fi360 Blog

DOL proposes new rules for how participants can receive advice

The Department of Labor's new proposed participant advice rules were published in the Federal Register this week.  The proposed rule relates to investment advice provided to participants and beneficiaries in 401(k)-type plans and beneficiaries of IRAs.  Similar to rules that were finalized in January 2009 and later withdrawn, the new proposal would implement a statutory prohibited transaction exemption created by the Pension Protection Act of 2006.  However, the proposal differs from the January 2009 rules in that it removes an administrative class exemption that would have relaxed the rules and allowed a broader set of professionals, including commission-based brokers, to provide advice. 

In order to respond to comments received on the January 2009 rules, the proposed regulations also include clarifying language with regard to the fee-leveling requirement and the use of computer models under the statutory exemption.  In particular, to address concerns related to conflicts of interests related to varying fees, DOL reiterated its position from Field Assistance Bulletin 2007-1 that a fiduciary adviser's receipt of payment from an affiliate that is based on investments selected by the participant or beneficiary is prohibited under the fee-leveling requirement.  The proposed regulation also clarifies that this limitation applies to both an entity rendering advice and any person working for that entity as an employee, agent, or registered representative.  

With regard to the use of computer models, the proposal includes a limitation that the model cannot distinguish among investment options based on a factor that is not expected to persist in the future, such as historical performance.  The DOL is also seeking specific comments in three key areas related to computer models: 

1. Generally accepted investment theories as they relate to the use of a model to generate advice.
2. The use of historical data in determining a model's expectation for future performance of asset classes and specific investment alternatives.
3. Appropriate criteria for determining asset allocation.

Specific questions asked by the DOL in these areas can be found in the proposing release.  

DOL also has invited general comment on the proposed regulations with all comments due by May 5, 2010.  With the proposal already drawing criticism and approval, DOL will likely receive comments from across segments the industry, which are already hard at work reviewing and responding to the proposal.  

For additional background on the development of this new proposal and its impact on pending legislation, we also recommend you read the DOL's fact sheet and the latest Washington, D.C. Update from the Reish & Reicher law firm.  

SEC Advisory Committee provides views on the federal fiduciary duty

As industry observers eagerly await Senator Christopher Dodd's revised financial reform bill to be released later this week, industry and consumer advocates on the SEC Investor Advisory Committee met on Monday to further discuss and recommend ways the SEC can act on its own to provide greater investor protections absent legislative action. 

During the Committee's afternoon session, the Investor as Purchaser Subcommittee, led by Mercer Bullard, opened up discussion on fiduciary responsibility, using a memo it had prepared on the fiduciary duty to facilitate the discussion.  Based on the memo and discussions at the meeting, the subcommittee is expected to work on recommendations for how the SEC can strengthen the fiduciary duty and to present those recommendations at the next committee meeting in a few months. 

The subcommittee's memo is a worthy read as it takes the time to discuss the substance and scope of the "federal fiduciary duty," which the subcommittee defines as the fiduciary duty owed by an investment adviser to his clients under the Investment Advisers Act of 1940 (Advisers Act).  The memo notes that statutes, SEC rules, and common law principles comprise an important aspect of the SEC's role in developing and implementing the federal fiduciary duty. 

An interesting discussion in the memo also notes that while a broker who provides investment advice and charges only commission is not subject to the Advisers Act and the federal fiduciary duty, the broker may be subject to a fiduciary duty in other contexts, such as state common law, ERISA, and state securities laws.  Moreover, broker rules promulgated by the SEC and FINRA can impose fiduciary requirements, such as the pending rules that would require mutual fund point of sale disclosures.  The memo acknowledges that the SEC and FINRA "might object to the suggestion that they have shoehorned fiduciary standards into a non-fiduciary regulatory scheme," but points out that "some broker rules have a decidedly fiduciary flavor."

