Law360, New York (May 23, 2017, 2:04 PM EDT) —
The second — and final — comment period has closed on the U.S. Department of Labor document published in the Federal Register on March 2, 2017 (delay proposal), requesting comment on an examination, at President Donald Trump’s direction, of the DOL’s investment advice “fiduciary” regulation and related prohibited transaction exemptions (together, the final rule) adopted April 8, 2016. (The first comment period, for comments on a proposed 60-day delay of the applicability date of the final rule, closed on March 17, 2017.)
More than 130 comment letters were filed by firms, trade groups, coalitions, think tanks and other thought leaders (collectively, institution comment letters) since the close of the first comment period, and even more comment letters were filed by individuals. Now that Alexander Acosta, the new DOL secretary, has announced that the DOL will not be seeking a further delay of the applicability date and will be focusing its efforts on the examination, attention is shifting to the institution comment letters. What did they urge the DOL to do with its examination? This article summarizes the institution comment letters and offers a few observations regarding key issues and concerns.
Under the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code, a person is a “fiduciary” to a plan or an individual retirement account (IRA) if the person provides investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or property of the plan or IRA. A person who is a fiduciary is not permitted to engage in certain prohibited transactions unless exempted. In 1975, the DOL adopted a definition of “investment advice” fiduciary, using a so-called five-part test, for ERISA plans and over succeeding decades adopted various “prohibited transaction exemptions” available to fiduciaries to ERISA plans.
On April 8, 2016, the DOL adopted a final regulation defining who is an “investment advice” fiduciary (fiduciary regulation) to replace the five-part test that had been in place since 1975, adopted two new prohibited transaction exemptions (PTEs) — the best interest contract (BIC) exemption and the principal transactions exemption — and amended certain other PTEs to add, among other things, the “impartial conduct standards” that had been developed for the BIC exemption. In adopting the final rule, the DOL established April 10, 2017, as the “applicability date,” when the final rule’s provisions would take effect. The final rule was promptly challenged by several trade groups and other affected parties, and over the course of the past year, three separate legal challenges have been winding their way through the courts and are currently under appellate review. A recently filed motion for an injunction was denied by the district court and promptly appealed; the parties are awaiting an appellate decision.
On Feb. 3, 2017, just two weeks after his inauguration, Trump issued a memorandum directing the DOL to examine whether the final rule may adversely affect the ability of Americans to gain access to retirement information and financial advice, and to prepare an updated economic and legal analysis concerning the likely impact of the final rule as part of the examination. The president’s memo also directed the DOL to commence a rulemaking rescinding or revising the final rule if the DOL makes an affirmative determination on three considerations posed by the memo, or conclude for any other reason that the final rule is inconsistent with administration priorities. On March 2, 2017, the delay proposal was published, requesting comment on a proposed 60-day delay in the applicability date, for which the delay proposal established a comment period ending March 17, 2017, as well as on the questions raised in the president’s memo and generally on questions of law and policy concerning the final rule, for which the delay proposal established a comment period ending April 17, 2017.
The DOL reported receiving approximately 193,000 comments and petition letters by March 17, 2017, addressing the proposed 60-day delay. On April 6, 2017, the DOL’s document approving a final rule delaying the applicability date for 60 days to June 9, 2017, as proposed, was published in the Federal Register; this document also modified provisions of the BIC exemption and PTE 84-24 as they would be in effect beginning June 9, 2017, until the end of the year. The second comment period closed 11 days later, on April 17, 2017. By then, more than 300 letters had been submitted since the close of the first comment period. The DOL is currently conducting the examination directed by the president’s memo, including reviewing the comment letters submitted.
Who Filed Comment Letters?
Institutions Submitting Comment Letters
As noted above, approximately 130 comment letters were filed by firms, trade groups, coalitions, think tanks and other thought leaders after the close of the first comment period. These letters can be grouped into: (1) letters from institutions supporting the rule; (2) letters from institutions focusing on a single issue; and (3) letters from institutions generally opposing the implementation of the final rule as adopted by the DOL last year.
Institutions Supporting the Final Rule
Roughly 30 of the institution comment letters offered broad support for the final rule, and urged the DOL to move forward with reaffirming the final rule without delay or revision. This group included:
Four consumer groups and coalitions (AARP, AFL-CIO, Americans for Financial Reform (a coalition of over 250 groups seeking to reform the financial industry that submitted two letters), and Consumer Federation of America (CFA));
Two financial planning trade groups (Financial Planning Coalition and CFA Institute);
Four trial and employment lawyer trade groups (National Employment Law Project (NELP), National Employment Lawyers Association, Public Investors Arbitration Bar Association (PIABA), and American Association for Justice);
Two law schools (University of Miami Investor Rights Clinic and St. John’s University Securities Arbitration Clinic);
Two state attorneys general (California and New York Attorneys General) and three state and local agencies; and
Five think tanks and thought leader organizations (Better Markets, Committee on Investment of Employee Benefit Assets, Center for American Progress, Economic Policy Institute, and the Committee for the Fiduciary Standard).
