The 5th Circuit has taken away the U.S. Department of Labor’s ability to enforce its fiduciary rule which extends the common law meaning of “fiduciary” to broker-dealers, insurance agents, and other sales people. The DOL now has until June 14, 2018 to appeal the 5th Circuit decision to the U.S. Supreme Court,but that’s not likely to happen given the Trump administration’s position on the DOL fiduciary rule. However, the SEC has recently stepped into the fiduciary rule arena by proposing its own fiduciary rule (with similar but less stringent standards than the DOL fiduciary rule) over broker-dealers.
The Trump administration previously delayed full implementation of the DOL fiduciary rule while it reassessed the regulation. A related lawsuit was brought by several industry groups that opposed the DOL fiduciary rule, including the U.S. Chamber of Commerce. After a Dallas district court upheld the DOL fiduciary rule in 2017, the case was then appealed to the 5th Circuit, and the court struck down the DOL fiduciary rule on March 15, 2018.
Here’s a 2018 timeline of the DOL’s and SEC’s activity related to the fiduciary rule:
March 15 –5th Circuit decides to strike down the DOL fiduciary rule
April 18 –SEC proposes its own version of the fiduciary rule
April 30 –DOL fails to file for en banc review before the 5th Circuit before the deadline
May 2 –5th Circuit denies intervenor status to CA, NY, and Oregon on the DOL fiduciary rule
June 14 –Deadline for DOL to appeal the 5th Circuit’s decision to Supreme Court
August 7 –Comments on SEC fiduciary rule proposal are due
The 5th Circuit has not yet issued the mandate that would put its March 15 decision into effect.
DOL Likely to Stay Passive in Defending the Rule
Based on the Trump administration’s willingness to delay the full implementation of the DOL fiduciary rule and the DOL’s decision to not file for en banc review before the 5th Circuit, the Department of Justice is not likely to appeal this case to the U.S. Supreme Court. As a result, the DOL fiduciary rule will likely die in court. Now the spotlight shifts to the SEC’s attempt at regulating broker-dealers in the context of safeguarding retirement savings.
SEC’s Proposal on Best Interest Obligation takes Center Stage
SEC Proposal –Regulation Best Interest
The SEC proposed its own version of the fiduciary rule on April 18, 2018 –requiring broker-dealers, and natural persons who are associated persons of a broker-dealer, to "act in the best interest of the retail customer without placing the financial or other interest of the broker-dealer ahead of the retail customer's interest.” The SEC proposal doesn’t actually define the term “best interest,” rather it imposes specific disclosures, care and conflicts of interest obligations on broker-dealers (and those associated with broker-dealers).
There are many differences between the two fiduciary rules but the biggest difference seems to be the scope of the transactions covered. In comparison to the SEC proposal, the DOL fiduciary rule applies to a significantly larger amount of potential transactions involving brokers and dealers.The SEC proposal would only apply to certain recommendations to a “retail customer.” A retail customer is defined as“a person, or the legal representative of such person, who:(A) Receives a recommendation of any securities transaction or investment strategy involving securities from a broker, dealer, or a natural person who is an associated person of a broker or dealer; and (B) Uses the recommendation primarily for personal, family, or household purposes.” In contrast, the DOL fiduciary rule applies to"recommendations by persons who represent or acknowledge that they are acting as a fiduciary within the meaning of the ERISA or the Code; advice rendered pursuant to a written or verbal agreement, arrangement, or understanding that the advice is based on the particular investment needs of the advice recipient;and recommendations directed to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA."
Required Disclosures, Care Obligation, and Conflicts of Interest
Generally, a broker-dealer must disclose to retail customers:
an explanation that the broker-dealer is acting in her "broker-dealer" capacity in the context of any investment recommendation;
a description of the fees and charges that apply to the retail customer's transactions, holdings, and accounts;
a description of the type and scope of services provided by the broker-dealer; and
a description of all "material" conflicts associated with the recommendation.
The SEC proposal’s Care Obligation requires a broker-dealer to consider alternative products when making a recommendation to a retail customer. Generally, broker-dealers must have a reasonable basis for their recommendation.The recommendation must be in the best interest of the customer and must take into account the suitability of the recommendation with respect to the customer’s situation. Broker-dealers are not required to recommend only the lowest cost product available.
The Conflict of Interest Obligations require broker-dealers to establish and enforce policies and procedures designed to identify, disclose, mitigate, or eliminate material conflicts of interest.
Comments on the SEC’s proposal should be received on or before August 7, 2018.
Regulation of Brokers and Dealers is (Still) Necessary
In balancing the vulnerability of retirees against the financial incentives of brokers and dealers related to the sale of investment products, clearly the advantage lies with brokers and dealers. The DOL recognized this vulnerability and the lack of regulation. As a result, the DOL developed the DOL fiduciary rule –arguably the best regulator when it comes to understanding fiduciary duties, especially when an individual’s life savings at retirement is at stake. However, there are many that believe the SEC is the more appropriate regulator when dealing with the application of fiduciary standards to brokers and dealers because the SEC (to a large extent) already regulates the industry and its sales practices.
The DOL’s mission through the Employee Benefits Security Administration is “to assure the security of the retirement, health and other workplace related benefits of America's workers and their families...” so it’s difficult to believe that the DOL would simply abandon the DOL fiduciary rule. Given the countless hours of agency work towards promulgating the DOL fiduciary rule, the DOL may ultimately ask the U.S. Supreme Court to decide its final fate. Meanwhile, if the DOL fiduciaryrule dies in the court system, the vulnerability of retirees remains the same, pending the final version of the SEC proposal.
Boutwell Fay LLP 2018, All Rights Reserved.This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us.The information contained in this article is effective as of May 31, 2018.