All of this discussion is to suggest that the while the federal fiduciary duty applies only under the Advisers Act, a (non-federal) fiduciary duty can apply nonetheless in other contexts outside of the Act.  Moreover, the memo highlights that the scope and substance of non-federal fiduciary duties can be greatly impacted by SEC action that may range from informally guiding parties in their application of the fiduciary duty to formally preempting a conflicting standard.  On the other hand, the memo notes that SEC inaction "may leave the fiduciary space open to be filled by a variety of actors in that space, include state and federal courts, state regulators, FINRA and arbitration panels."

In preparing the memo, the subcommittee chose not to address pending legislation due to its uncertain fate.  By doing so, the subcommittee has drawn attention to the areas where it believes the SEC already holds authority with regard to the federal fiduciary standard.  What remains to be seen is how the SEC will exercise that authority if legislation fails to extend the fiduciary standard to brokers who provide investment advice.  However, with concrete recommendations expected to be delivered by the Investor Advisory Committee, the SEC likely will be on the hot seat to take action to respond to those recommendations.  

Why Sen. Johnson's amendment is unnecessary and bad for investors

As has been widely reported this week, Senator Tim Johnson, has drafted an amendment that, if adopted, would put on hold the extension of fiduciary duty to brokers providing advice and instead require a study by the SEC of regulatory standards for brokers and advisers.  The amendment is the result of considerable lobbying done on the part of the insurance and brokerage industries.  However, consumer and advisory industry advocates for the fiduciary standard are concerned that Johnson's amendment is merely a stalling tactic. 

While it is true that harmonization of broker and adviser regulation and extending the existing fiduciary standard to brokers who provide advice will not be easy tasks, how a study would assist the process remains unclear.  A look at the amendment reveals that the SEC would be required to study "the effectiveness of existing legal or regulatory standards of care" and "whether there are legal or regulatory gaps or overlap" in those standards.  Such a request is puzzling, though, given that the SEC is the expert in legal and regulatory standards for brokers and advisers.  In fact, a recognition of existing gaps in regulation is what led the SEC to suggest to the Obama administration that harmonization and the fiduciary standard should be addressed in the plan the administration released last summer.

Johnson's amendment would require the SEC to consider several factors when conducting a study of broker and adviser standards of conduct.  In particular, the SEC would be required to consider how the protection under broker regulations compare to the protection under adviser regulations.  However, given that the RAND report, issued just two years ago, already addressed these different protections and investors perceptions of them, it's unclear what a new study would achieve.  Other factors the SEC would be required to consider are the impact and cost to entities and individuals of any changes in the standard of care for brokers and the impact on SEC resources.  However, as a result of significant administrative requirements, such impacts and costs would as a matter of necessity be quantified and considered in a rulemaking by the SEC.  Therefore, it's again unclear why a separate study is needed.

When considered as a whole, it is hard to understand how Johnson's proposal is anything but a delaying tactic given the SEC's significant amount of expertise in this area and the careful consideration the SEC would be required to undertake in any rulemaking it engages in to set conduct and other requirements for brokers and advisers.  In fact, it is puzzling why the information Congress would be asking for couldn't be provided through testimony or meetings with the SEC as well as in current legal and regulatory literature, rather than waiting for a report to be issued eighteen months after legislation is passed and delaying rulemaking for up to two years.   

The fiduciary debate is not new, and as recognized by the Committee for the Fiduciary Standard, the time for action is now. The Committee has asked its members to advocate against Johnson's amendment and has raised the following three key points for opposing the proposal:

1. All investors need protections afforded by the fiduciary standard, now.  As SEC Commissioner Walter has repeatedly pointed out, investors need to count on their adviser being held to the fiduciary standard and not worry about varying protections that different standards might provide.
2. The concerns expressed by lobby groups against the fiduciary standard are not generally held by brokers in the field.  According to a survey conducted by the Committee and SEI, a majority of brokers SUPPORT being held to the fiduciary standard.
3. Finally, most of the questions the proposal poses be addressed in the study are already answered or known in The Rand Report, other independent academic research, or through the SEC itself. The study is not needed.

