Interesting data from Jennifer DeLong and her good team at AllianceBernstein on the misunderstanding of which activities and roles trigger fiduciary status. A better understanding is all the more important considering that some are conflating the extension of the DOL Fiduciary Rule’s transition period with reduced/no fiduciary duties!
Just over a month ago, the U.S. Department of Labor (DOL) partly explained an 18-month extension of its fiduciary rule by saying the additional time was necessary to allow for ample opportunity for input from, and, ideally, coordination with, the U.S. Securities and Exchange Commission (SEC) and state regulators. Just a few days ago, however, the state of New York announced proposed changes to its rules governing the sales of insurance and annuity transactions involving both retirement and nonretirement accounts. If implemented, these changes could have a significant effect on New York insurance agents and brokers. Though the revised rule was styled as merely “clarifying” the duties and obligations of producers when making recommendations to consumers, New York Governor Andrew Cuomo tied this proposal to the delay of the DOL fiduciary rule when he said, “As Washington continues to ignore and roll back efforts to protect Americans, New York will continue to use its role as a strong regulator of the financial services and insurance industries to fight for consumers and help ensure a level playing field.”
Here are our observations:
- The proposed changes to New York’s annuity suitability rule would require that any “recommendation” to a consumer by an insurance agent or broker regarding a proposed or in-force “policy” be “based on an evaluation of the suitability information of the consumer that reflects the care, skill, prudence, and diligence that a prudent person familiar with such matters would use under the circumstances without regard to the financial or other interests of the producer, insurer or any other party.” The insurer would need to make this best interest determination if “no producer is involved.” This best interest requirement is in addition to the existing determination of suitability under New York law.
- As is always the case, the devil is in the details. The proposed regulation, like the DOL fiduciary rule, broadens the types of communications that give rise to a “recommendation”: namely, “one or more statements or acts” by a broker or agent that either “reasonably may be interpreted by a consumer to be advice,” which results in “a consumer entering into or refraining from entering into a transaction” in accordance with the recommendation, or where the communication “is intended by the producer, or an insurer where no producer is involved, to result in a consumer entering into or refraining from entering into a transaction.” A “policy” means a “life insurance policy, annuity contract, or a certificate issued by a fraternal benefit society or under a group life insurance policy or group annuity contract.” As with the existing rule, policies used to fund ERISA or other plans, such as governmental plans, are exempted.
- There are a number of other proposed changes, including a need to disclose, at the time of the recommendation, “all relevant suitability considerations and product information, whether favorable or unfavorable, that provide the basis for any recommendations,” as well as a prohibition against any recommendation stating or implying “that a recommendation to enter into a transaction is a part of financial planning, financial advice, investment management or related services unless the producer has a specific certification of professional designation in that area.” There would also be a new requirement to establish and maintain procedures “designed to prevent financial exploitation and abuse” and additional disclosures.
- The proposed amendments to the New York annuity regulation differ from what is currently being contemplated by the National Association of Insurance Commissions (NAIC), which is in the process of adopting its own updated model suitability rule (on which the New York regulation was based). This means that, barring changes by either NAIC or New York, there may be material differences among the states regarding when a duty of best interest is required for the sale of insurance products, and what specific obligations flow from the best interest duty.
- The New York regulation, as proposed and already in effect, along with similar regulations of other states, is generally considered coterminous with the DOL fiduciary rule, meaning that advisers are subject to both. The DOL recognized as much when it stated in the preamble to the final version of its fiduciary rule: “The Department’s obligation and overriding objective in developing regulations implementing ERISA (and the relevant prohibited transaction provisions in the Code) is to achieve the consumer protection objectives of ERISA and the Code. The Department believes the final rule reflects that obligation and objective while also reflecting that care was taken to craft the rule so that it does not require people subject to state banking, insurance or securities regulation to take steps that would conflict with applicable state statutory or regulatory requirements. The Department notes that ERISA section 514 expressly saves state regulation of insurance, banking, or securities from ERISA’s express preemption provision.”
