How Wall Street emasculated the DOL rule with an old-fashioned end game: 'Somebody made a deal' -- and why tort lawyers are licking their chops

Brooke’s Note: In the comments of this article, Rick Meigs, president of 401khelpcenter, takes the story’s central point to task that DOL capitulated the enforceability of its new rules in the name of “workability.” Meigs went so far as to says the article’s thrust has “no basis in reality.” I responded with my own comment about why we chose that story angle despite the great chorus of voices in press releases saying that the concessions didn’t concede much. I hope the chorus is right. For now, it’s hard for us at RIABiz, based on some admixture of facts and journalistic spidey senses, not to believe the chorus is a little off key. I sincerely hope other people jump in with comments to offer greater clarity about what the future may hold.

As the ink dries on the Department of Labor’s final rule released yesterday, experts are lauding fiduciary advocates for their successful, if protracted, six-year slog to get the 1,000-page regulatory document on the books.

But a certain hollow feeling in the pit of the stomach remains.

That’s because Wall Street lobbyists prevailed on the aspect of the DOL rule that counts — enforcement. See: The DOL’s final rule contains a litany of 11th hour concessions to brokers that show Wall Street lobbyists earned their keep.

“It’s not enforceable,” says Louis Harvey, president of Boston-based Dalbar Inc., when compared to an earlier iteration of the proposal that contemplated the client and the advisor signing a best interest contract exemption. Under that scenario, the legal burden was simply one of proving a contract breach.

“Then, it’s up to the client to call in a lawyer and sue for breach of contract in small claims court,” Harvey explains. See: Proposed DOL regs expose more advisors to fiduciary liability.

Under the final rule, however, a consumer must prove the harder-to-pin-down breach of fiduciary duty — a standard that wouldn’t pass television’s Judge Judy’a litmus test: If it doesn’t make sense, it’s not true.

“Under the final rule, you have to find them guilty of fiduciary breach and it’s a much higher hurdle. If it’s a contract breach — where the contract says you’re going to do X, Y, Z, — it’s a slam dunk,” Harvey says. See: Top RIA lawyer explains to the SEC why 'harmony’ is a harsh misnomer and why the price of its false spin is paid by investors.

No backup for Borzi

Lou Harvey: It’s not enforceable.

There’s a word for the DOL caving to Wall Street’s endgame negotiations and allowing this hurdle to exist: Shameful.

But there’s blame to go around and the outcome also reflects poorly on fiduciary advocates, says Knut Rostad, president of the Institute for the Fiduciary Standard in McLean, Va., who includes himself among those deserving blame.

“Phyllis Borzi moved heaven and earth with the tools she had and I think we let her down. I think we were too polite. We responded to their objections to the rule very well but we never responded to their overall argument well at all. We responded very badly to the big picture.” See: Borzi: Exemptions from conflict of interest will be part of new fiduciary proposal.

For years, the assistant secretary for employee benefits security for the Labor Dept. crusaded for this rule with blunt comments and a bare knuckles style that signaled to the most seasoned Wall Street lobbyists that she wasn’t interested in compromising efforts of American workers to save for retirement. See: A Q&A with Phyllis Borzi, the DoL powerbroker aiming to remake the retirement market.

In the last year, Secretary of Labor Thomas Perez set a more polished, Ivy League tone in negotiations with the financial services industry.

Fix is in

Harvey smells a rat.

“Somebody made a deal,” he says. “My sense is it’s election season and I’m sure that some guys on Wall Street basically said if you want campaign contributions, make this digestible. I can’t imagine it being anything else. [The DOL was] so adamant before and Phyllis Borzi was swearing that 'this is the way it’s going to be.’”

Rostad agrees that, in the end, political considerations were the true decider. “This became a battle between Congress and the administration. That explains it to me.”

Jamie McLaughlin, head of consultancy firm J. H. McLaughlin & Co. in Darien, Conn., also sees “apparent capitulation in these last innings of the DOL’s determination.”

Jamie McLaughlin: Republicans are again on
the wrong side of a distinct
populist movement.

To describe it, he cites E.E. Schattschneider’s “capture theory,” a sort of inside-the-Beltway Stockholm Syndrome whereby “the regulators and the regulated and all the courtiers in the middle lose their detachment and succumb to the needs of the regulated.” See: Secret recordings reveal 'regulatory capture’ at Goldman Sachs by NY Fed examiners capitulating to the corporation — before they were even asked.

