By Kevin Moore

Background

While the Department of Labor’s (“DOL”) well-intentioned adoption of the fiduciary rule for financial professionals arguably protects consumers, the Department’s altruistic motive will do more harm than good by hindering an unsophisticated consumer’s ability to receive adequate financial planning advice. The DOL’s action widens the definition of “investment advice fiduciary” under the Employee Retirement Income Security Act of 1974.[1] Financial firms have braced themselves for potential liability under the new legal and ethical standards albeit with great confusion. The DOL’s goal is to safeguard the public from deviant financial advice, but financial firms may turn new consumers away due to litigation risk arising from the rule’s enforcement mechanisms. As consumers are forced to take flight from financial professionals, all they may find is turbulence.

Compliance officers and in-house counsel for financial firms must be prepared for any potential fallout. To make matters more complicated, the rule’s future is uncertain because the Regulatory and Exchange Commission (“SEC”) is currently drafting a new version thus making it difficult to prepare.[2]

Under the former suitability standard “as long as an investment recommendation met a client’s defined need and objective it was deemed appropriate.”[3] By contrast, the new standard holds advisors to be “legally obligated to put their client’s best interest first rather than simply finding suitable investments.”[4] This means that a financial recommendation comes with a significantly heightened legal responsibility to the consumer when providing investment advice. Advisors will be considered fiduciaries if they provide recommendations related to retirement planning services or handle client’s retirement accounts in exchange for a fee.[5] A few retirement plans subject to the rule include several 401(k) plans, individual retirement accounts (IRAs), and 403(b) plans.[6]

Financial firms must take the proper precautions.[7] Firms may want to institute adequate training for its advisors to better shield itself from liability. Attorneys must inform advisors how to perform their jobs in this new environment that is hot for potential lawsuits.[8]

I recommend an exhaustive reassessment of the firm’s available financial products and sales procedures is necessary to make needed internal adjustments. Firm-wide information sessions and materials are highly recommended despite the expense because the consequences for failing to comply are astronomical.[9] Enforcement actions brought by the DOL could result in financial sanctions that may sink smaller firms in addition to the severe risk of consumer class-action lawsuits.[10] Finally, current contracts must be adapted to fit the new regulatory scheme and new disclosure agreements may need to be provided to customers.[11] For example, “Amendments might include adding appropriate new ERISA representations, warranties, covenants and reporting provisions.”[12]

Financial firms may need to eliminate commission incentives or alter customer accounts; “Registered investment advisers who accept varying compensation will have to comply with more stringent procedures and disclosure requirements under some circumstances when offering advice to IRA clients or to tax-advantaged retirement plans.” [13]

The Fiduciary Standard May Open Financial Firms to Class Action Lawsuits

The Best-Interest Contract cannot waive a client’s right to bring a class-action lawsuit.[14] This potentially creates a financially devastating cocktail that may scare financial firms from providing certain retirement advice.[15] Potential litigation is the teeth of the rule because it “effectively serve[s] as the regulation’s main enforcement mechanism” by allowing customers to bring legal action against firms for failing to adhere to the heightened legal standard.[16] Currently this provision is under review, but nonetheless it would be wise for compliance attorneys to prepare as if it will be implemented. [17]

States May Adopt Individualized Versions in Response to Federal Uncertainty

As a response to efforts to impede implementation of the Fiduciary Rule, some states may devise near identical financial regulations.[18] For example, Nevada recently passed a bill that subjects Brokers within the state to “meet the fiduciary standard when providing investment advice.”[19] Firms should attentively track state legislative progress regarding changes to financial planning laws as well as understand how the law works in conjunction with existing federal law. Lisa Bleier, managing director at the Securities Industry and Financial Markets Association (SIFMA), recently described the complexity that comes with state by state adoption in her testimony to Nevada’s securities regulator, “We are concerned that a state-by-state approach would subject financial professionals and firms to confusing and potentially contradictory array of requirements.”[20]

Additionally, firms should not count on the SEC or other regulatory authorities to make beneficial changes. While the SEC is taking comment letters on potential changes, Jay Clayton, SEC Chairman, recently responded the critics of the Fiduciary Rule clamoring for the SEC to make changes, “The DOL has a responsibility. States have a responsibility. We need to cooperate.”[21] The Chairman is stating that the SEC is unable to take full jurisdiction of any drafting and implementation of a new rule, and changes will require input from various governmental authorities.[22]

Conclusion

The Department of Labor’s fiduciary rule creates a plethora of legal concerns and uncertainty for financial firms. The rule’s future hanging in the balance only adds to the perplexity. It is vital that attorneys and compliance officers understand the magnitude of the rule’s implantation, and that they understand the duties of brokers and advisors. Despite the uncertainty of the rule’s actual impact and possibility of a rollback, it is best to use the delay as time to over prepare to avoid playing catch up.

Firms will need to ensure consumers are educated about the changes to avoid surprises when they seek financial advice. The Financial services and products available that can be offered must be made clear, and if relevant, where to go if the firm no longer offers certain services. Consumers need to understand the changes are not just formalities, and that the relationship between them and their advisors may have drastically changed.

