In 2010, the Department of Labor proposed a new definition of fiduciary. But, it retracted that proposal based on retirement industry concerns, and has recently reissued what it now calls a proposed conflicted investment advice rule.
CEO of the American Retirement Association Brian Graff, during the American Society of Pension Professionals and Actuaries’ (ASPPA’s) first-ever virtual conference, noted that the proposed rule is not just changing the definition of fiduciary under the Employee Retirement Income Security Act (ERISA)—it adds two new prohibited transaction exemptions (PTEs), six amendments to existing PTEs, and pulls individual retirement accounts (IRAs) and IRA holders into the definition of fiduciary investment advice.
Graff added that the proposed rule is very broad in whom it captures as an ERISA fiduciary, and he contended the proposal creates a significant challenge for conversations with participants about what to do with their money. “The proposed rule applies to retirement plans, but doesn’t apply to retail products, and that’s one of the problems with the rule,” he said.
As an example, Graff noted that a retirement plan participant who has been working with a plan adviser for 20 years may want to continue working with the adviser after he leaves the plan because he trusts the adviser. However, the plan adviser may propose that because the participant is going to require more comprehensive advisory services after rolling over his plan balance to an IRA, he will charge a higher level fee than he charged to the plan.
According to Graff, under the DOL proposal, if the level of fees in an IRA is structured differently than the fees in the plan, a rollover to that IRA would be considered a prohibited transaction. This means the adviser would have to establish and comply with the rule’s Best Interest Contract (BIC) prohibited transaction exemption. The adviser would have to notify the DOL’s Employee Benefit Security Administration of the intent to use the exemption, enter into a written contract with the participant, and adhere to standards set forth in the proposed rule, including multiple disclosures.
On the other hand, Graff said, if the participant’s relative has a friend who is an independent financial adviser, even if that adviser would charge the participant a higher fee than the plan’s financial adviser would, there would be no prohibited transaction from the rollover of the plan balance into that financial adviser’s IRA and no need for the contract or disclosures.
NEXT: How the rule may affect buy-and-hold investors and participant education.
Ilene H. Ferenczy, managing partner at Ferencszy Benefits Law Center LLP, told virtual conference attendees this is an example of the rule not protecting who it intended to protect—unsophisticated investors. Bob Kaplan, ASPPA Government Affairs Committee co-chair and national training consultant with Voya Financial, added that participants who want to continue a relationship with plan providers would be handed large contracts and multiple fee disclosures that may confuse them and make things more complicated. Graff said, “It’s as if participants and advisers are being punished for an ongoing relationship.” He added that advisers may say if the account is small it’s not worth the additional contract and disclosure costs.
Graff discussed the DOL’s examples of acceptable fee structures for advisory firms and noted that while they are not required, the DOL says they should be considered and if they are used, no BIC exemption is needed. “Basically, the DOL is saying, if you do business the favored way, it’s business as usual, but is it okay for the government to decide what an acceptable business model is?”
According to Graff, under the proposal, if an adviser is getting commission-based pay and approaches a small (<100 participants) employer to sell a start-up plan, that is a prohibited transaction. Craig P. Hoffman, ASPPA general counsel, says this demonstrates how the proposal sets up protections for participants, but not plan sponsors. Graff added that he feels this will reduce the number of new plans because small business owners aren’t thinking about retirement plans, they’re thinking about keeping the business going, so they need someone to approach them.
In addition, Graff feels the proposal as it relates to fee structures may hurt “buy-and-hold” investors. As an example, he showed how an IRA investor that wants to buy a portfolio of income-producing stocks with the intention of holding on to those stocks until the required minimum distribution rules require liquidation and taking distributions of the dividends could be hurt by the proposed rule’s fee disclosure requirements. Adviser A may receive a 5% commission on the purchase and sale of the stock. Because her compensation varies with account activity, she must provide a point of sale disclosure which could show estimated cumulative one-, five- and 10-year fees of $10,000, $10,000 and $11,350, respectively. Adviser B will receive a 1.0 % per year advisory fee. Because this percentage does not vary with account activity, no point of sale disclosure is required.
Based on information provided, the investor may choose Adviser B, but cumulatively, because he is a buy-and-hold investor and Adviser A’s commission is based on the purchase or sale of stock, the investor would pay less with Adviser A.
Finally, Graff noted that one part of the DOL’s proposed rule hurts participant education efforts (see “Changes Plan Sponsors Would See with New Fiduciary Rule.”). Under current rules, plan sponsors or advisers providing participant education may give examples of appropriate portfolios based on participant age or risk tolerance and use names of funds they have access to in the plan’s investment lineup. The education material must include a disclaimer that there are other funds available besides the ones shown that would fit into the example allocation. Under the proposed rules, the education may no longer include specific examples from the plan’s fund menu. “The DOL says it believes disclaimers do not work,” Graff said.
Ferenczy contended that participants, especially unsophisticated investors, need these examples. “Taking out the ability during enrollment meetings to list investments that are on the plan menu does not protect the unsophisticated investor; it leaves them blind,” she stated.
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