Fi360 supports the advocacy efforts of the Committee and hopes that other supporters of the fiduciary standard will heed the Committee's call to action and contact Senator Johnson and his staff directly to voice their opposition to his amendment. 

A look at the legislative and regulatory agenda for 2010

This week, law firm Reish & Reicher issued a Washington D.C update, outlining the full agenda the feds have planned this year.  As discussed in greater detail in the bulletin, industry observers can expect action in Washington in the following areas:

• DOL plan-level disclosure rule: DOL is expected to release a new final rule under ERISA section 408(b)(2) in May.
  
• DOL participant investment advice proposal: DOL is expected to issue a new proposed regulation governing participant-level investment advice to replace the rule that was withdrawn in late 2009.
  
• SEC and DOL target date fund guidance: SEC is expected to provide guidance for target date funds on labeling marketing materials and communications about risks; DOL is expected to provide guidance that expands the communication requirements in the QDIA regulation and provides checklists to plan sponsors and participants.
  
• DOL participant disclosure regulation: DOL is expected to issue a new regulation under ERISA 404(a)(5) on participant disclosures by the end of 2010.
  
• DOL and Treasury request for information (RFI): DOL and Treasury have issued an RFI asking for information that will help them consider whether they should take steps to facilitate access to arrangements that would provided a stream of income to individuals after retirement. Comments are due May 3, 2010.

The Reish & Reicher bulletin also provides an update on the status of legislation meant to deal with disclosures to plan sponsors, disclosures to participants, fiduciary advice for participants, and target date funds.  For a more detailed discussion of all of these legislative and regulatory actions, check out the bulletin.  Fi360 designees can also expect to receive a customized version of the bulletin within the next couple of weeks providing additional insights on how these changes in Washington may affect your fiduciary responsibilities and practices.

Slow progress, but more support for a fiduciary standard

With political momentum shifting on the heels of Scott Brown's victory in Massachusetts last week, the future of financial regulatory reform and how quickly it can get done is becoming a bigger question mark with each passing day. While many hoped the Senate Banking Committee would be ready to tackle financial reform issues by late January or early February, recent reports indicate that it likely will be spring by the time the the committee has a bill ready. Committee Chair Christopher Dodd is still working through several issues with Committee Ranking Member Richard Shelby in hopes of gaining the bipartisan support that will be needed for financial reform to pass in the Senate.  However, reports from the Hill are that no final decisions have been reached on key provisions in a proposed Senate bill.  

Despite the slow progress in the Senate and increased lobbying by the insurance industry, remarks made by Goldman Sachs CEO Lloyd Blankfein and Bank of America's Sallie Krawcheck last week make it clear that support for applying a fiduciary standard to all professionals who provide investment advice is widespread.  What remains unclear, however, is whether these industry leaders support extending the existing fiduciary standard recognized by groups such as the IAA, Financial Planning Coalition, and the Committee for the Fiduciary Standard, or whether their views fall in line with SIFMA's call for a new federal fiduciary standard.  

And even if a new fiduciary standard is what is being referred to, it's still uncertain what SIFMA and its members think such a standard should look like or why such a new standard is needed.  Throughout the fiduciary debate, SIFMA and others have argued that fiduciary law lacks clarity due to the presence of state common law and a lack of understanding of when a fiduciary duty applies.  However, such arguments ignore the fact that requirements under the securities laws, including the Investment Advisers Act of 1940, are federal standards.  In fact, an outline on the SEC website describing regulation of investment advisers by the SEC explains that the fiduciary standard applied to investment advisers at the federal level does not rely on state law and is therefore a uniform standard (you'll find the explanation of fiduciary duty on pages 13-16 and the reference to the federal standard in footnote 80).  Even the Supreme Court has stated more than once that the anti-fraud provisions of the Investment Advisers Act establish "federal fiduciary standards" to govern the conduct of investment advisers.

