Thousands of financial advisors are facing new potential rules from the Department of Labor that could affect their businesses significantly or just start a new wave of industry legal fights.
After taking over last year, the Biden Administration’s Labor Department acted quickly in
Enter trade groups such as the Financial Services Institute, which is cheering the latest court
Groups including the AARP, the AFL-CIO, the Consumer Federation of America, the Public Investors Advocate Bar Association and Phyllis Borzi — the former Obama Administration Labor Department’s assistant secretary for employee benefits security and author of the prior fiduciary rule
The biggest delay for the Department’s Employee Benefits Security Administration in issuing a new rule likely stems from “the difficulty of crafting a workable rule for independent insurance agents” because the range of products they sell is under monitoring and supervision by several different financial entities rather than just one, Borzi said.
“The biggest problem is in this rollover area. What we've seen over the past decade and what we see in the inexorable future is this tsunami of assets leaving the qualified plan space,” she said. “Although not perfect, ERISA provides protections for people in a world where there are no protections.”
In terms of the other matter before the department, experts say that the March 14 decision in the federal court of Beaumont, Texas, ruling that the Biden Administration’s May 2021 withdrawal of the rule violated the Administrative Procedure Act carried many more consequences for janitors, home health aides, agricultural and construction workers and Uber or Lyft drivers than for independent advisors.
“The Department of Labor isn't going to go after arrangements like that if the workers aren't complaining,” said Catherine Ruckelshaus, the general counsel of the National Employment Law Project. “It feels more ideological than actually a strategic legal problem for the members. … I’ve never seen a case brought on behalf of a worker like that.”
Agency not showing its hand
For its part, the Labor Department’s EBSA and its Wage and Hour Division sent statements that leave their respective choices in both matters as open questions for coming weeks and months.
The court decision about the Independent Contractor Rule is “surprising and disappointing,” Solicitor of Labor Seema Nanda said, noting that the department is “evaluating all legal options, including the potential need for rulemaking.”
“When employers misclassify workers as independent contractors, workers lose key rights and protections, hurting labor standards across the board and making it harder for law-abiding employers to compete on an even playing field,” Nanda said.
On the fiduciary rule, Acting Assistant Secretary of Labor for Employee Benefits Security Ali Khawar and his team have received the message from the consumer advocates. The agency placed the
“While we are still reviewing the letter, we share the goal of protecting retirement savers and understand the coalition's concerns related to conflicts of interest in investment advice,” Khawar said.
The industry’s perspective
FSI, an advocacy group for independent brokerages and their advisors, is waiting to see what Khawar and Labor Secretary Marty Walsh will do about any possible new fiduciary rule. The organization
“We of course are going to review very closely any proposal from the Department of Labor that would change the standard of care to retirement investors,” said David Bellaire, FSI’s general counsel. “We don’t come into that with any preconceived notions. Reg BI has greatly improved investor protection without pushing advice out of reach from Main Street.”
With respect to rules about independent contractors, Bellaire conceded that the withdrawal of the Trump Administration’s rule didn’t in itself pose dangers to independent advisors. He also admitted that a bill in Congress that
“The point is not that the Pro Act dooms the independent broker-dealer channel. Each successive effort to limit or narrow who can be an independent contractor increases the costs of being an independent broker-dealer, increases the complexity of it, increases the regulatory risk. As a result, we can expect to have fewer independent broker-dealers,” Bellaire said. “We think it's very important that we maintain the independent channel. Our channel delivers financial advice, products and services to Main Street America, people that oftentimes are overlooked by the wirehouse firms.”
For now, advisors, industry professionals, consumers and other stakeholders in both issues will argue their views and await the next signal of the Labor Department’s plans.
Who’s subject to ERISA today at which time?
With respect to ERISA and advice about rollovers to the holders of 401(k)s and IRAs, the main issue involves whether clients are getting one-time or ongoing advice. If it’s part of an ongoing relationship, an advisor is subject to ERISA’s fiduciary duty. If it’s one-time, it’s not.
