DOL could ride on the back of Reg BI for fiduciary rule

Department of Labor officials are looking to harmonize their upcoming fiduciary rule-making with the Securities and Exchange Commission's new standards-of-conduct package as some states press ahead with proposals of their own.

The SEC's rule package, commonly known as Reg BI for its centerpiece best-interest standard that compels brokers to put clients' financial interests ahead of their own and requires them to mitigate financial conflicts, was approved June 5.

The new rules do not affect retirement plans, except some small 401(k) plans served by brokers. But financial professionals who provide advice to retirement plan participants, including rollover recommendations, are subject to the new rules.

In recent months, DOL officials including Secretary Alexander Acosta; Preston Rutledge, assistant secretary for the Employee Benefits Security Administration; and Jeanne Klinefelter Wilson, EBSA's deputy assistant secretary for policy, have said the agency was working with the SEC to promulgate new rules.

"Although the Department of Labor and the SEC have two different statutes, our goal is to proceed under a raw common framework and propose Department of Labor rules (that) track as closely as possible with SEC's best-interest regulations," Ms. Wilson said June 5 at the SPARK National spring conference in Washington.

No specifics have been disclosed yet, but sources said the DOL will likely update prohibited transaction exemptions for conflicted compensation.

Generally, commissions are conflicts of interest and therefore prohibited, which means that it would be forbidden for a broker-dealer to give fiduciary advice that leads to them receiving commissions, said Fred Reish, a Los Angeles-based partner for law firm Drinker Biddle & Reath LLP. "I expect to see proposals that say that, in those cases, commissions would be allowed to be paid if the compensation is reasonable, the advice is in the best interest of the plan or (individual retirement account), and if other similar conditions were met," Mr. Reish said.

The DOL could also change the definition of what constitutes investment advice, said Kevin Walsh, an attorney at Groom Law Group in Washington. The SEC's package included an interpretation of "solely incidental" — which references a provision in the Investment Advisers Act of 1940. The interpretation exempts broker-dealers giving investment advice from registering under the Advisers Act if their advice is "solely incidental" to the conduct of their business as a broker-dealer and they don't receive "special compensation" for the advice, according to an SEC summary.

"(The DOL) can define investment advice the same way as [the SEC is] using the broker-dealer exception to the Advisers Act," Mr. Walsh said.

The 5th U.S. Circuit Court of Appeals in New Orleans vacated the DOL's fiduciary rule in March 2018, saying it represented regulatory overreach. But in its fall regulatory agenda, the DOL said it is "considering regulatory options in light of the (5th) circuit opinion," with a final rule expected by September.

Will Hansen, chief governmental affairs officer at the American Retirement Association, a retirement industry trade group in Washington, wants the DOL to provide greater clarification on ERISA fiduciaries providing advice on rollovers, who are not covered under the SEC's Reg BI package. "Our advisers are concerned on whether or not they can provide such advice," Mr. Hansen said. "It's an open-ended question at this point."

Like many consumer advocacy groups, including the AARP and the Consumer Federation of America, Kathleen M. McBride, a founder of the Rumson, N.J.-based company FiduciaryPath, which assesses the investment fiduciary practices of investment advisers, retirement plans, endowments and foundations, does not think the SEC's Reg BI package will protect investors. Among other reasons, the best-interest measure is too ambiguous and does not sufficiently mitigate conflicts of interests, she said.

For the DOL, Ms. McBride said it's important that participants seeking advice on rollovers are protected. "I'm hoping for the best from DOL but I fear that if they're going to be harmonizing with the SEC, that will lower the standard," she said.

Under ERISA, fiduciaries, which include plan trustees, plan administrators and members of a plan's investment committee, must run the plan solely in the interest of participants and beneficiaries and for the exclusive purpose of providing benefits and paying plan expenses.

Other stakeholders said they're encouraged that the DOL and SEC are working toward a common goal, but the end result remains a mystery. "It's challenging … to know what's coming next from a DOL perspective because they haven't tipped their hand much," said Daren R. Domina, a New York-based partner with Haynes and Boone LLP.

Massachusetts Secretary of the Commonwealth William F. Galvin isn't waiting to see what the DOL produces. On June 14, he said he would propose a regulation that would apply a fiduciary conduct standard on broker-dealers, agents, investment advisers and investment adviser representatives when dealing with their customers and clients.

"We are proposing this standard because the SEC has failed to provide investors with the protections they need against conflicts of interest in the financial industry, with its recent 'Regulation Best Interest' rule," Mr. Galvin said in a statement.

Similar proposals are on the table in New Jersey and Nevada, while legislators voted down a fiduciary rule in Maryland in April.

With respect to the New Jersey proposal, a group of 11 trade associations, including the U.S. Chamber of Commerce and the Securities Industry and Financial Markets Association, in a June 14 letter urged the state to reconsider its efforts.

In a separate letter sent on the same day, SIFMA said different state rules would lead to investor confusion. "A state-by-state approach … would result in an uneven patchwork of laws that would be duplicative of, different than, and possibly in conflict with federal standards. It would also heighten investor confusion. We urge the (New Jersey Bureau of Securities) to pause its rule-making process, review Reg BI, and re-evaluate its proposal before deciding whether it is necessary to proceed with an additional state regulation."

For the ARA's Mr. Hansen, the main concern with state fiduciary rules is that they could impact ERISA fiduciaries. In New Jersey, he noted that the proposed rule offers an exemption for those financial professionals.

"ERISA has been around for 40 years and there are already certain duties that a fiduciary must engage in, there are standards in place … therefore if there's not a carve out, state rules could impose additional compliance burdens on ERISA fiduciaries as well as differing standards of care, which we think would harm the retirement sector," Mr. Hansen said.

While nothing has been publicly floated yet, attorneys said the SEC's Reg BI could face legal challenges, though it's unclear on what grounds. "Anytime an agency promulgates a rule now there's always going to be the possibility of litigation," Mr. Walsh said. "There are definitely rumblings that consumer groups or states attorneys general are looking for ways to challenge the regulation."

"Creative attorneys will come up with creative arguments," he added.

Mr. Reish said the DOL rule will likely "integrate the SEC's Reg BI in a manner that the DOL can justifiably say that the SEC rule is a proper basis for the new regulation and exemptions" in order to thwart lawsuits.

Mr. Domina noted that any state rules could also be subject to lawsuits. "Those situations are more subject to court challenges on the idea that the states have exceeded their rule-making authority or they've put a broker in an untenable situation between complying with federal and state requirements," he said.