Bottomline, the federal fiduciary standard is established and has been applied by federal courts and the SEC for years.  And though political momentum has shifted in Washington, it is still clear that the individuals in the investing public  are concerned about the economy, their financial futures, and their ability to rely on financial professionals.  It may take more time and compromise to make financial regulatory reform a reality, but both political and public pressure is mounting to make it happen and to ensure investor protection is a key part of reform.   

The year of reform is upon us

December was a big month for agenda setting in Washington as legislators and regulators looked ahead to making reform a reality in 2010. On the legislative front, Senators Christopher Dodd and Richard Shelby of the Senate Banking Committee issued a joint statement indicating progress was being reached on a financial regulatory reform package and that they hoped to resolve all issues prior to reconvening this month. In addition, Senator Herb Kohl, Chairman of the Senate Special Committee on Aging, announced plans to introduce legislation requiring target date fund managers to assume fiduciary responsibilities. 

Meanwhile, the House Ways & Means Committee was granted an extension until later this month to consider the 401(k) Fair Disclosure and Pension Security Act of 2009 (HR 2989), which would cover both investment advice and 401(k) fee disclosure. Consideration of the bill has been delayed to date as a result of reports that the investment advice provisions may be pulled from the bill.  Moreover, Congress appears content for now to defer these issues to the DOL, which posted its semi-annual agenda in early December. Under the agenda, DOL is expected to release final 408(b)(2) disclosure rules in May, and fee and expense disclosure rules for all 401(k)-type plans in September. DOL also will issue newly proposed investment advice rules in the next few months, and plans to issue a proposal in June to expand the definition of "fiduciary" under ERISA.

The SEC also appears ready to pursue aggessive reforms in 2010. In addition to preparing for initiatives adopted by Congress, including hedge fund manager registration, improved oversight of OTC derivatives, and extending the fiduciary standard to brokers providing advice, SEC Chairman Mary Schapiro added to her list of regulatory goals a review of 12b-1 fees and target date funds.  

Of course, questions remain on how quickly legislators and regulators will act in 2010. With much of the leg work completed in 2009, it appears that Congress may be poised to finalize financial regulatory reform legislation by early Spring.  The House has passed its bill, and the Senate seems closer to achieving the bipartisan support that will be necessary for its bill to pass. The SEC has been viewed by some as slow to respond to needed to reforms, but legislation improving its funding could allow it to act faster.   Moreover, the agency showed its ability to act by adopting new investor advisor custody rules and enhancements to proxy disclosures at the end of 2009.  DOL also reportedly has been hard at work behind the scenes drafting rules in order to stay on target with its agenda.  With all of this positive momentum, reforms are likely to begin taking shape by mid-year and many significant rule changes could be implemented by year end.

Fiduciary provision takes a hit in the House

The passage of the Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4173) by the House last week brought with it small victories for the advisor industry in the form of the removal of a provision that would have allowed FINRA to gain oversight of firms dually registered as investment advisors and broker-dealers, and the inclusion of provisions extending the fiduciary standard to broker-dealers who provide personalized investment advice.  However, a closer look at the final House provision regarding broker-dealers' fiduciary duties reveals quite a few shortcomings that have all been the result of legislative compromises and may chip away at core fiduciary principles. 

As reported this week, a manager's amendment introduced by Barney Frank last week added a limitation to the extension of the fiduciary duty. In particular, the provision that would require the SEC to adopt rules applying a fiduciary standard of care to broker-dealers now states: "Nothing in this section shall require a broker or dealer or registered representative to have a continuing duty of care or loyalty to the customer after providing personalized investment advice about securities." 

While the new language seems to have taken the advisor industry by surprise, it is actually the result of a compromise in the making since late October.  Similar language was introduced by Rep. Jeb Hensarling (R-TX) in October during the House Financial Services Committee markup of the Investor Protection Act, a bill that was rolled into the comprehensive legislation approved last week.  At the time, Hensarling voiced concern about certain business models, such as discount brokerage, that don't involve the provision of advice.  The Hensarling amendment was withdrawn at the committee level, but only with the understanding that Hensarling's concerns would be addressed by the time the legislation made it to the House floor.  Hence, the new limiting language in the final House bill.

