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Proposed Rule on Conflicts of Interest in Investment Advice (November 2015)

Date Published: 
Tuesday, November 3, 2015

The Pension Rights Center submitted comments to the Department of Labor (DOL) and testified at a hearing in support of the department’s proposed revision of the definition of “fiduciary.” The proposed definition describes the circumstances under which a financial adviser becomes a fiduciary and must give advice in the best interest of the customer, avoiding all conflicts of interest unless they are expressly allowed.

Background
The Employee Retirement Income Security Act (ERISA) requires financial advisers who are fiduciaries to put the interests of plans, participants, and beneficiaries first. For example, advisers who are fiduciaries cannot accept payments that would create a conflict of interest, unless they meet the requirements of an exception. The core question addressed in the Labor Department’s rule is this: “When is a person giving ‘investment advice’ subject to the law’s fiduciary standard?”

The current DOL rule was written in 1975, before IRAs became popular and before 401(k)s even existed. It included large loopholes that allow people to give retirement investment advice without complying with the fiduciary duty. For example, under the 1975 rule still on the books, irregular or occasional advice is not covered, no matter how much the client needs guidance or how much money is at stake. As a result, many financial advisers give conflicted advice that benefits the adviser and not the participant. Too often this means that advisers recommend investment products because they earn large commissions, not because those products serve the client’s best interest. The proposed rule is designed to close this loophole and others.

Proposed revision to the fiduciary rule
The proposed definition describes when someone giving advice becomes a fiduciary. A fiduciary is a person giving retirement investment advice to a plan sponsor, plan participant or IRA owner for a fee or other compensation, whether direct or indirect. The advice must be individualized or specifically directed to the plan sponsor, plan participant or IRA owner, for consideration in making investment decisions.

What is retirement investment advice under the proposed rule?
The proposed rule lists the types of advice that are “investment advice:”

  1. Recommendation to acquire, hold, dispose of or exchange securities, take a distribution or rollover;
  2. Recommendation on how to manage securities, including distributions and rollovers;
  3. Appraisal opinions regarding value; and
  4. Recommendation of a person who will provide advice.

Under the proposal, a number of activities are exempt from regulation as a fiduciary responsibility, such as investor education. In addition, investment advice does not include routine brokerage activities, such as the buying and selling of securities at the request of a plan, a participant, or an IRA owner.

How do you know whether your adviser is a fiduciary?
Under the proposed rule, a person is a fiduciary if they engage in the types of activities described above or if they say they are acting as a fiduciary. See our related fact sheet, Investment Advisers: Who Are They and Why Does It Matter? 

Best Interest Contract Exemption
Under this exemption, financial advisers can receive compensation that creates a conflict of interest as long as the advice they give is in the client’s best interest. Advisers in this situation must comply with the terms of the “Best Interest Contract Exemption.” An adviser must have a written Best Interest Contract with an investor before making investment recommendations. The exemption basically requires advisers to:

  1. Acknowledge that they are fiduciaries and give only advice in the client’s best interest;
  2. Avoid recommendations if the resulting compensation would be unreasonable;
  3. Adopt meaningful policies and procedures designed to mitigate any conflicts of interest and ensure compliance with the contract;
  4. Avoid the use of quotas, bonuses and performance incentives that could encourage advisers to give conflicted advice; and
  5. Disclose conflicts of interest and all costs and fees that the adviser and the employing firm receive.

The Proposed Rule also would allow investors to bring actions against their advisers for breach of the Best Interest Contract. Although it gives advisers the right to insist on binding arbitration, it makes clear that class actions, designed to address the most serious violations, would be permitted.

The required disclosures are especially important. These include annual disclosures of each asset bought or sold and its price, the total dollar amount of all fees and expenses paid for each asset, and the total dollar amount of compensation received by the adviser or financial institution directly or indirectly from any party.

Carve-outs
The new proposal includes several “carve-outs” or exemptions for advice to plan fiduciaries of an ERISA plan. For example, the seller’s carve-out applies to sales pitches given to an ERISA plan fiduciary with financial expertise. This exception is available for advice to large plans only, those with 100 or more participants or assets of $100 million or more.

For participants, the most important carve-out is for investment education. Materials and information given as part of an investment education program will not be considered fiduciary advice unless it includes a specific recommendation for investor action.

The comment period ended September 24, 2015. The proposed regulation defining “fiduciary” and all comments can be found on the Employee Benefits Security Administration website.

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