Views on improving the integrity of global capital markets
24 April 2015

DOL Unveils Fiduciary Rules: One Step Forward for Investors


The US Department of Labor (DOL) has released for public comment its proposed rules for imposing a fiduciary duty on those who provide investment advice to retirement plans and IRA account holders.

ln the 300-plus pages of proposals, the DOL has taken an innovative approach by neatly sidestepping many of the thorny issues that plagued its 2010 proposals. In particular, the rules are principles-based, which may offer a mechanism for those who provide advice to structure their businesses in a way that suits them while still offering investors assurance of a high standard of care. At the heart of the rules is a new “Best Interest Contract Exemption” that would allow for conflicts of interest between the investor and the firm and individual offering advice to remain, as long as the adviser agrees contractually to meet the fundamental obligations of fair dealing and fiduciary conduct. Fiduciary conduct in this sense is defined as giving advice that is in the client’s best interests; avoiding misleading statements; receiving no more than reasonable compensation; and complying with state and federal laws about giving advice.

The rules also take a functional approach to fiduciary duty, dispensing with many of the issues around which regulatory regime the different providers are subject to. They also remove the prior distinction between providing ongoing advice and offering recommendations on a one-time basis, properly reasoning that even single investment recommendations can be enormously consequential — consider, for example, the decision for how to roll over 401(k) account balances. Distinctions between education and advice are addressed, as well, with specific acknowledgment of the value of educational offerings to investors around longevity risk and approaches to addressing it that shouldn’t rise to a fiduciary obligation — but that stop short of pitching annuity products. Similarly, asset allocation approaches can be discussed as long as they don’t refer to specific vehicles that might be perceived by investors as advice.

The proposals provide the agency with regulatory flexibility but at the expense of precision, and that will create difficulties, especially at first; for example, the issue of what constitutes “reasonable compensation” for providing advice. Consequently, if these rules are ultimately adopted as is, we should expect some early legal tests on how these matters are defined by both investors and advisers and, as importantly, by judges. Longer term, though, the reasonable price provision could affect quality and quantity of service to many investors.

Another area of concern is in how the potential avenues for investor redress as potential disputes are adjudicated. The rules allow for advisers to mandate arbitration of disputes, which as we noted in our 2014 publication Redress in Retail Investment Markets: International Perspectives and Best Practices doesn’t always serve investor interests well. The rules do permit participation in class actions, thus preserving a “nuclear option” for redress that most would hope would be used rarely.

How the proposed rules would address principal-based fixed-income trades is another area prime for dissension. Such transactions would be permitted as long as the adviser gets two unaffiliated quotes, executes the client trade at a price at least as good as in the independent quotes, and discloses the mark-up to the client. Getting quotes might not be a trivial exercise as dealers reduce inventory and bond markets liquidity slips. This process could introduce costs that partially offset some of the benefits of superior execution. This, in turn, could push investors to invest in products like exchange-traded funds (ETFs) or mutual funds rather than building their own bond portfolios. Would this best serve an investor’s interests given their objectives and tolerances?

It isn’t hard to believe that there are plenty of lawyers suiting up to challenge the rules for plenty of reasons, but most especially on the basis of the quality of the cost/benefit analysis mandated by law for rules of such economic consequence. The White House Council of Economic Advisers provided evidence around the costs of conflicted advice that has stoked some spirited responses from the industry who questioned some of the data and extrapolations, and challenges to the DOL’s economic analysis can be expected. Nevertheless, it is hard to challenge the intuition that investors are better served by advisers who have their best interests in mind.

We hope that the rules progress successfully through the public comment period and that the SEC is taking notes. As it stands, investors still stand to be confused by multiple standards of care depending on how their adviser organizes its business and whether the assets in question are retirement assets or not. The proposed DOL rules improve things by requiring fiduciary conduct for those who advise retirement investors, eliminating the yawning gaps in the existing Employee Retirement Income Security Act (ERISA) and Internal Revenue Code rules that allow otherwise. The SEC’s Dodd-Frank mandate is to consider rules that impose a uniform fiduciary standard at least as robust as that in the Investment Advisers Act, but that also permits a commission-based business model. The DOL’s approach may be the first step to convergence, and during the comment period, as we all wade through the details, we expect better assessment for how the proposed DOL fiduciary obligations stack up with the behavior expected by the Advisers Act. But it is just a first step, and investors need more: their advisers should serve with investor interests foremost, no matter the context.

We suggest that the investment advice business is headed towards a de facto best interests standard in any event, but regulation will speed the inevitable evolution and end this confusing era of multiple standards. Opponents — and there is an informal bipartisan coalition in Congress along these lines — to changes in standards for those who provide investment advice suggest that fiddling with the current system would lead to abandonment of a whole class of investors who would be left on their own or to inadequate technology. In an age of robo-advisers specifically addressing the economies of scale of the advice business, that scenario seems increasingly unlikely. Even so, it may be a risk worth taking in comparison to leaving the least well-equipped investors with the biggest stake in the consequences of their investment decision-making — their retirement nest egg — at the mercies of advisers who can’t — or won’t — find a way to make a living at offering advice that is in their clients’ best interests. Loyalty, prudence, and care aren’t just legal concepts: they are the business model of our future.

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Image Credit: iStockphoto/Nikada

About the Author(s)
Bob Dannhauser, CFA

Bob Dannhauser, CFA, was the head of global private wealth management at CFA Institute.

1 thought on “DOL Unveils Fiduciary Rules: One Step Forward for Investors”

  1. John Stone says:

    Here are the steps to take care of this. 1) Involve Republican and some
    Democratic legislators to repeal Dodd-Frank. 2) Recruit old line professional Bankers (Not Wall Street type but- Community Bankers) to oversee
    all activity and rule making for the Brokerage/Investment Advisor Business.
    *This is about the dumbest conflict between agencies. Outsiders with common
    sense (hence conservative Community Bankers) need to be involved.
    3) Require consumer education before investing. 4) Provide consumers with
    an agency to go to for assistance before investing and allow them to waive
    their right. 5) ** Make all Brokers AND Investment Advisors provide a detailed disclosure indicating to the penny what they are paid for everything as well as examples of alternatives and what they would cost. This is unbelievable. We need different people involved with this to give it a fresh look. Clients always need to be treated fairly and their interest must come
    first. It is called INTEGRITY. This is really sad. I enjoyed your article.

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