Several other limiters have also been inserted into the House bill over time, such as the addition of language addressing commissions and proprietary products. Despite Congress' apparent desire to delegate the fiduciary issue to the SEC as the expert agency, such limitations in any final bill will likely tie the commission's hands in how far its rule making can go. Moreover, such qualifying language appears to be a roadblock to true harmonization of the standard of care and rules that apply to all professionals who provide investment advice. 

So where does financial, and in particular fiduciary, regulatory reform go from here?  It's becoming clearer that on the Senate side even more compromise will be required for reform to pass, and even once it does, a conference committee will be required to resolve any differences that emerge between the Senate and House bills, an activity that will require even more cooperation.  While there are other provisions in the comprehensive financial legislation that will require more compromise than others, the longer that reform takes, the greater the likelihood that fiduciary provisions may change more, for better or worse as was seen this past week. 

House set to debate financial reform

Last week, the House Financial Services Committee completed its work on proposed financial regulatory reforms and released The Wall Street Reform and Consumer Protection Act (H.R. 4173), a comprehensive bill that incorporates nine major pieces of legislation, including the Investor Protection Act, which would extend the fiduciary standard to broker-dealers providing investment advice. The full House will begin to debate the comprehensive reform bill today. House Financial Services Committee Chair Barney Frank expects debate to continue over the next three days with a vote on the bill taking place on Friday.  Frank and others have been working behind the scenes to resolve any outstanding issues and opposition to the bill, but still expect several amendments to be introduced on the House floor.  For now, it appears that provisions related to fiduciary issues will survive, but oversight of investment advisers remains an area of concern, including a current provision that would give the SEC the authority to delegate to FINRA examination authority over firms dually registered as investment advisers and broker-dealers. 

Despite the progress on the House side, the pace of financial reform has slowed down substantially in the Senate as a result of sharp criticism from Republicans and Democrats alike aimed at a proposal issued last month by Senate Banking Committee Chair Christopher Dodd.  As a result of opposition to his bill, Dodd announced a new plan for addressing the legislation to his Committee right before the Thanksgiving break in hopes of reaching workable compromises and gaining bi-partisan suport.  While the new approach will hopefully aid the eventual success of financial reforms, it has also created a delay that will prevent the Senate from considering a complete financial reform bill until the new year.  

With financial regulatory reform looming in 2010, regulators appear to be gearing up for the large amount of work that will be required to implement legislative changes.  In a speech delivered earlier this week, SEC Chairman Schapiro outlined her agency's efforts to improve investor protection and restated her belief that "all securities professionals [who provide advice] should be subject to the same fiduciary duty" as well as an "effective oversight regime."   Meanwhile, NASAA President Denise Crawford, voiced support for a legislative approach that  preserves the "authentic fiduciary standard" and also announced the signing of a Memorandum of Understanding that will allow states to work with each other to regulate additional investment adviser firms if the threshold for federal registration is raised to $100 million assets under management.  Such statements seem to confirm that regulators are laying the groundwork and will be ready to act quickly once Congress enacts the much anticipated financial reforms.

New Investment Advice Rule Expected in 2010

Many industry observers were left scratching their heads after the Department of Labor first delayed and then canceled just a few days later the investment advice rule that it finalized at the beginning of the year. However, as reported earlier this fall, DOL has every intention of putting new rules into place.  While it was originally thought a new rule proposal would be ready for public comment by mid-November, the administrative process has taken longer than expected. According to recent reports, DOL has sent new proposed rules to the Office of Management and Budget for approval and will likely release those rules for a short comment period in December or January.   

