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Snakes and ladders: What to expect in the unexpectedly triumphant final DOL fiduciary rule

Whether converted or just plain exhausted, the staunchest opponents are standing down to make way for the new rule that will go into effect in 2017

Friday, December 18, 2015 – 12:28 AM by Guest Columnist Duane Thompson
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Duane Thompson: Its harshest critics might compare the process to a giant anaconda that, having swallowed its prey, now lies motionless for several months as it slowly digests its meal.

Brooke’s Note: I admit it. I was agog to learn that DOL had, in effect, prevailed in creating a new fiduciary rule as of 2017 — one with teeth and one that will be difficult to dislodge. Maybe I was jaded by endless alternating bouts of hope and despair. But I shouldn’t have been, not entirely, given that I had literally just read this Duane Thompson article reprinted below in IMCA’s magazine that rather clairvoyantly predicted the outcome in all its particulars. My first act after hearing the news yesterday — that the retirement rider was left out of the omnibus bill — was to call Thompson and ask him if I was wrong to presume this whole DOL thing was DOA. He reassured me that my at-a-remove instincts had basis in fact. “The DOL kind of got a black eye in the first round and returned to its corner and never came out for the second round. The opposition did a great job of gathering opposition in the Democratic Party. You’d think it might have gone away.” Why didn’t it? Thomson went on to explain that what might have seemed like a lay-down by DOL was really a manifestation of having no new Labor secretary — a matter righted when Thomas Perez took the job. Thompson added that the DOL is not really the kind of thing that “goes away” given its immense size and budget. “The DOL’s budget is 11 times the SEC’s,” he says. Still, I asked: How did it not hop aboard the omnibus bill? Would Obama really have gone to war over a DOL rule issue that the public isn’t even aware of? Thompson agreed that question may remain unanswered and that only Paul Ryan, Nancy Pelosi and Mitch McConnell may know for sure. And he agreed with me that Republicans’ sleeves were filled with aces. “The money and the boots on the ground were on the industry opponents’ side 20 to one,” he says. So did the SIFMA, FSI crowd have a come-to-Jesus moment? “I don’t think they waved the white flag,” Thompson says. “I think Obama drew a line in the sands and said 'no.’ There was just a growing realization that they might lose.” Apparently, reports of President Obama’s lame duck status have, yet again, been greatly exaggerated. See: As President Obama takes the gloves off, pro-broker groups throw up 'sledgehammer’ response.

This article originally was published in the November/December 2015 issue of IMCA’s Investments & Wealth Monitor.

The great debate over a fiduciary standard for retirement advice, now in its fifth year, is about to enter its final, climactic phase. In the meantime, the Department of Labor has entered a self-imposed blackout to review feedback on its proposed conflict of interest rule.

DOL is legally constrained from discussing any specific changes in advance, but this article offers an analysis based on specific issues that key supporters and some opponents agree need revisions; and on other, recent remarks by senior DOL officials suggesting that they are open to change in certain areas of the proposal.

However, although it is clear that modifications will be made, many observers believe the basic framework—including carve-outs from the definition and safe harbors permitting commissions and third-party payments to firms and agents with conditions designed to mitigate conflicts of interest—will remain largely unchanged.

It is also the author’s belief that a history of recent rejections by courts of the Department’s amicus briefs asserting that financial services firms met the functional, statutory definition of a fiduciary in the Employee Retirement Income Security Act (ERISA)—has strengthened DOL’s resolve to update the 40-year-old regulation.

After 160 days for public comment that closed Sept. 24, which included an estimated 100 meetings with interested parties and four days of hearings, DOL is poised to issue a final rule by mid-year 2016.

Listen up

Its harshest critics might compare the process to a giant anaconda that, having swallowed its prey, now lies motionless for several months as it slowly digests its meal. After all, DOL has 3,131 comments to review, including 2,300 substantive letters. See: DOL’s proposal puts the screws to legacy 401(k) providers.

Of course, DOL and its supporters view the results in brighter terms. DOL assistant secretary Phyllis Borzi, speaking at an industry conference on Oct. 20 described the comments as a “mixed bag of opposition and support,” adding that DOL had been looking for constructive ways to enhance the rule and “found them.”

Despite intense congressional pressure to delay or kill the proposal, the outcome is not in doubt. Absent a successful legal challenge, financial advisors with widely varying business models—registered representatives, insurance producers, and even fee-only financial planners—need to be aware of the new fiduciary requirements under the law. See: Phyllis Borzi tightens the noose on 401(k) providers that flout DOL disclosure, not without critics.

Final — really final — draft

Phyllis Borzi says she was looking for constructive ways to enhance the rule and found them.
Phyllis Borzi says she was looking
for constructive ways to enhance the
rule and found them.

