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Why exactly DOL's latest action is so shocking to so many brokers -- and even ERISA lawyers -- despite years of warnings

Brokers managing IRA assets never imagined they'd need to make a written promise to do right by investors

Monday, April 20, 2015 – 5:42 PM by Lisa Shidler
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Marcia Wagner: I don't want obnoxious crap like that in my contract.

Brooke’s Note: For so long, a too-many-brokers-to-bring-to-heel aspect of quality of care to 401(k) assets has kept the brokers’ interests chronically ahead of the interests of the hapless retiree. The Department of Labor, with a grit we have seen before but now super-reinforced by a White House manned by an Obama who sees little to lose, has taken a serious swipe at the safety-in-numbers refuge. Should the latest DOL proposal become hardened into law, there is another party that will lose its cover — the SEC. The DOL is supposed to be the pupil, not the teacher, but the roles have been reversed here. History is on the side of the DOL and the SEC is likely to feel that deeply — maybe even more deeply than its nostalgic tug toward letting Wall Street have its way.

Unless the Department of Labor can be pushed off of its charted course, millions of investors, holding a combined $7 trillion of individual retirement account assets, will be empowered for the first time to file class actions against advisors and their broker-dealers whom they believe have failed to put their interests first. See: Fidelity Investments wins huge in the 'biggest 401(k) case in decades’ — but bearing battle scars.

Last Tuesday, the DOL unveiled for the first time its much anticipated conflict of interest rule for retirement investment advice. The financial services industry has been anticipating stiff 401(k) rules for years. Even so, the 120-page proposed rule was a shocker, carrying an IRA bombshell and a brand new “best interest standard” for brokers. See: A newly emboldened Obama may yet win on financial services reform.

For an industry accustomed to muddy rules and a focus on funneling the fury of ERISA toward 401(k) plans, not IRAs, the long-awaited proposal seems harsh, unforgiving and out of left field, according to broker-dealers and advocacy groups. See: IRA assets could be ripped from the grasp of brokers if DOL has its way.

So sue me?

RIAs acting as fiduciaries to individual retirement account clients shouldn’t see many changes. But any advisor, namely brokers, with a conflict must enter into a contract with the client pledging to make investments that are in the client’s best interest. The contract must include a caveat explicitly stating that if the advisor violates the contract, the client(s) can file a class action. In the past, all cases were arbitrated.

Randy Long: Any advisor with those soft-dollar arrangements will have to come up with an individual contract.
Randy Long: Any advisor with those
soft-dollar arrangements will have to come
up with an individual contract.

Traditionally, 401(k) plans have been governed by the Employee Retirement Security Act and have been subject to class action lawsuits. See: What a wave of 401(k) lawsuits tell us about what RIAs really need to worry about.

But IRA contracts don’t fall under ERISA, meaning that in the past, advisors could write their own contracts requiring clients to settle contract disputes with arbitration rather than in the courts.

The new demand is gratuitously harsh, according to Marcia Wagner, an ERISA attorney with The Wagner Law Group in Boston.

“Have you ever seen a contract that says if you sign up with me then you can also sue me?” she asks. “The client has the private right of action to be in a class action lawsuit. It’s opening up the doors to the tort bar. This is a big deal. As a lawyer, when I make engagements with clients, I don’t want obnoxious crap like that in my contract.” See: 9 things advisors to 401(k) plans must do to keep clients out of hot water.

Sitting pretty

RIAs in the 401(k) field are taking the news with equanimity.

“The proposed regulations have very little impact on SageView since we have operated as a fiduciary for the past 10 years and do not work the rollover market,” says Randy Long, managing principal of SageView Advisory Group LLC in Irvine, Calif., whose firm oversees nearly $30 billion in retirement assets. Long also has commission assets for smaller 401(k) plans and uses Cetera Financial Group as his firm’s broker-dealer.

“For us, it’s a nonevent,” Long adds. “Any advisor with those soft-dollar arrangements will have to come up with an individual contract. We serve as fiduciaries to the plan and to plan participants. We don’t work with any rollovers either.”

Caught looking

Wagner isn’t the only expert blindsided by the class-action provision for IRAs.

“I didn’t see the contract coming, so I have to assume many other observers didn’t either,” says Rick Meigs, president of 401khelpcenter.com LLC in Portland, Ore. “The contract would have to be signed by the broker and his/her firm, and the client. It then becomes a legally binding contract enforceable in the courts if violated.” See: Two advisors debate the financial viability of serving as a fiduciary to small accounts amid DOL’s new rules.

