A new DOL fiduciary rule? 26 key excerpts from the proposal

November 7, 2023 3:01 PM

Acting Secretary of Labor Julie Su spoke at an Oct. 31 event announcing the administration’s new “retirement security rule” proposal in the State Dining Room of the White House alongside AARP CEO Jo Ann Jenkins and President Joe Biden in the State Dining Room of the White House.

President Joe Biden's administration rolled out its "retirement security rule" proposal at the White House last week with a speech that drew immediate pushback.

The Labor Department's plan to rewrite the definition of "fiduciary" — the most significant potential change to the Employee Retirement Income Security Act since the 2016 rule that was vacated by a court decision — is already dividing the industry between supporters and opponents. With public comments and a hearing plus inevitable industry lawsuits poised to drag out the debate for months and years, the slideshow below covers more than two dozen excerpts from the proposal on the rationale, research and major possible impact to the industry.

In his speech, Biden criticized "bad annuities" and "junk fees" that he said are hurting the nest eggs built up by 401(k) savers and individual retirement account holders. His comments omitted an estimated cost of compliance for the industry of more than $1.5 billion over 10 years.

"Now, let me be clear about something," Biden said, according to the White House transcript of the Oct. 31 remarks. "Most financial advisors give their clients good advice at a fair price and are honest with them. But that's not always the case. Some advisors and brokers steer their clients toward certain investments not because it's the best interest of the client; because it means the best payout for the broker. I get it, understand it. But I just want you to know we're watching, to put it colloquially. Now, look, they're putting their self-interest ahead of their clients' best interest. And they're scamming Americans out of hard-earned money. People should be able to trust that when they get advice from a so-called expert, they're getting real help, not getting ripped off."

The proposal drew praise from groups such as the AARP, the CFP Board and consumer and union advocates uniting as the Save Our Retirement coalition. Trade and advocacy groups like the National Association of Insurance and Financial Advisors, the Financial Services Institute, the American Council of Life Insurers and the Insured Retirement Institute criticized the prospect of another new regulation, though.

"The President's proposed fiduciary rule will harm the very consumers he wants to help and deepen the nation's retirement crisis by limiting access to sound financial advice," IRI CEO Wayne Chopus wrote in response to Biden's speech. "IRI will fight this latest proposal as tenaciously as we fought and defeated the 2016 rule. We are committed to protecting the rights of workers, retirees, and their families to ensure that they are not deprived of access to retirement savings strategies, choice of products to execute those strategies, and the right to choose their financial advisor on terms that best fit their needs. President Biden and the Department of Labor showed a fundamental misunderstanding of how the insurance industry and annuity products work for the benefit of consumers."

To see 26 key excerpts from the proposal that will be central to the debate, scroll down the slideshow. For a sampling of the reaction across the industry to last week's announcement, click here. And to see 24 other new rules and proposals to watch, follow this link.

The Labor Department’s description of the problem

"These individual investors have far greater responsibility for decisions about their retirement savings than was true in 1975, when investment professionals directly managed plan investments. Individual investors routinely depend on the quality of the advice they receive from financial professionals who commonly hold themselves out as trusted advice providers. Because these professionals have inherent conflicts of interest, however, there is an ever-present danger that the investment advice the retirement investor receives will be driven, not by the best interest of the investor, but by the financial interests of the investment professional or firm whom they depend upon for advice that is in their interest."

Seeking to change 2 aspects of the 5-part test

"The Department's experience in the current marketplace is that the five-part test — in particular, the 'regular basis' requirement and the requirement of 'a mutual agreement, arrangement, or understanding' that the investment advice will serve as 'a primary basis for investment decisions' — too often work to defeat legitimate retirement investor expectations of impartial advice and allow some advice relationships to occur where there is no best interest standard."

How retirement saving has changed

"In 1981, private defined benefit plans held more than twice the assets in private defined contribution plans, and roughly 10 times more than IRA assets. By the first quarter of 2022, the order had reversed: IRAs held $13.2 trillion in assets, private defined contribution plans held $9.2 trillion, and private defined benefit plans held $3.7 trillion in assets. This trend is expected to continue as retirement investors are projected to move $4.5 trillion from defined contribution plans to IRAs from 2022 through 2027."

Rollovers central to the proposal

"The Department continues to believe that decisions to take a benefit distribution or engage in rollover transactions are among the most, if not the most, important financial decisions that plan participants and beneficiaries, and IRA owners and beneficiaries are called upon to make. The Department continues to believe that advice provided in connection with a rollover decision, even if not accompanied by a specific recommendation on how to invest assets, should be treated as fiduciary investment advice. A distribution recommendation involves either advice to change specific investments in the plan or to change fees and services directly affecting the return on those investments. Even if the assets would not be covered by Title I or Title II of ERISA when they are moved outside the plan or IRA, the recommendation to change the plan or IRA investments is investment advice under Title I or Title II of ERISA."

