DOL fiduciary regulation reform proposal brings out fans, foes

Whether a new fiduciary regulation is needed to provide clarity and protection to retirement plans and participants or would be an onerous, costly and unnecessary regime that will curtail advice and wreck financial markets is what Department of Labor policymakers now must decide.

The proposed DOL regulation would change the five-part test that determines who is considered a fiduciary, the first update to the rule in 35 years. Last week, nearly 200 organizations from across the defined benefit and defined contribution industries lined up to voice their praise or disdain for the proposal at a hearing held by the Employee Benefits Security Administration.

DOL spokeswoman Gloria Della said Labor Department policymakers will consider and deliberate on the comments, but no final date for determination has been set.

The DOL says the proposed regulation aims to protect participants from conflicts of interest and self-dealing. “In recent years, non-fiduciary service providers — such as consultants, appraisers and other advisers — have abused their relationship with plans by recommending investments in exchange for undisclosed kickbacks from investment providers, engaging in bid-rigging, misleading plan fiduciaries about the nature and risks associated with plans' investments, and by giving biased, incompetent and unreliable valuation opinions,” the DOL noted in its proposal to change the fiduciary standard.

The EBSA cited in the proposed regulation a May 2005 study by the SEC, which “found that 13 of 24 pension consultants examined or their affiliates had undisclosed conflicts of interest.”

The proposed regulation changes the definition of a fiduciary by, among other things, removing existing provisions from the five-part test requiring advice to be given on a “regular basis” and mandating that the advice must serve as the “primary basis” for investment decisions. Other provisions in the five-part test in determining fiduciary status that will remain are: providing advice or recommendations on the purchase, sale or value of securities and other property; having a mutual understanding with the plan or fiduciary that advice is being given; and requiring that the advice is individualized based on the particular needs of the plan.

The updated test would cast a wider net by assigning fiduciary status under ERISA to those who meet any part of the new test. The current definition requires interested parties to meet all five parts of the test before being declared a fiduciary.

The proposal also requires service providers marketing investment options to disclose in writing that they are not providing impartial investment advice in order to avoid fiduciary status.

Brian Graff, executive director and CEO of the American Society of Pension Professionals & Actuaries, said in prepared testimony filed jointly with the Council of Independent 401(k) Recordkeepers and the National Association of Independent Retirement Plan Advisors that the regulation “would provide needed clarity in terms of whether plans are receiving ERISA-covered investment advice.” All three organizations are based in Arlington, Va.

Mr. Graff said in a telephone interview that plan officials often inaccurately believe they are getting ERISA advice on the investment options they provide. “If someone tells me these are the 20 options you should use, anyone would think that is advice, but under ERISA it's not advice,” he said.

Mr. Graff also said the regulation should not apply to individual retirement accounts because of “fundamental differences between IRAs and qualified retirement plans.”

“It's crucial that no guidance be given (on IRAs) without support of an active enforcement regime,” he said in written testimony. “If the department decides to extend these regulations to IRAs ... players in the retirement industry who are more formally regulated with extensive compliance departments will comply with the rules, and those less formally regulated who know there is no practical enforcement of the rules, will choose not to comply,” giving them a competitive advantage over firms that are in compliance.

Mr. Graff also said disclosures required for commission-based brokers/advisers in the proposal are overly broad and “unduly harsh” and that DOL should allow them to avoid fiduciary status by disclosing the amount of any commission received, that the advice may not be impartial if a commission is received and that brokers/advisers are not acting as a fiduciary.

Other groups similarly argued against provisions of the proposal.

Paul Schott Stevens, president and CEO of the mutual fund industry's Investment Company Institute, Washington, said in a telephone interview that it is appropriate to update the regulation, noting that fiduciary status should apply to those giving advice even if it's not ongoing. But he added that other parts of the proposed regulation would trigger fiduciary status in unintended ways.

Plans receiving general assistance from record keepers, for instance, could put the record keepers in the category as fiduciary. This could force plans to hire independent fiduciaries or forgo any assistance rather than obtaining input from record keepers, Mr. Stevens said.

“Trying to apply a fiduciary standard where it doesn't fit will distort the market and penalize both plans and plan participants,” he said.

The American Benefits Council, Washington, argued that the proposal would hurt retirement plans and participants by increasing costs.

Kent Mason, partner with law firm of Davis & Harmon and representing the council, said in prepared testimony that the proposal will have a “very adverse effect on retirement savings by raising costs and inhibiting investment education and guidance for plan participants.”

“We understand the desire of the department to update and improve the regulatory definition of fiduciary,” he said in a news release. “However, we believe that the proposed regulation creates too broad a definition.”

The proposed regulation could also impact on financial markets and the ability of defined benefit plans to manage risk, according to one industry group.

T. Timothy Ryan Jr., president and CEO of the Securities Industry and Financial Markets Association, Washington, said in prepared testimony that counterparties to swap transactions could become fiduciaries under the proposed regulation, forcing pension funds out of the swaps market.

“For example, defined benefit plans often use interest rate swaps to improve the match between assets and liabilities in order to reduce risk,” Mr. Ryan stated. “Hedge funds execute strategies using swaps. The capital markets would be thrown into disarray for plans and plan asset vehicles, regardless of the intent of Congress and the government agencies responsible for regulation of financial markets.”

It also could prompt prime brokers, who under the current regulatory regime are not considered fiduciaries, to refuse to provide services to plans, “forcing these accounts off of efficient platforms for trading, cash management, lending and other services,” he said.

Mr. Ryan also warned against provisions in the proposed regulation that would apply fiduciary status to real estate appraisers hired by fiduciaries recommending the property as a potential investment to retirement plans. He said hedge funds, private equity funds and real estate investors will reconsider plan investments if the fiduciary standard is applied to appraisers.

“The result may be significantly reduced capital in these markets, at a time when those reductions would harm the current economic recovery,” Mr. Ryan said in testimony.