[1] Final DOL Fiduciary Rule- Considerations for Plan Sponsors, THE NAT’L L. REV. (June 14, 2016), https://www.natlawreview.com/article/final-dol-fiduciary-rule-considerations-plan-sponsors.

[2] Mark Schoeff Jr., DOL Fiduciary: OMB receives rule providing for 18-month delay, INVESTMENT NEWS (Nov. 2 2017), http://www.investmentnews.com/article/20171102/FREE/171109989/dol-fiduciary-omb-receives-rule-providing-for-18-month-delay.

[3] DOL Fiduciary Rule Explained as of August 31, 2017, INVESTOPEDIA (Aug. 31, 2017), http://www.investopedia.com/updates/dol-fiduciary-rule/

[4] Id.

[5] Janet Luxton, Gene Paranzak, Regulatory Brief: The Final DOL Fiduciary Rule: What it Means to Plan Sponsors, VANGUARD(Aug. 2016), https://institutional.vanguard.com/iam/pdf/FIDRULPA.pdf?cbdForceDomain=false.

[6] DOL Fiduciary Rule Explained as of August 31, 2017.

[7] Liz Skinner, The DOL Fiduciary Rule Will Forever Change Financial Advice, and the Industry Has to Adapt (May 9, 2016), http://www.investmentnews.com/article/20160509/FEATURE/160509939/the-dol-fiduciary-rule-will-forever-change-financial-advice-and-the.

[8] Id.

[9] SIFMA Study: Costs of Fiduciary Rule Compliance Exceed $4.7 Billion (Aug. 11, 2017), BARRON’S, http://www.barrons.com/articles/sifma-study-costs-of-fiduciary-rule-compliance-exceed-4-7-billion-1502477561.

[10] Department of Labor Pushes Back Fiduciary Rule Implementation (Apr. 3, 2017), http://www.finracompliance.com/department-of-labor-pushes-back-fiduciary-rule-implementation/.

[11] Christopher Robbins, Understanding The Fiduciary Rule’s Best Interest Contract Exemption FA MAG (May 6, 2016), https://www.fa-mag.com/news/understanding-the-best-interest-contract-exemption-26741.html.

[12] Maurren Gorman and Lennie Occhino, DOL Fiduciary Rule: Impact and Action Steps (July 21, 2017), https://corpgov.law.harvard.edu/2017/07/21/dol-fiduciary-rule-impact-and-action-steps/.

[13] Daisy Maxey, The ABCS (and T’s and Z’s) of the New Fiduciary Rule, WALL STREET J. (July 9, 2017), https://www.wsj.com/articles/the-abcs-and-ts-and-zs-of-the-new-fiduciary-rule-1499652600.

[14] Greg Lacurci, DOL fiduciary rule: The 5 biggest things to watch for if BICE’s class-action provision is killed, INVESTMENT NEWS (Aug. 29, 2017), http://www.investmentnews.com/article/20170829/FREE/170829927/dol-fiduciary-rule-the-5-biggest-things-to-watch-for-if-bices-class.

[15] Lisa Beilfuss, Fiduciary-Rule Review Zeroes In on Industry Costs, Liabilities ,WALL ST. J. (July 20, 2017), https://www.wsj.com/articles/fiduciary-rule-review-zeros-in-on-industry-costs-liabilities-1499515201.

[16] Labor Department to Roll Back Fiduciary Rule Compliance Deadline.

[17] Lowell Putnam, The DOL Fiduciary Rule Practically Necessitates Account Aggregation, INVESTMENT NEWS (Aug. 18, 2017), http://www.investmentnews.com/article/20170818/BLOG09/170819930/the-dol-fiduciary-rule-practically-necessitates-account-aggregation.

[18] Melanie Waddell, State Fidcuiary Rules Create a Regultaory ‘Mess’, THINK ADVISOR (Sept. 21, 2017), http://www.thinkadvisor.com/2017/09/21/state-fiduciary-rules-create-a-regulatory-mess.

[19] Mark Schoeff, New Nevada Law Imposed Fiduciary Duty on Brokers, INVESTMENT NEWS (June 16, 2017), http://www.investmentnews.com/article/20170616/FREE/170619947/new-nevada-law-imposes-fiduciary-duty-on-brokers

[20] Lisa Beilfuss, Securities Industry Pushes Back on Nevada’s Fiduciary Rule, WALL STREET JOURNAL (Oct. 6, 2017), https://www.wsj.com/articles/securities-industry-pushes-back-on-nevadas-fiduciary-rule-1507317493.

[21] Mark Schoeff, Clayton says SEC Can’t Simply Take Over DOL Fiduciary Rule, INVESTMENT NEWS (Oct. 23, 2017), http://www.investmentnews.com/article/20171024/FREE/171029975/clayton-says-sec-cant-simply-take-over-dol-fiduciary-rule.

[22] Id.