In aftermath of appeals court decision, some raise legal issues and jurisdictional concerns
With the Department of Labor fiduciary rule facing a May expiration date after being invalidated by a court order, the focus now shifts to the Securities and Exchange Commission and a few states considering ways to fill the void.
"I think every option is under review. For plan sponsors and individual investors, the SEC could really come out with a very good, real fiduciary rule if they wanted to," said Kathleen M. McBride, a founder of the Rumson, N.J.-based Committee for the Fiduciary Standard — an advocacy group for the authentic fiduciary standard as established under the Investment Advisers Act of 1940 — and an accredited investment fiduciary analyst.
Despite fierce opposition from financial services firms and many Republicans in Congress, DOL officials in the Obama administration succeeded in finalizing a new standard in 2016 that expanded fiduciary status to more retirement market participants, including brokers and insurance agents in certain situations. Partially implemented in June 2017, the final pieces were slated to fall into place this summer.
That all changed March 15, when the 5th U.S. Circuit of Appeals in New Orleans vacated the rule, arguing the DOL had overstepped its legal authority and waded into the SEC's regulatory domain.
The court gave the DOL 45 days to appeal the ruling, but that is considered unlikely given the Trump administration's 2017 memorandum to reconsider the rule and the department's announcement after the court decision that it would not enforce the rule "pending further review."
Legal experts are now debating possible, if not probable, tactics that proponents of the rule could take to hold the order to vacate at bay, including having a third party ask the 5th Circuit to allow it to intervene and calling for a rehearing of the 2-to-1 decision by the circuit's full judicial panel.
Backers of the rule were encouraged by the dissenting opinion of Carl E. Stewart, the 5th Circuit's chief judge, who called the new rule "an expansive-but-permissible shift in DOL policy." The DOL, Mr. Stewart wrote, "acted well within the confines set by Congress in implementing the challenged regulatory package."
Another legal debate centers on whether the order is limited to the circuit court's jurisdiction — Texas, Louisiana and Mississippi — or applies nationwide.
Rule-backers also point to a narrower ruling from the 10th U.S. Circuit Court of Appeals upholding the standard over a provision related to fixed indexed annuities. Invoking that decision could be a possible tactic, however slim, for arguing that a circuit split warrants review by the Supreme Court.
If the court order goes into effect May 7, the standard reverts to the five-part test of what constitutes a fiduciary, which has been in place since 1975.
Under the five-part test, someone is a fiduciary if he or she regularly advises a retirement plan on investment decisions, has an arrangement with plan fiduciaries, and provides advice that serves as the main basis for investment decisions or provides advice tailored to a particular plan.
For plan sponsors worried about participants getting pressure to roll their 401(k) balances into individual retirement accounts, the distinction between ongoing vs. one-time advice is a critical one that will have to be addressed either by regulators or through legal challenges.
SEC Chairman Jay Clayton, who has made protecting "Mr. and Mrs. 401(k)" a top priority, is eager to get started on a new rule proposal that could come out by summer. "From my perspective, the sooner the better," he told a Securities Industry and Financial Markets compliance conference March 19.
"The SEC is still highly motivated to move forward with their own rule," said Karen Barr, president and CEO of the Investment Adviser Association in Washington. "This is a space that they should have been acting in all along, and they've spent the last 20 years trying to get this done." Ms. Barr also noted that just in the past several months there has been growing consensus on how to approach the issue.
One of the SEC's key tasks will be defining titles, to help investors know whether they are dealing with advisers looking out for their interests, or brokers trying to sell them something.
"I think the titles issue is a real problem. Does it mean you're taking one hat off and putting on another? That's why plans end up getting sued," said Ms. McBride, the fiduciary consultant.
Registered investment advisers already are held to a principles-based SEC fiduciary standard under the 1940 advisers law, so not much change is expected there. The biggest change should be a tighter standard for brokers, requiring fuller disclosure and management of conflicts of interests. Brokers connected to firms with fiduciary obligations or giving more than incidental advice could choose to register under the 1940 law, and those wishing to call themselves advisers would have to register under the act.
A study mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act recommended the SEC adopt a uniform fiduciary rule for brokers that is "no less stringent" than the fiduciary standard for registered investment advisers under the 1940 act. "We would like the SEC to clarify that assets under management, either discretionary or for a fee, would be subject to the Investment Advisers Act. If not, it creates confusion among clients and potential clients," said Ms. Barr of the IAA.
The CFA Institute wants the SEC to require broker-dealers to disclose that they are agents of their brokerage firms, and not working for the investor. While the SEC, unlike the Department of Labor, does not focus exclusively on retirement plans, "what the SEC can and should do is get the titles right," said Jim Allen, head of capital markets policy for the CFA Institute in Charlottesville, Va. "Let's make sure investors know who they're dealing with."
He and others note the SEC does not have jurisdiction over non-securities products like annuities, and thinks the DOL needs to take that on, "but it's not going to be an overnight process," he said.
States step in
State insurance commissioners are drafting principles that their states could adopt, and some states already have been preparing for revisions or repeal of the DOL rule, raising concerns among plan sponsors and service providers about a patchwork approach.
Nevada enacted its fiduciary duty law in June, and Maryland legislators came close to enacting a law extending fiduciary duty to all financial professionals providing investment advice.
In February, Massachusetts' securities division charged Scottrade Financial Services Inc. with failing to supervise behavior that violated DOL standards on impartial conduct.
"If the Department of Labor will not enforce its own laws and rules, then the states must do what they can to protect retirees," Commonwealth Secretary William Galvin said at the time.
Market practices also could be a powerful if unofficial regulator, considering that major financial firms were prepared for the DOL fiduciary rule. "A lot of them had already made big changes to get good practices in place by June 9, so why would they go back?" said Ms. McBride, the fiduciary analyst.
"For plan sponsors, there are a lot of benefits, including the benefit of reputation and lower cost fiduciary insurance," said Ms. McBride, who works with the Center for Fiduciary Excellence, which certifies fiduciary advisers to retirement plan sponsors and non-profits and helps sponsors determine best practices for hiring and monitoring retirement plan services.