- New York’s best interest proposal comes on the heels of the passage of Nevada’s revisions to its financial planner law, which now imposes fiduciary duties on, and creates a cause of action against, advisers and broker-dealers. The Nevada securities regulator is still due to issue regulations sometime this year on the specific requirements of the amended financial planner law. Other states, meanwhile, have either introduced their own laws that would tighten the screws around investment advice or are contemplating doing so. The states seem committed to updating their standards as if anticipating a significant rollback of the DOL fiduciary rule. Leadership at both the DOL and the SEC appear to recognize the importance of working with the states to avoid an unwieldy maze of regulations governing the same conduct. Only time will tell whether New York’s and Nevada’s actions will expedite the DOL’s or SEC’s timetables.
- The proposed amendments to the New York regulation are subject to a comment period that closes on Feb. 26, 2018.
I penned an op-ed in Pensions & Investments on why fiduciaries should consider their best execution obligations in connection with rebates paid to broker-dealers by trading venues. (subscription required)
An early holiday gift to many, the U.S. Department of Labor (DOL) on November 27 formalized an extension of the transition period of the Best Interest Contract (BIC) Exemption, the Principal Transactions Exemption, and certain conditions of Prohibited Transaction Exemption 84-24. The transition period will now end on July 1, 2019 rather than January 1, 2018. Investment advice fiduciaries are expected to adhere to the “impartial conduct standards,” among other conditions (depending on the applicable exemption) during the transition period. As a reminder, the impartial conduct standards impose a duty on fiduciaries to make recommendations in accordance with ERISA’s long-standing stringent duties of prudence and loyalty, to charge no more than reasonable compensation for their services, and to avoid making any misleading statements to the retirement investor. Absent any changes or further delays from the DOL, firms and individuals who provide fiduciary investment advice in need of an exemption will be subject to all conditions of these exemptions, including (among others) the controversial duty to enter into an enforceable contract with IRA investors, as well as a requirement to adopt numerous exacting policies and procedures, starting on July 1, 2019.
The DOL stated that its decision to extend the transition period gives it “time necessary to consider public comments submitted pursuant to the Department’s July Request for Information, and the criteria set forth in the Presidential Memorandum of Feb. 3, 2017, including whether possible changes and alternatives to exemptions would be appropriate in light of the current comment record and potential input from, and action by the Securities and Exchange Commission, state insurance commissioners and other regulators.”
The Fiduciary Rule itself determines whether one becomes a fiduciary by reason of providing non-discretionary investment advice to retirement investors. Generally, if one obtains fiduciary status, and earns compensation in connection with its fiduciary responsibilities, a prohibited transaction occurs and an exemption is needed. The aforementioned exemptions are the primary exemptions under the Fiduciary Rule. The Fiduciary Rule went into effect on June 9, 2017 and is not subject to this (or any) delay; the transition period (and extension thereof) only relates to certain conditions of the exemptions. This means that firms and individuals should continue to ascertain (i) whether they are making “recommendations,” including with respect to roll-overs and distributions, in the first place (ii) whether an applicable “exception” to the Fiduciary Rule is available, and (iii) if necessary, which exemption to rely upon. Here are some additional observations:
- Firms, to the extent they are relying on these exemptions, are expected to evaluate and upgrade, as necessary, their adherence to the impartial conduct standards. Given that the DOL is allowing for compliance flexibility, firms should consider seizing the opportunity to tailor their approach to the impartial conduct standards. The DOL has been clear that good faith compliance is essential; DOL Secretary Alex Acosta confirmed as much when he told Congress recently that the DOL would initiate enforcement against firms for willful non-compliance. There could also be excise taxes imposed for non-exempt prohibited transactions.
- The DOL opted for the transition period to end on a date-certain (July 1, 2019) rather than upon the occurrence of a particular event (e.g., a formal pronouncement by the DOL that it would not propose any changes to the Fiduciary Rule) on the basis that the former would provide the market greater certainty and avoid needless compliance costs.
