New Labor Department guidance seems to strengthen fiduciary exemption

April 19, 2021

The Department of Labor this week issued guidance for advisors that seemed to take a tough stance on conflicts of interest as it interpreted the Trump-era exemption for fiduciaries operating in the retirement space.

Tuesday's announcement from the department drew praise from some investor advocates, who hope that the Labor Department and SEC will move to tighten advisor standards and crack down on conflicted advice. While proponents of stronger advice standards opposed the rules the DoL and SEC produced in the previous administration, clarifying guidance to strengthen those provisions could be a faster path to enhance investor protections than restarting a lengthy and politically contentious rulemaking process to write new regulations or amend old ones, advocates say.

In addressing conflicts, the DoL guidance looks at the issue both from the perspective of the individual advisor and at the firm level.

In addressing conflicts, the DoL guidance looks at the issue both from the perspective of the individual advisor and at the firm level.

Bloomberg News

One of the two documents the DoL issued this week is billed as a guide for retirement investors to choose an advisor, offering a series of questions to ask prospective advisors about their fiduciary obligations, the fees they charge, and how they navigate conflicts of interest.

The other document is a series of frequently-asked questions to comply with the prohibited transaction exemption. That’s the waiver that set the rules for advisors to receive payments for conflicted retirement advice they offer as fiduciaries under the Employee Retirement Income Security Act. That rule was adopted by the DoL in December 2020, and took effect in February.

"The retirement investor guidance provides helpful information regarding the importance of selecting an investment advice provider who is a fiduciary and the protections that are provided to retirement investors under the ... exemption," Ali Khawar, acting assistant secretary of labor for employee benefits security, says in a statement. "The compliance-focused frequently asked questions provide assistance to financial institutions and investment professionals as they ramp up compliance with the exemption."

The years-long battle over ERISA fiduciary standards has been contentious, with industry groups leading an ultimately successful legal campaign to defeat an Obama-era rule. In the waning days of the Trump administration, the Labor Department adopted a replacement that investor advocates like Barbara Roper opposed, saying it failed to adopt specific, meaningful protections, and instead aligned with the SEC's Regulation Best Interest advice standard for brokers, another framework opposed by Roper and other advocates.

Roper, director of investor protection at the Consumer Federation of America, says that the DoL's initial rule seemed "to look to the weak, undefined, non-fiduciary best interest standard from Reg BI to satisfy ERISA's high fiduciary standard."

"Importantly, however, DOL retained its authority to interpret and enforce the standard," Roper says in an email. "This guidance from the DOL shows how meaningful those standards can be in the hands of a regulator intent on reining in abusive industry conduct."

In particular, she praises at the DoL's guidance on mitigating conflicts of interest and its commentary on payout grids In the documents, the department acknowledges that conflicts involving compensation are unavoidable, but also directs firms to ensure that advisors' incentives are aligned with those of their clients as much as possible.

"As we have said repeatedly, reining in harmful incentives is the key to solving this problem, and the DoL has hit this one out of the park," Roper says.

In addressing conflicts, the DoL guidance looks at the issue both from the perspective of the individual advisor and at the firm level, saying that the requirement to mitigate conflicts "extends to the financial institution's own interests, including interests in proprietary products and limited menus of investment options that generate third-party payments."

Knut Rostad, president of the Institute for the Fiduciary Standard, calls the introduction to the question on mitigating conflicts of interest that could misalign an advisor's incentive from their clients "excellent," and sees in it support for his longstanding contention that the current business model of the brokerage sector is fundamentally incompatible with strong fiduciary principles.

"It acknowledges the great challenge of infusing fiduciary conduct into a broker-dealer model designed and built to distribute products," Rostad writes in an email.

Roper and Rostad hope that Tuesday's DoL release will be a down payment on more guidance to come from the department and the SEC that would strengthen advice standards.

Not all advisors feel the same way.

WealthWise Financial Services CEO Loreen Gilbert lauds the DoL's PTE for fiduciary retirement advice, but would like to see the regulators take a pause before adopting more stringent interpretations of their existing rules.

"We hope there is not more guidance from both the DoL and the SEC," she says, warning of the potential for "more confusion and bureaucracy created if both the DOL and the SEC get involved."

"There continues to be a battle between the DOL and the SEC on who defines the rules," she says.

Rostad, meanwhile, would like the DoL to come forward with some specifics to bolster the provisions concerning conflicts in the prohibited transaction exemption for fiduciary retirement advice.

"[T]to fulfill the fiduciary mission of the exemption, additional guidance with required concrete practices is essential," Rostad says. "Anything less is bound to fail."

As for the SEC's Reg BI, he argues for it to be renamed "New Suitability," arguing that it's not a great departure from the previous, longstanding benchmark for broker conduct. Going forward, he hopes to see amendments to the rule, which he says "cannot be fixed from new guidance and enforcement alone."

Roper, meantime, is hopeful that the SEC will push out interpretive guidance to clarify how it will interpret and enforce the central pillars of Reg BI concerning recommendations and mitigating conflicts.

In a statement, the DoL positions the new guidance as only the first document in an ongoing review of "issues of fact, law and policy related to the exemption, and more generally, its regulation of fiduciary investment advice," suggesting that more will follow.

Then on Wednesday morning, the Senate voted to confirm Gary Gensler as chairman of the SEC, giving the regulator a full panel of commissioners and inviting the prospect that the agency will follow the DoL's lead and begin moving to strengthen Reg BI.

"The guidance is an important first step forward," Roper says, "but there’s still a lot of work to be done."