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Fiduciary Definition Has Another Charlie Brown Moment

Will the DOL jerk the football away from those advocating for the fiduciary standard?

W. Scott Simon, 03/05/2015

W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award.


Note: This is the second month in a row that January's column, which was the first in a multipart series examining a public school district's 403(b) plan agreement, has been interrupted. But fast-breaking events have required me to postpone once more a return to that subject. Hopefully, April's column will pick it up again.

By nature, I'm an optimistic chap. Friends and family have always marveled at my famously peachy disposition. But after reading through the U.S. Department of Labor's (DOL) Frequently Asked Questions: Protecting Retirement Savings (FAQs), issued in conjunction with President Obama's speech before AARP on Feb. 23 advocating for a fiduciary definition by the DOL, I must admit that I've turned into a Gloomy Gus concerning the latest developments in what I've termed, in other columns, the fiduciary wars.

The DOL's FAQs reminded me of the comic strip Peanuts. Every fall, Lucy would offer to be the holder so that Charlie Brown could place-kick his football to begin the season. At the last moment, though, Lucy would inevitably jerk the football away, Charlie Brown would go flying through the air and land on his back, looking up at the clouds and emitting a big sigh. Every autumn Lucy promised Charlie Brown that she wouldn't do what she did last autumn, but she never kept her promise. As a result, Charlie Brown always ended up exasperated.

So, too, some of us that advocate for the fiduciary standard feel exasperated by the latest thinking from the DOL concerning its proposed fiduciary definition. If such indications turn out to be accurate, then we will end up with the worst of all worlds: continuing in place certain business models--which largely are the reason many participants in retirement plans get the short end of the stick in the first place--as long as they are coupled with disclosures of conflicts of interest, and then blessing all with the fiduciary moniker. Voilá! Presenting a new fiduciary standard twisted into a simple bundled disclosure of conflicts.

The old adage, "Be careful what you wish for," could not be more apropos.

No one more than I truly wishes that I'm 100% wrong about all this. But time and again during the fiduciary wars that have raged over a good part of the last decade, those forces that just don't want to be fiduciaries have managed to delay proposals (much less implementation of them) that would subject stockbrokers, insurance agents, those with such nebulous titles as "wealth managers," "financial planners," "retirement experts" as well other various and sundry "advisors" to a legally meaningful fiduciary standard. The business models that many of these brokers, et al. use allows them to suck a lot more money out of plan participants than would be the case if they were subjected to a legally meaningful fiduciary standard. Their huge war chests and the vast political power they buy allow them to continue impacting plan participants in such harmful ways.

Instead of signaling that the DOL's proposed fiduciary definition will have sufficient legal teeth to stop at least some of the egregious practices permitted by the corrupting business models in use by brokers, et al., the DOL's FAQs appear not only to continue to permit them to exist but to actually expand their use. For example, FAQ 2 reads, in part: "Although the proposal is still subject to interagency review and could change, we have said in the past that it will not prohibit common compensation practices, such as commissions and revenue sharing. It will include new proposed exemptions from ERISA's and the Internal Revenue Code's restrictions on fiduciaries receiving conflicted compensation…" One takeaway from this is that the DOL may allow even broader exemptions from the restrictions on fiduciaries' receipt of conflicted compensation. Another is that such exemptions may be narrowed.

These suppositions as all others are just that, since the DOL's proposed fiduciary definition won't be made public until it goes through an interagency review coordinated by the Office of Management and Budget, which could last three to four months (or perhaps shorter if it's put on a fast track). Add to that time period the publication of a "Notice of Proposed Rulemaking" (which will include an explanation of the proposed fiduciary definition), the time it will take for the public as well as other stakeholders to voice their comments, the time it will take for the DOL to review and digest all those comments, the time it will take the DOL to decide what to include in the final fiduciary definition, and the time it will take before any final definition actually goes into effect.

Given that scenario, it's likely that brokers, et al. will nibble the DOL's proposal to death so nothing may happen at all--at least not before the 2016 election. And if anything does happen, it could well be a worst-of-all-worlds fiduciary standard that allows fiduciaries-in-name-only to simply disclose conflicts of interest and be done with it. (Of course, there are big differences in mere disclosures, disclosures and knowingly understanding them, and the real transparency required of a true fiduciary.)