Advice and conflicts of interest

"Employment-based retirement plans and IRAs are critical to the retirement security of millions of America's workers and their families. Because retirement investors often lack financial expertise, professional investment advice providers often play an important role in guiding their investment decisions. Prudent professional advice helps consumers set and achieve appropriate retirement savings and decumulation goals more effectively than consumers would on their own. For many years, the benefits of professional investment advice, however, have been persistently undermined by conflicts of interest that occur when financial services firms compensate individual investment advice providers in a manner that incentivizes them to steer consumers toward investments and transactions that yield higher profits for the firms. These practices can bias the investment advice that providers render to consumers and detrimentally impact their retirement savings by eroding plan and IRA investment results."

Compliance cost of $1.55 billion over 10 years

"To estimate compliance costs associated with the proposal, the Department considers the marginal cost associated with the proposed amendments. The Department estimates that the proposal would impose total costs of $253.2 million in the first year and $216.2 million in each subsequent year. … Over 10 years, the costs associated with the proposal would total approximately $1,553.1 million, annualized to $221.1 million per year (using a 7% discount rate)."

The size of the industry’s retirement plan channel

"As of 2021, there were approximately 765,000 private sector retirement plans with 146 million participants and $13.2 trillion in assets that would be affected by these proposals. Approximately 46,000 of these plans were defined benefit plans, with 31 million participants and $3.7 trillion in assets, and approximately 719,000 are defined contribution plans with 115 million participants and $9.5 trillion in assets. The Department recognizes that some plans, such as simplified employee pension (SEP) plans and savings incentive match plan for employees IRA (SIMPLE IRA) plans, are exempt from filing and are not included in these estimates but would typically be affected by the proposal."

How many RIAs would be affected

"In 2021, 54% of registered investment advisers provided employer-sponsored retirement benefits consulting. Based on this statistic, the Department estimates that 16,182 registered investment advisers, including 7,770 SEC-registered investment advisers and 8,412 state-registered investment advisers would be affected by the proposed amendments."

Brokerage impact

"Assuming the percentage of broker-dealers provide advice to retirement plans is the same as the percent of investment advisers providing services to plans, the Department assumes 54%, or 1,894 broker-dealers, would be affected by the proposed amendments. The Department requests comment on this estimate."

The main benefits

"The most significant benefits of the proposal are expected to result from (1) changing the definition of a fiduciary by amending the five-part test, (2) requiring advice given to a broader range of advice recipients, including plan fiduciaries and non-retail investors, to meet fiduciary standards under ERISA, (3) extending the application of the fiduciary best interest standard in the market for non-security annuities, creating a uniform standard across different retirement products and (4) requiring that more rollover recommendations be in the retirement investor's best interest."

Potential advantages to retirement investors

"In this analysis, the Department identifies three specific areas in which retirement investors would benefit from an extension of protections: one-time advice regarding the rollover of assets, advice on non-security annuity products and advice given to ERISA plan fiduciaries."

Investor expectations

"Under the current regulation, an independent producer selling an indexed annuity, a financial professional giving a retirement investor one-time advice to roll investments into an IRA, or a financial professional giving advice on one transaction, could portray themselves as serving the best interest of the investor while being held to lower care standard than financial professionals subject to the Investment Advisers Act of 1940 or the SEC's Regulation Best Interest or the Department's fiduciary standard. In contrast, the amended rule would broadly align the standard of care required of all financial professionals giving retirement investment advice with retirement investors' reasonable expectations that those recommendations are trustworthy. This would in turn create a retirement market where all advisers compete under a uniform fiduciary standard, reducing investor exposure to harms from conflicted advice."

Changing the definition of ‘fiduciary’

"This proposal would extend important and effective protections broadly to retirement investors. Specifically, the proposal would replace the 1975 regulation's five-part test with a new fiduciary status test, which would capture more financial investment transactions in which the investor is reasonably relying on the advice individualized to the investor's financial needs and best interest. This proposal would also increase the number of rollover recommendations being considered as fiduciary advice, which would enhance protections to retirement investors, particularly in regard to recommendations regarding annuities."

A goal of harmonization

"The Department believes that by harmonizing the application of fiduciary duty for retirement investment advisers across regulatory regimes, retirement investors will benefit from more uniform protections from conflicted advice. While extending fiduciary duty to more entities will generate costs, the Department believes any new compliance costs will not be unduly burdensome as the proposal broadly aligns with those compliance obligations imposed under the Investment Advisers Act and the SEC's Regulation Best Interest on investment advisers and broker-dealers, respectively, and simply expands them to larger portions of the retirement market."

Attempting reconciliation

"There are currently many situations where the retirement investor reasonably expects that their relationship with the advice provider is one in which the investor can (and should) place trust and confidence in the recommendation, yet which are not covered by the current regulation. This proposal attempts to reconcile the regulatory text with both the reasonable expectations of the retirement investor along with the statutory text and purpose."