Due to intense political pressure to demonstrate flexibility in rulemaking—the Department received 34 mostly group letters from members of Congress, including a total of 387 signatures, with some members signing multiple letters—the Department must signal its openness to change after nearly five contentious years of debate. At this late stage, it cannot contradict numerous public statements and congressional testimony that it is open to change.

The question is how much will change in the final rule. The author believes not much, except for some streamlining, as mentioned in Borzi’s recent remarks. Consensus is growing that all the roadblocks thrown up by opponents—congressional oversight hearings, a bill to require the Securities and Exchange Commission to adopt a fiduciary rule of its own before DOL, legislative riders on DOL’s 2016 budget prohibiting use of funds for the rulemaking, and a possible lawsuit—are unlikely to derail the proposal. At least one trade group has stopped lobbying against it.

Though not widely reported by the press, some of the political winds on Capitol Hill have shifted in favor of the rule. That is to say, where Democrats previously were divided, and some even voted to kill the measure two years ago, many have reconsidered. The original 2013 legislation by Rep. Ann Wagner (R-MO), the Retail Investor Protection Act (H.R. 1090), was voted out of a House committee in 2013 with 28 Democrats voting yes. A nearly identical bill was voted out of the same committee on Sept. 30, 2015, but this time with only one Democratic “yes” vote.

Govtrak, an independent tracking service, gave the 2013 bill a 20% chance of becoming law; this time it’s only 11%. Democrats continue to call on DOL to make the bill (H.R. 1090) workable, but they have closed ranks with the Obama administration. On Oct. 27, the full House passed the bill, with only three of 187 Democrats supporting it. Now that it has been referred to the Senate, Democrats have procedural opportunities to kill it if it is attached as an amendment to must-pass legislation. There is even less chance of it passing as a stand-alone bill. Each year only a tiny percentage of bills make it to the president’s desk, and there is little doubt that President Barack Obama would veto this one, given the political stakes involved.

Fiduciary carve-outs will stay limited

The definition of a functional fiduciary under the revised proposal would change dramatically under the proposal by reducing the old, complex five-part test of fiduciary status into a streamlined definition. No longer would a court have to analyze all five conditions to determine whether, for example, the advice was the primary basis for an investment decision, or whether the advice was provided on an ongoing basis. Moreover, referrals to investment managers; investment advice on rollovers from a plan, individual retirement account or distribution; and managing IRA portfolios, or providing intermittent advice, would be fiduciary acts under the new proposal.

Most of the limited carve-outs—principally for platform providers disclaiming fiduciary status—would remain. The proposal drew controversy, however, when DOL, concerned about product vendors steering participants to proprietary products during education seminars, modified the longstanding education carve-out by prohibiting advice on specific investment products. That may change because even some consumer groups objected. They suggested an alternative that would allow references to all products in an asset class without favoring one over the other, but they also made clear they would object to extending the carve-out to brokerage windows in plans or IRAs.

Best interest contract exemption will be modified

The centerpiece of the exemptions from ERISA’s prohibited transaction requirement—the best interest contract exemption, or BICE—was created by DOL to permit commission or other third-party incentive compensation. BICE was essentially a response to industry critics who accused DOL of wanting to ban commissions. In exchange for allowing a firm or agent to receive variable compensation, BICE mandates, among other things, conditions for managing the conflict, including detailed disclosure of costs, affirming their role as a fiduciary, and charging reasonable compensation. Moreover, BICE also would apply to rollover and IRA advice if variable compensation was received. Many opponents claim the exemption’s numerous disclosure and other contractual requirements make BICE inoperative.

The industry would like to see BICE go away, but it is almost certain to remain in the final rule. DOL has invested too much political capital in this exemption, and removing it would only reinforce critics’ argument that DOL intended to ban commissions. Removing an exemption central to the proposal also would increase opponents’ calls to return to the drawing board and propose yet a third draft for public comment.

BICE provisions sticking around

We can expect to see some streamlining of BICE in the final version. Here are some of the areas that the author believes are likely to change:

• Detailed disclosure of compensation arrangements is likely to be streamlined, including disclosure of the total dollar amount of compensation received by the individual agent and firm.

• Point-of-sale disclosure of anticipated future costs, based on future projections for holding periods, may be eliminated due to conflicts with Financial Industry Regulatory Authority rules restricting investment performance projections.

• The proposed three-way contract among firm, agent, and client will be reduced to a two-party contract between firm and client.

• Negative consent will replace the requirement for execution with the client of an entirely new BICE contract. In other words, the client will need to opt out of the BICE contract.

