As we discussed in our Standards of Care Quick Take, the Proposal is designed to better align with Reg BI. This is the DOL’s third attempt to amend the definition of a fiduciary in a decade — the 2015-2016 version was vacated in litigation — and this version takes a vastly different approach to the previous two iterations in several ways, including alignment with both Reg BI and the fiduciary duty of investment advisers. Such coordination across standards of care regimes is unprecedented and a positive change after years of debate as to whether the SEC or the DOL is best positioned to regulate retail advice.
We continue to work on an analysis of the Proposal and its interplay with Reg BI, the soon to be implemented Massachusetts Fiduciary Rule and other standards of conduct developments impacting the brokerage and asset management industries, such as the National Association of Insurance Commissioner’s revised annuity suitability rule.
Below we share our initial reactions to the Proposal:
- Expansion of the five-part fiduciary test – The Proposal retains the five-part fiduciary test, which is a significant departure from the 2016 rule that would have eliminated it entirely, but the DOL seems to apply a more expansive interpretation of its elements. While reaffirming that the five-part test is ultimately based on an analysis of the relevant facts and circumstances, the DOL notes that IRA rollovers will generally be considered part of an ongoing advice relationship that would satisfy the regular basis prong. In addition, recommendations made pursuant to Reg BI (or another analogous requirement) should reasonably be understood to serve as a primary basis for an investment decision. The result is that while the five-part test remains intact, it will be more difficult for financial institutions and investment professionals to rely on the five-part test to argue that they are not acting as an investment advice fiduciary.
- Strong emphasis on investor protection with the potential to insulate the Proposal from litigation and political risk – The title and stated purpose of the Proposal and its accompanying release focus on improving advice for workers and retirees, with an emphasis on how ERISA plans and IRAs can represent a lifetime of savings and often comprise the largest sum of money a worker has for retirement. The focus on IRA rollovers, in particular, also reflects a long-standing policy concern that investors may not be receiving appropriate advice regarding the conversion of assets from ERISA plans. The strong focus on investor protection should mitigate consumer advocate litigation potential while also minimizing the risk that the Proposal would be upended in the event of a change in administration after the 2020 presidential election.
- Broader and more flexible relief, supplemented with disclosure – The Proposal is a departure from the ERISA regime of prohibited transactions with narrow exemptions. Instead, the Proposal creates an exemption that builds on the impartial conduct standard, bolstered with disclosure and additional compliance obligations. In this way, the DOL permits financial institutions to continue to rely on existing controls put in place in reliance on Field Assistance Bulletin No. 2018-02, after the 2016 DOL fiduciary rule was vacated, and leverage the existing SEC framework for disclosure and controls under Reg BI and the Advisers Act. This Proposal demonstrates coordination and deference to the SEC. Chair Clayton’s statement provides further confirmation of this approach.
- No private right of action – The Proposal requires financial institutions to acknowledge in writing that the financial institutions and their investment professionals are fiduciaries under ERISA and the Code, but it eliminates the contractual provision that created a potential private right of action under the 2016 rule. The DOL was very clear that it does not intend the fiduciary acknowledgement to create a private right of action, nor does it believe the proposed exemption would do so.
- Enforcement risk, particularly from the SEC – Given the size and scope of its own examinations and enforcement program, it remains unclear how aggressive the DOL will be in bringing enforcement actions against financial firms that engage in non-exempt prohibited transactions, if the Proposal is adopted. Of course, the SEC does not directly enforce DOL rules and standards. However, based on past experience, the SEC's Office of Compliance and Inspection Examinations (“OCIE”) likely will seek information during examinations from firms on their processes and procedures to comply with the DOL exemption (should the Proposal be adopted) as part of OCIE's evaluation of the overall effectiveness of a firm's compliance system, incorporating any deficiencies into the exam report. This is particularly the case here because OCIE will already be examining firms for Reg BI compliance and many Reg BI concepts are incorporated into the Proposal. In addition, SEC Enforcement may look at any apparent violation of DOL rules as an opportunity to bolster a potential enforcement case under the securities laws. Because the Proposal has a disclosure component, the SEC also could argue that inaccurate disclosure under the final proposal may constitute securities fraud or a breach of fiduciary duty.
We also wanted to note additional related standards of care developments:
- Reg BI lawsuit – The Second Circuit held in favor of the SEC in the lawsuit brought by XY Planning Network, Ford Financial Solutions, and the Attorneys General of seven states and the District of Columbia with regard to the Reg BI rulemaking. The decision, dated 26 June 2020, held that Ford Financial has Article III standing, but that the Attorneys General do not, and also held that the SEC was authorized to promulgate Reg BI under Section 913(f) of the Dodd-Frank Act and that Reg BI was not arbitrary or capricious under the Administrative Procedure Act. The timing of the decision and the DOL’s release of the Proposal are closely related, particularly in light of how much the Proposal aligns with Reg BI.
- Form CRS FAQs – On 26 June 2020, the Form CRS FAQs were updated. Firms would benefit from reviewing the updated FAQs, both to ensure that no changes need be made to their existing Form CRS, and also as the latest FAQs provides clarity on the Form CRS delivery and redelivery triggers. For example, the SEC staff notes that new types of services that might trigger delivery include the initial recommendation or provision of margin capability, options eligibility, account monitoring or discretionary trading. However, new account features, such as check writing privileges, that do not relate to investment options or capabilities would not require redelivery for existing clients.
- Massachusetts Fiduciary Rule for broker-dealers and their representatives – The enforcement deadline for this rule is set for 1 September 2020, and will remain unchanged. As firms return to work on MA rule implementation, they may find our summary comparing this rule to Reg BI helpful.