Several firms engaged in the financial services business also submitted comment letters supporting the implementation of the final rule without change. Notably, the CFA’s comment letter went beyond the scope of the final rule and called upon the administration to extend the final rule’s protections to nonretirement accounts through rulemaking by the U.S. Securities and Exchange Commission.
Single-Issue Comment Letters
A handful or so of the institution comment letters were submitted by trade groups and firms focusing on one or two discrete issues implicated by the rule, such as the comment letters submitted by the American Bankers Association HSA Council and the National Association of Health Underwriters, which urged that health savings accounts (and medical savings account in the case of NAHU) be excluded from the scope of the final rule.
Similarly, the Bond Dealers of America urged reconsideration of the final rule’s impact on municipal bond transactions for retirement accounts, given that the final rule imposes a blanket prohibition on principal transactions in municipal bonds by fiduciaries. B.C. Ziegler and Company, a firm that underwrites so-called church bonds and other bonds issued by 501(c)(3) community organizations, noted that the fiduciary rule would not provide a PTE relevant to transactions in those types of bonds and urged the DOL to address this gap. Several comment letters, including one filed by the American Bankers Association, expressed concern with the import of a conflict of interest FAQ published by the DOL in January 2017 concerning recommendations to purchase life insurance with required minimum distributions from an ERISA plan or IRA account. (The DOL issued its first set of FAQs on Oct. 27, 2016, a second set on Jan. 13, 2017, and and a third set on May 22, 2017.) The ABA comment letter urged the DOL to consider clarifying that the definition of “investment property” in the investment advice fiduciary regulation excludes any product regulated as insurance by state insurance authorities.
Institutions Opposing the Final Rule
The remaining institution comment letters (industry letters) urged substantial changes to and/or repeal of the final rule. More than 65 of the industry letters were submitted by individual organizations, including more than 30 broker-dealer firms, roughly 25 insurance companies and insurance marketing organizations, and more than 10 firms that provide record keeping and/or asset management services to ERISA plans and IRA investors. Just under 30 industry letters were submitted by trade groups, think tanks and other thought leaders, including:
Two broker-dealer trade groups (Securities Industry Financial Markets Association (SIFMA) and Financial Services Institute (FSI))
Eight insurance industry trade groups (American Council of Life Insurers (ACLI), Committee of Annuity Insurers (CAI), Insured Retirement Institute (IRI), National Association for Fixed Annuities (NAFA), Indexed Annuity Leadership Council (IALC), AALU, Independent Insurance Agents & Brokers of America Inc., and National Association of Insurance and Financial Advisors (NAIFA));
Five investment adviser and mutual fund trade groups (Investment Company Institute (ICI), Investment Advisers Association (IAA), Money Management Institute (MMI), and SIFMA’s Asset Management Group);
Seven other industry trade groups (Chamber of Congress (Chamber), American Retirement Association (ARA), Defined Contribution Institutional Investment Association (DCIIA), the SPARK Institute Inc., Investment Program Association (IPA), Managed Funds Association (MFA), and the Public Non-Listed REIT Council of the NAREIT);
Four think tanks and other thought leaders (Americans for Prosperity, Financial Services Roundtable (FSR), American Council for Capital Formation, Washington Legal Foundation (WLF)); and
One law school (George Mason University law school).
Notably, the U.S. House of Representatives Committee on Education and the Workforce also submitted a comment letter during the second comment period expressing its opposition to the final rule.
The industry letters across the board urged the DOL to consider a further delay in the applicability date for the final rule beyond the 60-day delay proposed in the delay proposal. SIFMA submitted a legal memorandum outlining a process for delaying the applicability date in light of the Administrative Procedures Act. The industry letters reflected different views regarding the ultimate fate of the final rule. Some of the letters submitted by trade groups, think tanks and thought leaders urged the DOL to consider substantial revisions to the final rule (SIFMA, IAA, ICI, MMI, IALC, AALU). Others, though, urged the DOL to repeal the rule (IRI, CAI, FSI, ACLI, NAFA and NAIFA), with the rest urging the DOL to either revise or repeal the rule (PIABA, Chamber, FSR and Washington Law Foundation).
Comments Responding to the President’s Memo
The delay proposal requested comment on the three questions that the president’s memo directed the DOL to consider during its examination of the final rule. The president’s memo also directed the DOL to consider whether the final rule is inconsistent with the administration’s priority to “empower Americans to make their own financial decisions, to facilitate their ability to save for retirement and build the individual wealth necessary to afford typical lifetime expenses, such as buying a home and paying for college, and to withstand unexpected financial emergencies.”
Reduction in Access to Products and Services?
