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Time to Put the Kibosh on Fiduciary Exemptions

DOL should apply the most logical standard to everyone that deals with retirement plans: the 'sole interest' fiduciary duty.

W. Scott Simon, 07/12/2011

Have a comment, insight, or burning opinion on this article? Make your feelings known in the comments section at the end of the article.

The politically powerful trade associations are now more determined than ever to keep their investment advisor membership from having anything to do with the word "fiduciary." In a missive to its members that's remarkably straightforward, the Securities Industry and Financial Markets Association (SIFMA) has demanded that the Employee Benefits Security Administration (EBSA) of the Department of Labor (DOL) withdraw its proposed rule redefining a "fiduciary" and then re-propose it--in accordance, of course, with the dictates of SIFMA. Here are a few quotable nuggets from the SIFMA communication--followed by my interpretation of what I think they really mean:

  • "Given the importance of personal choice, your clients deserve strong protections from a new uniform fiduciary standard without sacrificing choice of products and services, or facing higher costs."
    Given the importance of flexibility to the profitability of your business model, there's no way that you should subject yourself to any fiduciary standard, which could prevent you from pitching the most lucrative products and services for your business.
  • The DOL "has proposed a new definition of fiduciary under ERISA.which will lead to increased costs and complexity and less choice for plans and individual retirement accounts which will negatively impact consumers."
    The DOL has proposed a new definition of fiduciary under ERISA.which will lead to decreased costs and complexity and greater low-cost choices for plans and individual retirement accounts, which will really hurt your profitability and your business model.
  • "It is imperative that you make your voice heard by joining the fight to protect your clients."
    It is imperative that you make your voice heard by joining the fight to protect your own business model.

This message to SIFMA members is somewhat ironic given that a number of polls have found that the membership of such trade associations is generally more open to being judged by a fiduciary standard than the leadership of these associations would seem to comprehend, based on their own missives.

The Seller's Exemption in the Proposed Rule
The rule proposed by the EBSA includes a nifty (for non-fiduciaries) provision known as the seller's exemption. Under the proposed rule, a "fiduciary" is anyone who provides "investment advice" which is defined as either (1) "recommendations on investing in, purchasing, holding, or selling securities" or (2) "recommendations as to the management of securities or other property."

And yet, a non-fiduciary such as a broker could still provide either kind of advice as long as (1) the broker represents that it isn't an ERISA fiduciary, (2) the broker isn't an ERISA fiduciary under either ERISA sections 3(21)(A)(i) or 3(21)(A)(iii), (3) the broker isn't an RIA, and (4) the broker doesn't provide individualized advice that's understood to be in connection with investment or management decisions with respect to plan assets. Given these four conditions, the broker won't be considered as providing ERISA-defined "investment advice" and therefore won't be an ERISA-defined "fiduciary." I noted in my last column that the seller's exemption in the proposed rule essentially swallows the rule.

So the key to avoid becoming a fiduciary when dealing with ERISA-qualified retirement plans is written disclosure. The head of the American Society for Pension Professionals and Actuaries (ASPPA) is most helpful in suggesting what this disclosure might look like: "If the advisor [e.g., a commission-based broker or other advisor] discloses to the client [e.g., the fiduciaries of a retirement plan] that they aren't acting in a fiduciary capacity, that they are being compensated by the plan provider [e.g., a broker/dealer, insurance company or mutual fund company] and they are transparent about the amount of the fees they are charging--and the client is OK with that--then they have satisfied their disclosure requirements."

While this suggestion may appear to be all sweetness and light, anyone who is experienced in dealing with retirement plans--and is truly honest in acknowledging the real limitations of a disclosure-only solution--knows differently. In the first place, many people--whether they're consumers, or fiduciaries of mom-and-pop or Fortune 500 401(k) plans--simply don't read disclosures. Others that do take the time to read them may do so until hell freezes over but will never understand the meaning of the disclosures on their own.

But not to worry because right at the side of such plan fiduciaries answering their questions will be those trusty folks who don't want to be fiduciaries (say, brokers, insurance agents, and benefits consultants). These folks will, no doubt, obligingly explain to the fiduciaries the meaning of the word "fiduciary" or will describe why, when a non-fiduciary is acting for a purchaser (or seller) on the other side of a transaction from the retirement plan, that will make the non-fiduciary's interests "adverse to the interests of the plan or its participants." Uh-huh.

Perhaps a DOL attorney who testified at the EBSA hearing in Washington, D.C., on March 1 defined the end-game of a disclosure-only solution best: "The mere fact that there was disclosure of the conflict may actually encourage them [e.g., plan fiduciaries] to believe, 'This guy [i.e., a non-fiduciary advisor] really does have my interests at heart. Look how honest he was. He told me about the conflict.'"

"Telling me about the conflict," of course, still (usually) doesn't mean that plan fiduciaries will have any understanding of plan issues such costs, risks, benefits or any of a myriad of other issues, thereby making it impossible for them to evaluate the extent of any such conflicts an advisor may have. This is often true even in cases where plan fiduciaries are (seemingly) sophisticated.

For example, in Braden v. Wal-Mart, the plaintiff Jeremy Braden--a Wal-Mart employee--alleges that plan sponsor Wal-Mart didn't carefully evaluate the investment options in the firm's 401(k) plan, including failing to consider trustee Merrill Lynch's interest in including funds that shared their fees with Merrill. Braden claims that Wal-Mart's failure condemned 1 million-plus plan participants (and perhaps an equal number--or more--beneficiaries) to seven retail-priced (and high retail-priced to boot) investment options in the $10 billion-plus Wal-Mart 401(k) plan, a plan that should have had significant bargaining power and access to lower-priced institutional share classes.

Or consider Tibble v. Edison International, a case in which plan advisor Hewitt didn't tell Edison that institutional class investment options were readily available in the marketplace. Edison appeared to be oblivious to such possibilities, which, if exploited, could have saved thousands of participants in the Edison multi-billion dollar 401(k) plan significant amounts of money, thereby generating higher compounding rates and boosting their plan account values that much higher.

The Platform Provider Exemption in the Proposed Rule
The EBSA proposed rule also has a platform provider exemption. This would allow a record-keeper--often affiliated with a non-fiduciary advisor--to go right on "recommending," "assisting," and "helping" plan fiduciaries make selection, monitoring, and replacement decisions concerning plan investment options. Many plan fiduciaries, of course, get sucked into thinking that a record-keeper is "taking care of things" when, in fact, the sponsor/record-keeper and/or sponsor/advisor contract(s) make clear that the sponsor still has sole responsibility and liability for any selecting/monitoring/replacement decisions.

The DOL should put the kibosh on both exemptions as well as many others that it has cobbled together over the years to allow non-fiduciaries such as broker/dealers to do business with qualified retirement plans. Then the DOL should apply the most logical standard to everyone that deals with retirement plans: the "sole interest" fiduciary duty of ERISA section 404(a). That necessarily means rejecting both a non-fiduciary standard and the "best interest" fiduciary standard of the Investment Advisors Act of 1940. Doing so would also have the great merit of doing away with the Rope-a-Dope sideshow of "harmonizing" a fiduciary standard played to such great effect by the powerful trade association lobbyists. It is these fiduciary issues that will be discussed in next month's column.  

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W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understanding is the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

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