Refuting of ‘regular basis’ test

"For example, under the 1975 rule, if the advice is not given on a 'regular basis,' it makes no difference if the person making the recommendation claims to make the recommendation based on the investor's best interest and knows that the investor is relying on that recommendation. Thus, if a plan participant seeks advice on whether to roll over all their retirement savings, representing a lifetime of work, out of an ERISA-covered plan overseen by professional ERISA fiduciaries, to purchase an annuity, the person making the recommendation with respect to the purchase of the annuity has no obligation to adhere to a best interest standard unless they meet all prongs of the 1975 rule, including regularly giving advice to the plan participant. This is true even if the person giving the advice holds themselves out as an investment expert whose recommendation is based solely on a careful and individualized assessment of the investor's needs, the plan participant has no investment expertise whatsoever and both parties understand that the participant is relying upon the advice for the most important financial decision of their life. Because the advice was not rendered on a "regular basis," the adviser has no obligation under ERISA to adhere to fiduciary standards, and thus would not be subject to ERISA's prohibitions on disregarding the participants' financial interests, recommending an annuity that is imprudent and ill-suited to the participant's circumstances, and favoring the adviser's own financial interests at the expense of the participant."

Reputation of annuities

"The annuity products offered by insurance companies are notoriously complex, leaving retirement investors reliant on advice from the insurance agent, broker, or independent producer selling the annuity. The fees and adviser incentives are similarly complex, often in a way that can conceal the full magnitude of the fees."

A bad combination

"Overall, evidence demonstrates that the combination of inexpert customers and conflicted advisers results in investment underperformance and negative outcomes for investors. According to a 2015 report by the Council of Economic Advisers, approximately $1.7 trillion of IRA assets were invested in products with a payment structure that generates conflicts of interests. A substantial body of research has shown that IRA holders receiving conflicted investment advice can expect their investments to underperform by approximately 50 to 100 basis points per year."

The extent of rollovers

"Most IRA assets are attributable to rollover contributions, and the amount of assets rolled over to IRAs is large and expected to increase substantially. In 2021, IRA rollovers from defined contribution plans increased by 4.9%. Cerulli Associates estimates that aggregate rollover contributions to IRAs from 2022 to 2027 will surpass $4.5 trillion."

Advice improves outcomes

"There is extensive evidence that investors, including retail investors and ERISA plan fiduciaries, are often subject to behavioral biases that lead to costly systematic investment errors. There is evidence that good advice can improve saving and investing decisions. Accordingly, the proposal may result in a beneficial reallocation of investment capital."

Would the proposal hurt clients with small accounts?

"Some observers have argued that some small savers, individuals, or households with low account balances or of modest means, will lose access to investment advice under this type of regulation and will be worse off. The Department has considered in detail the overall impact of the proposal on small savers."

Agency argues proposal helps small-account investors

"The Department expects the proposed rule and exemptions would not significantly impact the overall availability of affordable investment advice but rather improve the quality of this advice as conflicts are removed. This would apply as well to small investors who continue to have access to advice. Furthermore, increasing the quality of advice provided to retirement plan fiduciaries will benefit many workers who are participating in a defined contribution or defined benefit pension plan."

Triangulating from the status quo

"The Department's proposal does not ban commissions or eliminate conflicted compensation structures, but rather relies upon conduct standards and oversight structures designed to minimize the harmful impact of conflicts of interest, while permitting a wide range of business practices and models. The Department's proposal represents a middle ground between no reform and the outright bans on conflicted payments, allowing businesses to use a range of compensation practices while minimizing the harmful impact of conflicts of interest on the quality of advice."

Why .5% or 1% makes a difference

"As discussed in the 2016 [regulatory impact analysis], the Department estimated that a 50 to 100 basis point performance gap of broker-sold funds would result in retirees losing $9 to $17 billion each year (or between 0.5 and 1 percentage point of return each year for $1.7 trillion in assets), $95 to $189 billion over 10 years, and $202 and $404 billion over 20 years. That means a retiree spending their savings down over 30 years would have 6% to 12% less to spend. If a retiree encounters conflicts of interest and experiences a 100-basis point reduction in performance, but still spends as though they were not encountering conflicts of interest, they would run out of retirement savings more than five years early."

Difference from 2016 proposal

"The current proposal bases investment advice fiduciary status on circumstances that indicate the retirement investor may place trust and confidence in the recommendation as a professional recommendation based upon the particular needs of the investor. The proposal reflects the Department's interpretation of the text of the statute, as informed by the Fifth Circuit's emphasis on relationships of trust and confidence. Accordingly, the proposed definition, unlike the 2016 final rule, does not automatically treat as fiduciary advice all compensated recommendations directed to a specific retirement investor regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA."

Calculation of cost of conflicts without 2016 rule

"Most significantly, the Department explained in its analysis that, in the absence of the 2016 final rule, the underperformance associated with conflicts of interest in the mutual funds segment alone could have cost IRA investors between $95 billion and $189 billion over the following 10 years and between $202 billion and $404 billion over the following 20 years. While these projected losses were substantial, they represented only a portion of what IRA investors stood to lose as a result of conflicted investment advice."