That means there’s a “gap in regulation right now,” according to Christine Lazaro, a PIABA member and the director of the Securities Arbitration Clinic at the St. John’s University School of Law’s
“It's really ensuring that those who are not covered right now but should be covered are,” Lazaro said. “The two biggest carveouts tend to be advice that's not on a regular basis or advice in which there's no understanding that it's the primary basis for the investment decision. Most brokerage firms attempt to carve themselves out of ERISA by using account agreements in which it is agreed that the recommendation will not be the primary basis for the investment decision.”
To demonstrate the point, Lazaro sent Financial Planning the relevant language on page 6 of a Morgan Stanley IRA account
“It is pretty crazy, and they've been doing this for decades,” Lazaro said.
Representatives for the Securities Industry and Financial Markets Association, a trade group representing securities firms, banks and asset managers, said in an email that no staff members were available for an interview. Out of the three firms themselves, only Schwab provided a statement in response to FP’s inquiry seeking comment.
The firm has “always agreed with the underlying principle” of existing Labor Department rules stating that fees “should be reasonable and thoroughly disclosed up front” and that the advice should be in their best interest, said spokeswoman Mayura Hooper.
“Schwab’s IRA offerings are predominantly self-directed and we do not provide discretionary advice unless a client specifically asks us to,” Hooper said. “Along with the rest of the retirement industry, we don’t know what specific changes the DOL is contemplating. However, we are fully compliant with the existing version of the rule and will implement any new requirements if and when they are issued. In all instances, where Schwab provides discretionary investment advice to IRA accounts, we do so according to FINRA rules and all applicable DOL and IRS requirements.”
On the other hand, retirement account holders may not understand all of the different fees they’re being charged and those expenses may not be in their best interest, according to Micah Hauptman, the director of investor protection with the Consumer Federation of America.
“Rollover recommendations are among the most consequential recommendations. Even though its one-time advice, it should still be covered under the rule,” Hauptman said. “Most people reasonably believe that, when they work with someone who refers to themselves as an advisor or uses terms of trust and confidence, it’s appropriate to rely on their recommendations. Especially in a market where things are so complex and investors may not know what they should be doing, it's natural to rely on trusted experts to look out for their interests. But that isn't necessarily the case.”
For Borzi, the issue goes back to what she was hearing in her time with the agency “over and over again” from plan participants and sponsors, particularly at small businesses, she said. The employers “were desperately trying to do the right thing but got very bad advice,” Borzi said, clarifying that it was “not because the people who were giving them advice were bad people, but because of the way that the business model was structured.”
“The problem in this marketplace is the institutionalizing of bad financial incentives,” she said. “It's a compensation problem.”
Future steps on independent contractor definition
On the independent contractor rule, the next stage could play out in court if the agency appeals the decision in the case against the Labor Department filed by FSI, building and contractors organizations and a group called the
“The pressure for immediacy stems from the change of administration from that of Former President Donald Trump to President Joseph Biden,” Crone wrote. “While the Biden Administration sought additional time to review, revise and repeal the Trump Administration’s lingering regulations, that objective does not constitute an emergency or, further, meet the high bar necessary for good cause.”
The ruling “surprised a lot of people” because it treated the withdrawal of the rule as a legislative change, rather than an “interpretive” one amounting to guidance, according to Ruckelshaus of the National Employment Law Project. The Trump Administration’s Labor Department was the first to go through a formal rulemaking procedure defining an independent contractor, Ruckelshaus said. The agency has several potential options now.
“Because the ruling is very technical on the [Administrative Procedures Act] that the court says they did not follow, they could just undo it and reinstate the rule based on what the court says it has to do,” Ruckelshaus said, noting that there’s a “very heavy regulatory agenda” at the agency currently. “It has stated publicly that independent contractor classification, especially in low-paying jobs, is a priority because it's a big problem for a lot of workers who are told they're running their own business but they're really not.”
