRA, SEC, state insurance departments and the NAIC models, and despite what DOL may say, with little or no dialogue or consideration of those regulators views.
Why, with a Trump administration seemingly committed to derailing the rule, do we still have this bastardized form of it? The administration got off to a rocky start in a withdrawn nomination for Labor Secretary, late appointment of a cautious, lawsuit-avoiding Alexander Acosta, and entrenched fiduciary rule advocates held over in the DOL, still carrying water for the rule’s ideals. Hence the current temporary compromise.
So now we have bad regulation in the service of a philosophy that has become more pervasive in U.S. polity over the past decades. That it was badly constructed and extremely disruptive is inarguable. In my opinion, safety and security, protection and provision drive an agenda at all branches of our government, but especially in the usurping “fourth branch” of government: regulatory. We are headed toward 100,000 of pages added to the Federal Register every year at an accelerating pace.
New “economically significant” regulations are added by the scores each year at a growing rate.
If you look at much of recent major regulation, safety and security seem to generate new rights and new punishments at every turn. They become the justification for more, and “better” regulation, fines, and lawsuits in pursuit of a just and fair society. Balancing principles of cost, liberty, freedom of expression in business are minimized, underestimated, devalued, or cast aside. Good regulation balances the “general welfare” with liberty and constitutionally limited government. The trend, though, may be inevitable, but it is a break with our past. Maybe it derives from a belief that we in financial services are like Jason Bateman’s character in “Ozark,” a Netflix series. He is a skillful financial planner lured to the dark side: money-laundering for a Mexican drug cartel. He is a nice guy slowly making one “justified” compromise after another until he has nothing left of his morality except love of family.
The other key force driving regulation like the DOL fiduciary rule is that with any organization, incentives drive behavior. Self-preservation and self-aggrandizement become an end in themselves. If a regulator runs out of Congressional mandates for developing regulation or enforcing its compliance, where is the incentive to gear down, decrease expense or personnel? None, in fact the incentives supersede even this preservation instinct. Expansion and inventive creation of new authority can be ends in themselves. They are not even to blame, it is basic behavioral science and economics with a Congress derelict in delegation and oversight.
Can bad regulation be reversed on procedure?
There are several procedural infractions for this rule which should have prevented it from seeing the light of day, or permit it to be struck down judicially. These include:
- The rule defines “fiduciary” and advice for a fee in contradiction to existing statutes.
- The rule violates the Tax Code and the Administrative Procedures Act. It uses exempt authority to proactively create a whole new regulatory structure.
- The rule creates a private enforcement action, which only Congress can do.
- Its class waiver ban is by the DOL’s own admission unlawful, conflicting with the Federal Arbitration Act. This point has even been conceded by the DOL.
Regardless of these, some will argue, at least in private, “Who really cares as long as a virtuous result of fairness, forcing people to make good decisions, and more safety are achieved?” This argument is self-defeating. A nation founded on rule of law for both fairness, but also efficient, productivity enhancing benefits to our society, crumbles when laws are to be treated as disposable because some believe their ideals to be above the law. In any case, when the shoe is on the other foot and “tricks” are used to circumvent black-letter law or common law for something they oppose, they howl just as loudly with indignation.
Handicapping possible outcomes
Three main outcomes for the rule are possible from here. Full implementation of the rule, revision of the rule, or removal of the rule.
Full implementation is unlikely at this point. If it did occur, it might come from some horse-trading done by the Trump administration with a possible Democratic Congress in 2018. The full rule as a bargaining chip in exchange for a more important administration priority is never out of the question. Otto von Bismark said, “Politics is the art of the possible.”
Revision is the odds on favorite. This could come as a result of the DOL’s review, which should be now underway. The house bet here would be a rescission of the July 1, 2019 requirements. This would permanently delete the Best Interest Contract, not disallow waiver class-action lawsuits, eliminate the requirement of financial institutions as fiduciaries with detailed and specific responsibilities, and eliminate required online, consumer-facing information for all products. Revision could also come about through Congressional action. Several bills have been proposed, but have little chance of making it through the Senate. A win by Market Synergy Group in their lawsuit would only affect FIAs by removing them from the BICE and placing them under 84-24.
Full removal of the rule is entirely possible. It could come about through a Court decision completely vacating the rule, most likely in the Chamber lawsuit, though another possibility is the NAFA lawsuit in the D.C. Circuit. Several grounds are promising as they allege the DOL overstepped its authority. Judge Edith H. Jones’ comment during the appeal hearing in the 5th Circuit, may be telling, “… it [the agency promulgating this rule] is the Department of Labor,” implying their authority should be limited to employer plans under ERISA. Should the industry win, it seems doubtful under the current administration that the government would appeal to the Supreme Court; that would end it for now. Such a result could actually chill the rising regulatory agencies’ continuing innovative encroachment into the boundaries of legislation. Another possibility: Congress legislating full removal would seem to have little chance, though they have been trying. They could expand what rules put into effect at the end of the prior administration can be reviewed for rescission or even pass the upcoming fall spending bill including a rider blowing it up entirely. However, a Republican Senate without 60 votes probably rules that out.
What forces are inexorable regardless of outcome?
As mentioned before, a rollback of the increasingly administrative state seems out of reach. Some form of client best interest responsibility is likely to survive or emerge. The NAIC is working on its own model law extending or morphing the current required client suitability regulations into best interest. Hopefully, this will be without the punitive, prescriptive DOL approach. Nevada, with a reflexive knee-jerk, has ventured into the fiduciary fray with its own law effective July 1, but without the implementing details to be set by the securities division in the coming months. It now covers BD reps and advisors, though not insurance-licensed agents, with fiduciary duty, disclosure requirements, record keeping, and ongoing monitoring of client situation. Three other states have fiduciary rules in the works. In addition, the SEC has finally committed to now issue its own fiduciary rule covering all securities sales and recommendations.
Expect a brighter spotlight to be shown on fees and compensation, with required disclosures. Expect some fee compression, which has already begun to occur in the securities industry. I believe we will continue to see broker-dealers and even RIAs no longer allow their Reps and Advisors to treat insurance sales or any financial recommendations as an outside, unsupervised activity. This will be part of a movement toward more full service financial planning. If there is continued movement toward best interest advice, how well can that satisfy best interest without understanding a client’s full financial situation? If the supervising entity (a BD, RIA, etc.) is liable for that advice, they will require a review of all activity and assurances that it was in the client’s best interest.
Increased record keeping and documentation will be necessary to ensure recommendations and sales are rationalized and preserved for posterity: the clients’ memory and trial lawyers’ discovery. The days of the yellow pad are definitely over. A routine method of reviewing and comparing products consistent with a client’s risk profile and objectives, and a repeatable process for the advisor’s efficiency will become almost mandatory. So-called robo-advice will continue to be touted and grow, but will never replace live or virtual interaction. Robo-aided live advisor is the most likely winner.
What should an agent, advisor, or rep do?
Start now. Evaluate your practice and partner with support firms who will make you more efficient in marketing, practice management, client reporting and follow up. Technological aids will be key to being a survivor and thriving. There are many more steps to take on the best interest path and, with apologies to Robert Frost, miles to go before we sleep.
FOR FINANCIAL PROFESSIONAL USE ONLY. NOT FOR USE WITH THE GENERAL PUBLIC. CP-1021 – 2017/10/4