That means advisors in IRA accounts will have major liability problems.

“It’ll be earth-shattering to advisors,” he adds.

As if that sign-your-death-warrant aspect of the class action class wasn’t enough, “a big surprise is how clearly it is going to impact IRAs and rollovers,” says Wagner.

For the first time, advisors will have the best interest clause in the contract. Now, most contracts have language related to whether the investment choices were “suitable.” This was dubbed the suitability standard. See: The suitability standard, defined. The best interest clause is new to lawyers — so new that some have never heard of it and are still trying to figure out what it means. See: Fidelity sees potential 401(k) rollover magnet for RIAs: retirement income plans.

“Everyone thought it would still be business as usual for IRAs, but that’s not the case at all,’ says Wagner. “Trillions of dollars in IRAs are now subject to new standards, which I’ve never heard of before. As a lawyer, I’ve never heard of a 'best interest standard’ but I think that’s even higher than the fiduciary standard and at a minimum it creates another type of fiduciary standard.” See: Why almost nobody seems fazed by an ominous lawsuit hanging fire against Financial Engines.

'Dangerous proposition’

Rick Meigs: It'll be earth-shattering to advisors.
Rick Meigs: It’ll be earth-shattering to

Such language is catnip to litigators, according to Jason Roberts, attorney and chief executive of Pension Resource Institute, LLC in Manhattan Beach, Calif.

“You’re held to the best interest and the claimant attorneys will go after this one. It scares the hell out of me.”

“As a normal person, 'best’ means there can be no better. It means this is the best you can do and that’s difficult to prove. Best seems higher than fiduciary,”

But Roberts disagrees with Wagner’s contention that the “best interest standard” will be more stringent than a fiduciary standard.

“I think it’s more relaxed than becoming a fiduciary because it is letting you have un-level compensation. But I have defended these breach of contract cases for broker dealers and RIAs and this is a very dangerous proposition.” See: TD throws its first client-best-interest summit, a micro-event, by 'candlelight’ in Palm Beach and ideas rise from the RIA deeps.

Acidic fine print

Although the industry is expressing astonishment at the DOL’s freshly revealed stance, there were clues that something was afoot. Labor Secretary Thomas Perez’s comments in February couched the issue in life-and-death terms. See: As President Obama takes the gloves off, pro-broker groups throw up 'sledgehammer’ response.

“Lawyers and doctors have an obligation to look out for what is best for you. If you have a serious illness, you don’t want your doctor to tell you what is suitable for you — at least I don’t. You want to tell them what is best for you and what is going to save your life,” he said in February. “When it comes to financial advice, conflicts of interest can lead to bad advice, hidden fees that all too often keep us from getting the investment advice that is in our best interest. The cohesive power of fine print, hidden fees and conflicted advice can eat away like a chronic illness at people’s hard earned retirement savings. This isn’t right and we have an obligation to fix it.”

Explaining the rule, the Department of Labor writes: “This broad regulatory package aims to enable advisers and their firms to give advice that is in the best interest of their customers, without disrupting common compensation arrangements under conditions designed to ensure the adviser is acting in the best interest of the advice recipient.” See: The PBS 'Frontline’ 401(k) documentary names suspects but leaves out major culprits of the theft of the American retirement.

Just noise

Knut Rostad: The permissiveness around commissions, 12b1 fees and other third-party payments and the rule's reliance on disclosure of conflicts is deeply troubling.
Knut Rostad: The permissiveness around commissions,
12b1 fees and other third-party payments
and the rule’s reliance on disclosure
of conflicts is deeply troubling.

Indeed, purist fiduciaries argue that the proposed rule doesn’t go far enough.

“The industry going crazy is noise,” says Knut A. Rostad, president Institute for the Fiduciary Standard. “The permissiveness around commissions, 12b(1) fees and other third-party payments and the rule’s reliance on disclosure of conflicts is deeply troubling. Work is needed to maintain the ERISA’s sole interest standard.” See: What the 8 pillars of a FINRA-replacing entity for RIA oversight look like and how personal accountability is key.

Another rude shock in store for the brokerage-rules-minded system is who will be judging these cases, says Fred Reish, ERISA attorney with Drinker Biddle and Reath LLP.

“It’s a big deal for IRAs because it imposes a new higher standard of care and people can file a class-action suit. In the past, it was stated that clients must arbitrate. This is all brand new for IRAs and was a huge surprise.” See: Do 401(k) assets require all fiduciary care all the time?.

This will impact RIAs specifically in regard to IRAs and IRA rollovers, Reish says.