McLaughlin, who served in the Connecticut State House and State Senate, also cites lack of guidance from a moribund Congress, “which kicked the can down the proverbial street to the SEC who predictably fell prey to the influence of certain industry interests whose ox might be gored.”

Lawyers, free market to the rescue

But John Anderson, director of practice management at SEI Advisor Network, is optimistic that lawyers will be able to effectively protect the investor under the just-issued DOL rule.

“What people are missing is every tort attorney will enforce this rule. You might even see advertisements where they ask questions, 'Is your advisor acting as a fiduciary?’ Are they filing exemptions and proving they are acting in your best interests?’ I think it will be enforced in the courts.” SEI is an outsourced investment manager for 7,000 financial advisors with $51 billion in assets under management in Oaks, Pa., SEI is See: Why exactly DOL’s latest action is so shocking to so many brokers — and even ERISA lawyers — despite years of warnings.

When tort lawyers fail to make 401(k) providers toe the fiduciary line, free market players will step in, says Terrence Morgan, president of Ok401k, a fee-only Oklahoma-based RIA focused on retirement assets.

“I have been really hoping that the dark side can still go out and sell 401(k) plans and have all kinds of commissions on top of their plans,” he says. “These broker-sold 401(k) plans with all kinds of proprietary funds and high fees are easy targets to replace when you get in front of the decision-maker and make them finally understand that their own 401(k) personal money is getting screwed by the dark side.” See: After years of DOL bluster, new 401(k) rules appear to make RIAs’ low expenses look higher than those of brokers.

Harvey takes no comfort from that enlightened consumer scenario, pointing out that 401(k) participants don’t sign a best interests contract with the advisor — it’s is the plan sponsor that signs the best interests contract with the advisor. See: Which three of DOL’s new 401(k) rules represent the biggest land mines for financial advisors and plan sponsors.

“It’s even further removed from the participants,” he says.

'Tremendously beneficial’

Kathleen McBride: Clients will have recourse,
many for the first time.

Even so, the new rule is still solid, according to Kathleen M. McBride, chairperson of The Committee for the Fiduciary Standard.

“The underlying fiduciary benefits to investors remain. In particular, advice on IRA rollovers will be fiduciary ….Then, if it is in the best interest of the individual to roll out of a plan into an IRA … advice on the assets in the IRA must be fiduciary. This is a sea change from advisors grabbing the investor’s assets with both fists.”

Ultimately, McBride says, level fees will dominate the landscape.

“Overall, this will be tremendously beneficial to investors. As far as I can see so far, the underlying fiduciary duty remains. Operationally, any firm can set themselves up to culturally be a fiduciary and they could also set themselves up to deceive clients — but clients will have recourse, many for the first time.

McBride continues: “The DOL rule will, in fact, bleed over — by client demand — beyond retirement accounts to set the tone for the entire relationship. It is game- changing regulation, written to protect investors from those who exploit the old ERISA loopholes.” See: FINRA and SIFMA win big for Wall Street with release of Senator Dodd’s bill yesterday.

They who get slapped

Indeed, the RIA consensus seems to be that the new rule can only help the crusade to provide unbiased financial advice to clients — if not now or tomorrow, then in the near future.

“We’ve been operating under the fiduciary model since inception. We won’t see an effect right away,” says Tom Terhaar, advisor with Conrad Siegel Investment Advisors Inc. in Harrisburg, Pa. “The rule has been somewhat diluted. But it’ll effect us only in a positive way. It’s baby steps.” Conrad Siegel’s RIA manages about $3 billion in assets. See: Selling your value proposition.

According to Anderson, the new rule gives true fiduciaries a psychological edge and political momentum and the reprieve Wall Street earned itself with 11th-hour lobbying will be short-lived.

“They’re giving a big heavy sigh of relief today but what will happen when their competitors come out of the woods and promote fiduciary fee-based advice and objectivity. Then, the brokerage people who are sitting back thinking they’re doing great will get slapped. The DOL made a first big step. The next step will tighten fiduciary requirements and it’ll be incremental steps rather than one monumental step. We’re going to see a lot of incremental change rather than one big piece of change.” See: One-Man Think Tank: Six reasons that FINRA should be dismantled.