- The DOL confirmed that it plans to propose a new class exemption, which will likely be aimed at market innovation and transparency, “in the near future.” The DOL did not rule out the possibility that this new exemption could be proposed before year-end.
- We remain somewhat optimistic that the DOL, the SEC and the states will coordinate on a rulemaking to avoid duplicative and inconsistent regulatory obligations. The DOL alluded to this need for harmonization in its decision to extend the transition period. SEC Chair Jay Clayton has also expressed a desire to coordinate with the DOL and the states on a uniform standard, the latter a necessary stakeholder because of recent state developments seeking to impose their own obligations on firms and individuals who provide investment advice, as we described previously.
- DOL staff continue to comb through the Fiduciary Rule for ways to wring out unnecessary regulatory costs and increase access of retirement investment advice by “Mr. and Mrs. 401(k)” (to use the artful phrase of SEC Chair Jay Clayton). As noted above, soon after President Trump took office, he ordered the DOL to conduct this analysis and propose changes to address these concerns.
- Speaking of the DOL, a number of personnel changes are afoot. Preston Rutledge was nominated by the President to serve as Assistant Secretary. He already had his confirmation hearing and it appeared to go smoothly. It is an open question, however, whether he will be confirmed before the end of the year. In the interim, Jeanne Klinefelter Wilson will serve as Acting Assistant Secretary (and, ultimately, Deputy Assistant Secretary). She is well-regarded by many ERISA lawyers. It is not entirely certain what role these individuals will have on the DOL’s current re-examination of the Fiduciary Rule.
On Oct. 17, Stradley Ronon Partner Lawrence Stadulis and Counsel George Michael Gerstein held a conference call, “The DOL, the SEC and the States: Fiduciary Law Developments,” to discuss the latest on the Department of Labor (DOL) Fiduciary Rule, the prospect of a uniform standard by the Securities and Exchange Commission (SEC) and the recent emergence of states developing their own fiduciary laws (most notably, Nevada). An audio recording of the briefing can be found here. For convenience, they have prepared this summary for those who wish to simply gather a high-level overview of these developments.
- The president officially nominated Preston Rutledge as an assistant secretary of labor, Employee Benefits Security Administration, which could have a significant impact on the DOL’s re-examination of the Fiduciary Rule. Rutledge most recently served as senior tax and benefits counsel on the Majority Tax Staff of the Senate Finance Committee. Rutledge would need to be confirmed by the Senate.
- Representative Ann Wagner (R-Mo.) introduced in the House of Representatives the Protecting Advice for Small Savers (PASS) Act. This bill would repeal the DOL Fiduciary Rule while creating a best-interest standard for broker-dealers and requiring broker-dealers to disclose compensation they receive and any conflicts of interest that exist.
- Jay Clayton, the chairman of the SEC, has confirmed during his recent testimonies before Congress that one of the SEC’s top priorities is to put forth a uniform fiduciary standard, and that staff are currently working on a new rule while coordinating with the DOL and the states.
- Several states are now considering laws that could impose their own fiduciary duties on federally regulated broker-dealers and advisers. Nevada passed a law on July 1 that imposes significant requirements on broker-dealers and advisers, though the contours of these requirements will be defined in regulations, which have yet to be promulgated. Unfortunately, the lack of regulations has created significant compliance uncertainty in the industry. The Nevada Securities Division recently held a workshop in Las Vegas on the new law, and Lawrence Stadulis attended; unfortunately, little guidance was offered. Separately, various states have introduced bills, including New York, New Jersey and Massachusetts.
- The DOL is expected to finalize the proposed delay of the transition period with respect to the Fiduciary Rule’s associated exemptions. Should the proposal be adopted, the transition period would extend from January 1, 2018 to July 1, 2019. The DOL has also confirmed that it is drafting a proposed class exemption, which would be aimed at products and services that present fewer conflicts of interest and greater fee transparency. It is not yet clear when this new exemption will be proposed.
Last October, Bloomberg BNA published a report of mine on the practical ERISA fiduciary implications of climate change on investment decision-making. Inadequate disclosures from issuers continue to remain an issue for asset managers.