“We’re getting e-mails and some of these are from RIAs who thought they weren’t getting 12(b)1 fees. They have to turn them off or comply with this contract.” See: How the new 12b(1) fee restrictions could transform the financial advisory industry.

RIA/IRA dilemma

The “best interest” requirement applies to advisors who are receiving commission or any type of compensation that is declared un-level or could be a conflict. That puts RIAs in the catbird seat, says Wagner.
“The 401(k) space is ahead of the curve because the industry slowly started moving toward this but IRAs have been in the Wild West forever. They’re not even close to being able to figure out conflicts. They have to figure out differential compensation. There will be a lot of compliance costs, complexity and class action lawsuits,” she says. See: How RIAs can rule the 401(k) realm by becoming advocates for plan sponsors — and start by eliminating eight marketplace conflicts.

But RIAs don’t come out of this completely untouched. If retirement-centered RIAs want to capture rollovers while they still work with 401(k) plans, they may need to have a contract in place pledging to fall under the best standards as well, says Reish, who thinks it could be hard for advisors to drill down on some of the information necessary.

“I think that some RIAs won’t make recommendations for IRAs because this will be too hard for an RIA. Most small RIAs won’t be able to commit to this kind of process. They have to have a written contract and also disclose if there’s a conflict of interest and they have to make certain financial disclosures.” See: IRA assets could be ripped from the grasp of brokers if DOL has its way.

Indeed, just because an RIA doesn’t collect commission revenue doesn’t mean they are immune to the new rules, says Roberts.

“Let’s say someone walks in the door and talks about moving their former 401(k) account from a different employer. Even if the RIA is making zero commission, they’re still making money by opening the IRA. So, you need to have a best interest contract. It’s not as risky but someone could still claim breach of contract saying it wasn’t in their best interests.” See: What exactly is doable for an RIA in the 401(k) business?.

Meigs says the DOL is trying to redress the cost-benefit analysis a wronged client might undertake in deciding whether to contest how they were treated.

“It is clear that the DOL sees this as a legally binding contract to enhance the ability of plan sponsors to bring lawsuits. They see this is an important enforcement mechanism.”

Temperate response

Jason Roberts: You're held to the best interest and the claimant attorneys will go after this one. It scares the hell out of me.
Jason Roberts: You’re held to the
best interest and the claimant attorneys
will go after this one. It
scares the hell out of me.

Despite what some view as draconian measures being ushered in, some big brokerage players are signaling a non-adversarial position as regards further fine-tuning of the proposal.

“We are encouraged by the best interest contract exemption provided in the rule proposal and look forward to working collaboratively with the Department of Labor during this comment period to refine the conditions and requirements and ensure access to brokerage products and services for all investors who benefit from them,” read a statement from independent broker-dealer LPL Financial, released last week.

“At LPL, we believe that access to independent, objective advice is a fundamental need for everyone, and we are committed to advocating for choice and transparency in that advice.” See: How Bill Hamm is turning a $10 billion-plus loss of 401(k) assets into a revenue-neutral, neural-neutral experience.

It’s a wise stance for such firms to adopt, Meigs says.

“To me, they were ahead of the game and saw the writing on the wall and they started to prepare for this internally.” See: LPL reconsiders FSI as it drops out of its board, offers own DOL stand and hires own lobbyist.

Unwelcome disclosure

Other potentially affected firms are still digesting the news.

“Fidelity is reviewing the proposal and expects to be able to provide you with more information in the coming days. We also plan to provide the DOL with our perspective.” says Boston-based Fidelity Investments’ Steve Austin.

Charles Schwab spokeswoman Anita Fox says: “We are reviewing the proposal to understand its impact and implications and whether we will have comments to offer within the public comment period.”

But general anxiety about the new rule is the order of the day. Jeff Brown, ‎senior vice president, and head of Schwab’s office of Legislative and Regulatory Affairs, told a crowd at the SIFMA conference in San Diego last week that his firm has serious concern about this change and that it will bring with it expensive challenges related to disclosures. See: Why the DOL’s proposed 401(k) rules could ding brokers and leave the spoils to RIAs.

Mentioned in this article:

SageView Advisory Group, LLC
401k Plan Consultant, Advisory Firm
Top Executive: Randy Long

Pension Resource Institute, LLC
Compliance Expert
Top Executive: Jason C. Roberts

Retirement Law Group, PC

Top Executive: Jason C. Roberts

David Maurice

David Maurice

April 28, 2015 — 10:24 PM

Thanks, Stephen. You’ve done it again. As I’ve read through the barrage of reaction, analysis and so-called observations on the proposed rule, I am amazed how filtered through bias and just plain ignorance of the issues that are being reflected by folks who’ve been so insulated from others’ perspectives and experience.

