RPC Reg Spotlight May 2, 2011

 

UPDATE:

 

On September 19, 2011, the Department of Labor announced that it planned to re-propose its rule to redefine the term “fiduciary” in an effort to clarify and address concerns so as to help mitigate the potential negative impact of the proposed rule.  The extended review is expected to push the eventual issuance of a new rule into 2012.

 

Regulatory Action in the Spotlight:

 

Department of Labor’s (DOL) Proposed Rule Redefining “Fiduciary”

 

Adverse Effects:

 

  • Creates conflicts with existing securities laws.
  • Adds significant costs to investing for IRA account holders.
  • Requires appraisers who place a value on investment to take on fiduciary status.
  • Potentially impacts the ability of millions of Americans to save for retirement.

 

Response of the Obama Administration:

 

The DOL has proposed a new definition of ERISA’s “fiduciary” (75 Fed. Reg. 65263), which will lead to increased costs and complexity and less choice for plans and IRA’s while increasing confusion for service providers.  The current definition of “fiduciary” encompasses advisors giving “investment advice for a fee or other compensation” and limited this provision to investment professionals providing “regular” investment advice serving as the “primary basis” for a plan’s investment decisions (29 C.F.R. § 2510.3-21(c)). 

 

Under the DOL’s newly proposed regulations, any individual who provides any advice regarding the “value, management or purchasing or selling of securities” to an ERISA plan becomes a fiduciary, even if that advice was not delivered on a “regular” basis or it was not the “primary” reason for the plan’s investment decision. This rule would also apply when investment professionals provide advice to a participant in an ERISA plan regarding investments in a defined contribution plan, like a 401(k) plan.

 

Impact on the United States:

 

  • Currently the SEC, under Dodd-Frank, and the DOL are working on defining fiduciary standards.  Many of the issues addressed by the SEC would affect firms and individuals covered by the DOL’s proposed fiduciary rule, creating a possible conflict of compliance. 
  • Costs will rise for IRA accounts.  Under the proposed rule, brokerage firms will presume that offering accounts and services, having a conversation, or practically any interaction with a client creates a fiduciary relationship.  As the rule will limit variable levels of compensation, brokerage firms will more than likely offer their current level of service to IRA accounts only through a fee-based approach.  A non-fee-based IRA may still be offered, but with very few services as to avoid establishing a fiduciary relationship.
  • The DOL proposal will require appraisers and others who place a value on investment to take on a fiduciary status.  Providers of these services will either exit the business or significantly increase fees to cover the added risk.  Owning investments such as real estate, swaps, or venture capital in IRA’s and by ERISA investors may prove difficult due to reluctance by appraisers to provide valuation.

 

In Closing:

 

The proposed DOL regulations create conflicts with existing securities laws and new rules expected from the SEC and CFTC under Dodd-Frank.  By expanding the definition of “fiduciary,” providing an appraisal or valuation will create a fiduciary status under ERISA and could result in providers exiting the business, increasing fees, and forbidding certain investment vehicles for ERISA investors and IRA account holders.

 

By imposing a fiduciary duty on virtually all communication between an investment professional and an IRA account holder, investors will be left with the choice of paying for full-service accounts or a low-cost account with minimal communication to avoid a fiduciary duty.  According to a study by the global management consulting firm Oliver Wyman, “…the proposed (DOL) “fiduciary” definition rule is likely to have serious negative and unintended effects on the very individuals the change is supposed to help.”  Furthermore, they concluded, “…that the proposed rule will disproportionately negatively affect small balance IRA investors…denying millions of current and future IRA investors access to professional investment help and investment services…and increasing overall costs for such support when available.”

 

Relevant Legislation:

 

The comment period for this proposed rule closed on February 3, 2011.  The record from early March hearings remained open until April 12th for additional comments.  In a March 15th letter to Secretary of Labor Solis, SEC Chairman Schapiro, and CFTC Chairman Gensler, Rep. Spencer Bachus, Rep. John Kline, and Rep. Frank Lucas, Chairmen of Financial Services, Education and the Workforce, and Agriculture Committees respectively, voiced their concerns on the lack of coordination and consultation between agencies.  With agencies proposing regulations on the same subject, this could result in companies having to comply with conflicting regulations.  The Chairmen requested that the DOL suspend its ERISA rulemaking until Dodd-Frank rulemaking is completed and interagency conflicts can be resolved.