• Fiduciary advice to defined contribution plans of fewer than 100 participants may be eligible for the BICE safe harbor. Currently only firms advising individual participants, IRA holders, and defined benefit plans of fewer than 100 participants are eligible for the BICE exemption.

• DOL will clarify that a signed agreement is not required before discussing investment recommendations with a prospective client.

• DOL will either exempt or create a streamlined BICE exemption for level-fee advisors offering rollover advice.

Consider them gone

Listed below are areas that opponents would like eliminated from BICE—but are nonetheless provisions likely to stay:

• Variable annuity transactions in IRAs will remain, and fixed annuity transactions will be covered by a separate prohibited transaction exemption (PTE), 84-24.10

• Call-center communications with participants about investment advice, including distributions, will continue to be subject to BICE.

• The range of permissible assets available under BICE—certificates of deposit, bank collective investment funds, mutual funds, exchange-traded funds, insurance company separate accounts, exchange-traded real estate investment trusts, most corporate bonds, publicly traded stocks, insurance and annuity contracts, guaranteed investment contracts, Treasuries, and municipal bonds—will remain.

What’s more

DOL likely will provide additional clarification to other areas of this complex and wide-ranging proposal that might apply to the fiduciary definition, a carve-out, or one of the PTEs. But DOL is unlikely to offer much else that will satisfy opponents—many of whom may be wondering whether they did too-good a job lobbying against the 2010 proposal.

One other major industry concern—the six-month transition period following rule adoption—also may be tweaked. Some industry commenters had called for a transition period of up to three years.

Given the political necessity of having the rule in effect before the January 20, 2017, presidential inauguration date, the effective date of the final rule is likely to be no later than Dec. 31, 2016. That would mean if DOL retains a six-month transition for implementation, it must approve the final rule by the end of June 2016—hence Borzi’s recent comment that the rule would be finalized in the first half of 2016.

If DOL is able to get through all the comments much earlier, including the voluminous cost-benefit analyses that could weigh heavily in any legal challenge, then the transition date may extend beyond six months. Some observers believe that such circumstances also may permit much longer phase-ins for certain requirements, such as the detailed disclosures required under BICE.


A lawsuit challenging the final rule could be filed within a few days of its adoption, adding a final wild card to the mix. Opponents are likely to seek a stay of the rule’s effective date from the U.S. Court of Appeals for the District of Columbia Circuit. And if the court agrees, and a Republican is elected president in the interim, that could be enough to kill the initiative.

Of course, if Republicans maintain control of both houses of Congress and win the White House in the next election cycle, then it could undo or significantly reverse a final Obama administration rule. However, the possibility of legislative revisions to ERISA is a long shot. Republicans are expected to easily retain control of the House, but the Senate is a different story. The GOP must defend 24 seats, and Democrats must retain only 10. Further, to achieve real legislative control, Republicans must increase their 54-seat majority to a filibuster-proof 60. At this early stage, political observers see a greater possibility of Republicans losing the Senate rather than strengthening their current majority.

In retrospect, many industry opponents would have found the original more palatable. Industry opponents also may reflect on whether it would have served their interests to actively lobby the SEC to move forward with its own rule first, as the House legislation now proposes. Other than general statements in support, there is little evidence that industry opponents of the DOL proposal took advantage of the four-year lull in the rulemaking to press the SEC to move forward with its own rule. Nor did most of the commissioners during this period publicly express their support for a fiduciary rule,11 and some privately expressed their reservations. Some publicly questioned it as a priority for the commission.

So at this point odds are fairly high that in early 2017 a new fiduciary rule will be in place—one that promises to transform the pension advice industry from the comfort zone it has enjoyed for 40 years to a new fiduciary world of due diligence processes as well as increased risk of liability. See: Legal analysis: Why the Yale 401(k) letters, limits aside, should raise an alarm to plan sponsors.

Duane Thompson is president of Potomac Strategies LLC, a public policy consulting firm in Kensington, Md. He earned a BA in history and studio art from Principia College and a master’s degree in journalism from the University of Missouri. Contact him at dthompson@potomacstrategiesllc.com.

Mentioned in this article:

Investment & Wealth Institute
Top Executive: Sean Walters

Stephen Winks

Stephen Winks

December 18, 2015 — 7:31 PM

The industry has 6 months to comply. After 70 years of denial, we can actually have a safe business environment in which advisors can work in the client’s best interest. Importantly, FINRA arbitration no longer holds b/ds harmless in managing client disputes on the basis that “brokers do not render advise” which requires the consumer to be their own counsel regardless how limited the consumer’s investment knowledge and experience may be. Brokers are now accountable for every investment recommendation they have ever made. This materially changes broker culture requiring attention to fiduciary duty and ongoing .counsel.

Stephen Winks

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