It all comes down to language again from my standpoint. The brokerage industry wants to be and has been allowed to call themselves 'financial advisors’ without ever accepting the inescapable implications to investor/consumers for that word. There is no way in language or logic to escape the implication and inherent connection with what the legal term 'fiduciary’ means from the vernacular term 'advisor’. No other industry allows its sales force to refer to themselves as 'advisors’ and there is a reason for it. It’s just that simple – and the only reason it hasn’t been that simple is the long and complicated history of the industry running from the obvious – which has done nothing for investor/consumers but add further layers of confusion in so called disclosures. Consumer/investors should not be required to go through the kind of mental gymnastics to understand the nature of the relationship they are receiving guidance/advice for on such a significant area of life decisions.

Want to help investor/consumers and arguably the most important element of that group – retirement savers? Easy. Let brokers continue to call themselves 'advisors’ and make them become that with the entire re-making of the industry business model or give up the marketing of that term and the obligations that come with calling your sales force 'advisors’. I personally do not see the brokerage industry remaking itself into an advisory model in my lifetime which I know Stephen disagrees with. But that’s what it will take to reconcile the language issue – which is where the mind of the consumer/investor must be addressed. Too bad the term was ever allowed to be used in the brokerage industry. Still stymies me how that ever happened. But that was before my time.

Stephen Winks

Stephen Winks

April 20, 2015 — 9:44 PM

The shock and awe in the responses to the DOL proposal establishes how ill prepared the industry is in supporting advisory services which requires fiduciary duty for professional standing.

There is nothing new for those concerned with professional standing and consumer trust, as fiduciary duties have been long established (for centuries). What is new is the brokerage industry has to abide by the best interest of the investing public when it comes to 401(k) plans and IRAs which by any definition are “retirement assets” and in the DOL’s regulatory jurisdiction. The DOL proposal simply requires the advisor who renders advice to fulfill their on-going fiduciary duties, which is not necessary under the broker suitability standard. Brokers are not accountable for their recommendations. it is up to the consumer to determine investment merit on their own under a suitability standard (regardless how limited the investors investment knowledge and experience may be), as the brokers simply makes the client aware of their investment alternatives. The broker has no ongoing responsibilities to act in the consumer’s best interest once an investment is made. I am curious why this is a new idea for some which belies the brokerage lobby arguement. Advisors are accountable for their recommendations and have significant ongoing fiduciary duties to act in the best interest of the investing public. The DOL affirms long standing statutory duties for those rendering advice on retirement assets as required by statute for those investing on behalf of others.

The elephant in the room is, shouldn’t the broker always act in the best interest of the investing public on all accounts including “retail investors” held captive under the broker suitability standard? An indisputable case has been made that the brokerage lobby has long denied the retail investor” (who needs the most help) the same consumer protections accorded all other investors.

The two principle areas brokerage industry advocates lament in response to the DOL proposal are (1) compensation and (2) the adjudication of client disputes.
1. Compensation: As much as 40% of the earnings on retirement assets is lost to Wall Street management fees, commissions, administrative cost. The DOL proposal charges advisors to manage account expenses as a cost center rather than a profit center in the best interest of the investing public. This, fundamental fiduciary duty engendering trust in advisors rendering personalized advice is not a consideration for brokers under the present suitability standard. The brokerage lobby’s suitability standard for this and many other reasons has lost the trust and confidence of the investing public. Can consumers rely upon the advice rendered by brokers and their firms under a suitability standard?
2. Adjudication of Client Disputes: The FINRA Arbitration procedure protects the brokerage industry interests not that of the consumer. By the industry maintaining that brokers do not render advice, it avoids ongoing fiduciary duty of the broker and fiduciary liability. This position has crippled the broker’s ability to act on the best interest of the investing public, thwarting broker access to technological innovation that is transforming the advisory industry in the best interest of the investing public. The brokerage lobby position is counter to modernity. Legitimate consumer complaints presuming their interests are being served are routinely dismissed in arbitration as the broker has no ongoing responsibility to act in the consumer’s best interest. The brokerage industry’s self-interest is self-defeating as it comes at the expense of the best interest of the investing public.

The false narrative and well-crafted legal defense of the brokerage lobby now must withstand the sunshine required for public trust and the courage of regulators who are charged with protecting public trust.

Stephen Winks

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