The fact that "common compensation practices, such as commissions and revenue sharing" are already incorporated from the get-go into the DOL's FAQs means that those who just don't want to be fiduciaries have already been influential in shaping the playing field to ensure that their business models are not harmed. Note that commissions, per se, are not the problem. Rather, the problem has to do with variable compensation--differences in commissions for different products. It's not difficult to see that an inherent conflict of interest exists when, say, two products thought to solve the same problem bear different commissions. In my view, that kind of situation is flat-out incompatible under any legally meaningful fiduciary standard. It's simply impossible to serve two masters.

Further, in FAQ 2: "These exemptions will include a new type of exemption that is more principles-based, providing businesses with the flexibility to adopt practices that work for them and adapt those practices to changes we may not anticipate, while ensuring that they put their client's best interest first and disclose any conflicts that may prevent them from doing so…The rule will not eliminate conflicts of interest, but it will mitigate them to protect consumers' interests." (The DOL's FAQs reference the "best interest" fiduciary standard that applies to fiduciaries governed by the Investment Advisers Act of 1940, instead of the "sole interest" fiduciary standard of ERISA section 404(a) that applies to fiduciaries of retirement plans. I'm not sure why that is.)

The term "principles-based" applies to the fiduciary standard. Fiduciary principles are open-ended and therefore subject to interpretation by the courts in a given situation. In my work as a fiduciary expert witness, for example, I'm often called on to determine whether, in a particular situation, a fiduciary has breached its duties in some way. I determine that by applying the principles found in the applicable fiduciary body of law at hand (such as ERISA or the Uniform Prudent Investor Act) to the facts and circumstances of the case (while incorporating my experience in the marketplace). In contrast, the term "rules-based" applies to the suitability standard. These cut-and-dried rules are applied to certain sales practices in a particular situation to determine whether they are suitable for a customer. Such rules provide, when followed scrupulously, a safe harbor for salespeople such as stockbrokers.

So when the DOL states that "These exemptions will include a new type of exemption that is more principles-based, providing businesses with the flexibility to adopt practices that work for them...," I cannot help but cringe. Allowing brokers, et al. to be governed by a more principles-based exemption--"providing businesses [brokers, et al.] with the flexibility to adopt practices that work for them [but not for plan participants, mind you]"--would seem to encourage their worst instincts in coming up with ever more clever ways to maximize their compensation at the expense of plan participants. Principles-based investing works well when legally meaningful fiduciaries are present, but that wouldn't seem to be true for fiduciaries-in-name-only, which I fear will be the end result of the DOL's efforts. On the other hand, perhaps brokers, et al. will be scared off by such a foreign concept as principles-based investing and instead lobby for the more familiar terrain of rules-based investing. In either case, plan participants wouldn't seem to benefit.

The DOL notes that any fiduciary definition will continue to allow brokers, et al. to provide general education on retirement saving to plan participants. Oh, boy. Such folks may recognize, in their face-to-face interactions with plan participants, little difference between advice and education. Instead, it's all sales to them. Just take a look at the pages on websites of insurance companies, brokerage firms, mutual fund companies, etc. They are designed solely to sell product under the guise of general investment education; they have no other reason for existing.

I'm not sure how blessing, with the fiduciary moniker, those business models that have largely created many of the problems impacting plan participants can be thought of as any form of progress. Corrupting business models are still corrupting business models even when they're legally permitted to attach the word "fiduciary." This is especially galling to those of us who know how such models actually operate in the retirement plan marketplace.

I repeat: No one more than yours truly hopes that I'm 100% wrong about all this. Among other things, I don't want those who have labored so long and hard to bring about true fiduciary reform in the retirement plan (as well as individual retail investor) marketplace to end up on their backsides like Charlie Brown, exasperated to find out that there will be no fiduciary reform at all, or be stuck with the worst of all worlds: fiduciaries-in-name-only simply disclosing conflicts of interest. In any event, let the fiduciary wars continue.




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 Understandingis 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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