Meanwhile, investment advice provisions being considered on Capitol Hill also appear to be set for the chopping block.  Earlier this year, House Education and Labor Committee combined two separate bills to create the 401(k) Fair Disclosure and Pension Security Act of 2009 (HR 2989), which would cover both investment advice and 401(k) fee disclosure.  The bill was voted out of committee over the summer and referred to the House Ways & Means Committee, which held a hearing in October to consider the legislation.  During the hearing, the bill received sharp criticism from Rep. Earl Pomeroy for proposing to reduce independent advice presently available under DOL's SunAmerica advisory opinion, which allows advice to be offered by providers through an affiliate using an independently developed computer model.  As a result of the criticism and decreased support, the Ways & Means Committee likely will remove the advice provisions from the bill later this month, but no official decision has been made yet.   

Though new legislation could be introduced in the future, for now, Congress appears to be clearing the way for DOL to take the lead on providing guidance on investment advice. And DOL appears to be determined to move forward with a new rule without further delay.  What remains unclear, however, is what the new rule will look like and how it will compare to the legislation or the rule proposed by the Bush Administration.  So for now, the industry must wait until the proposal is released in the coming weeks.

Laying the groundwork for a big 2010 for fiduciary law

With the final month of 2009 fast approaching, 2010 is looking to be a big year in the fiduciary arena as regulators and legislators prepare to pass key regulations and legislation, and the high court delivers a key ruling and also considers whether to take up more fiduciary issues. 

This week, the Department of Labor announced another delay in the effective date of the investment advice regulations that were originally published in January.  The delay is in line with a previous announcement made by Phyllis Borzi, the Assistant Secretary of the Employee Benefits Security Administration, that the agency would pull the rules finalized in January and issue new rules.  With a new effective date of May 17, 2010 set, DOL will likely seek to release new proposed investment advice rules for public comment in early 2010 and finalize the rules by May.  DOL is also expected to finalize its long awaited 408(b)(2) plan fee and expense disclosure rules in early 2010. 

Meanwhile, on Capitol Hill, House Financial Services Committee Chair Barney Frank announced that the House vote on financial regulatory reform will likely not occur until the second or third week of December.  The House Financial Services Committee is still working this week to finalize pieces of the comprehensive legislation the House will consider.  Once the legislation is ready, the House is expected to take at least three days to consider the package of financial reforms, including the extension of the fiduciary standard to all investment professionals who provide advice, as detailed in the Investor Protection Act (HR 3817). 

In the other chamber of the Capitol, the Senate Committee on Banking will hold its first hearing this morning to consider opening statements on the Restoring American Financial Stability Act of 2009, which is the Senate version of a comprehensive financial regulatory reform package.  As I explained in my post last week, the proposed bill also seeks to extend the fiduciary standard, but would take a different statutory approach.  Following today's hearing, the Senate Banking Committee is expected to continue its consideration of financial regulatory reform right after Thanksgiving.  With the House and Senate separately considering similar financial reforms and time in 2009 quickly running out, it is becoming increasingly likely that a final consolidated bill enacting financial regulatory reforms will not be ready for President Obama's signature until early 2010. 

Finally, this past month, the high court was presented with another opportunity to consider fiduciary issues related to fund fees with the filing of a petition for review by employees of Deere & Co.  The employees are seeking review of a decision by the U.S. Court of Appeals for the 7th Circuit, which ruled against the employees and found that Deere did not violate its fiduciary duty under ERISA by imprudently selecting investment options with excessive fees.  The 7th Circuit denied a petition for rehearing earlier this year, clearing the path for the Deere employees to seek review by the Supreme Court.  It remains unclear whether the Supreme Court will take up Hecker v. Deere, and its decision could hinge on its final ruling in Jones v. Harris Associates, which the court heard arguments on earlier this month.  Although the Jones case involves fiduciary duties under a different law, the Investment Company Act of 1940, it is tied to the Heckercase because both cases rest on a premise that fund fees are the result of market competition and both cases were decided by the 7th Circuit.  A ruling in Jones is not expected until summer of 2010, which could mean the court will not decide whether to take up the Hecker case until then as well.