The president’s memo directed the DOL to consider whether the anticipated applicability of the final rule has harmed or is likely to harm investors due to a reduction of Americans’ access to certain retirement savings offerings, retirement product structures, retirement savings information, or related financial advice. Comment letters submitted by consumer groups generally argued that the final rule would not have that impact; AARP, for example, asserted that the final rule allows a “wide variety of investment products.” The CFA asserted that the final rule has spurred pro-investor innovations in investment products. Industry letters on the other hand, offered reports and information indicating that, in the IRA market, firms are considering various restrictions and limitations on products and services for IRA investors, such as moving IRA brokerage clients to a self-directed (i.e., no advice) platform, and limiting or restricting products (such as certain classes and types of investments) or services (such as only fee-based accounts). (SIFMA, FSI, Chamber.)
Americans for Prosperity referenced several studies and reports, including a NERA Economic Consulting study estimating that more than 57 percent of current retirement savings account holders will be forced out of their current plan by the final rule, a Brookings Institution estimate of consumer losses as high as $80 billion, and an Oliver Wyman report concluding that the rule could raise the price of financial advice by nearly 200 percent. Several industry letters cited an April 2017 Oxford Economics Report, “How the Fiduciary Rule Increases Costs and Decreases Choice.” Other letters, including the ICI’s, offered analyses showing that retirement investors would pay more over time for investment advice if they were limited to fee-based accounts as many have predicted.
Dislocation or Disruption in Services?
The president’s memo directed the DOL to consider whether the anticipated applicability of the final rule has resulted in dislocations or disruptions within the retirement services industry that may adversely affect investors or retirees. The CFA’s letter quoted public statements by senior executives with a number of companies in the financial services industry purportedly indicating that they are “prepared to implement the rule without significant disruption.” But many of the industry letters expressed concern that the final rule would cause industry members to shift away from commission-based accounts to fee-based accounts to the potential detriment of retirement investors. A few industry letters noted that the compliance costs associated with the final rule will force further consolidation of smaller firms, ultimately reducing choice and access. Some letters referred to the Oxford Economics study and Oliver Wyman study noted above, which suggest that consolidation would restrict professional investment advice to only high-net-worth investors. The FSI’s letter cited a study estimating that 7.2 million IRA investors would lose access to services due to account minimums.
Potential Increase in Litigation?
The president’s memo directed the DOL to consider whether the final rule is likely to cause an increase in litigation, and an increase in the prices that investors and retirees must pay to gain access to retirement services. Letters supporting the final rule, such as the letter submitted by NELP, generally argued that there was no evidence suggesting that there would be a new wave of litigation. Industry letters, such as the CAI’s and FSI’s, countered that the final rule, particularly the BIC exemption, creates new and significant litigation risk, pointing out that even meritless litigation can be costly. Industry letters, such as FSI’s, also pointed out that class action litigation under ERISA has been increasing in recent years.
Further, several industry letters, including the ACLI’s letter, noted that the DOL’s regulatory impact analysis (RIA), published in conjunction with the adoption of the final rule, did not take into account the potential litigation costs associated with the BIC exemption. DCIIA’s letter pointed out that the RIA projected increased insurance coverage costs in relation to the additional compliance and litigation risks resulting from the implementation of the final rule, but did not take into account costs and claims not covered by insurance. Several industry letters, including those submitted by ACLI, IRI and FSR, referred to a Morningstar analysis that estimated annual costs of $70 to $150 million for class action settlements arising under the final rule.
Inconsistent with Administration Priorities?
Several institution comment letters offered views on whether the final rule is inconsistent with the administration’s priorities for Americans. American Association for Justice, which supports moving forward with the final rule, argued that the president’s memo and resulting delay “does the opposite.” But industry letters, including FSI’s, asserted that the final rule would be inconsistent with the administration’s priorities because it would limit investors’ access to professional financial advice and education, limit investment options, increase costs to investors through compliance burden and the threat of private litigation, and discourage investors from seeking professional financial advice to increase their individual wealth.
Key Points Raised in Industry Letters
The Industry letters generally asserted, to varying degrees, the following points:
The DOL’s RIA published in conjunction with the adoption of the final rule was seriously flawed and the DOL needs to conduct additional cost-benefit and economic analysis. The RIA had relied to a considerable extent on a Council of Economic Advisors report estimating that conflicted advice costs retirement investors $17 billion. Industry letters generally made three points: (1) that the data supporting this estimate, as well as other cost-benefit estimates on which the RIA relied, were outdated, misstated and/or improperly extrapolated, and in the case of one key study, the study had since been updated and significantly revised; (2) that other reports and studies show that investors receiving advice from financial professionals save more and have better investment outcomes than those who did not work with financial professionals; and (3) that the DOL itself in 2011 had estimated that consumers who invested without professional advice make investment errors that collectively cost them $114 billion per year.
The appropriate fiduciary standard for retirement accounts is a uniform standard of care adopted by the SEC, not the DOL. (Notably, a bill in the U.S. House of Representatives, the Financial CHOICE Act, would apply the SEC’s standard to advice provided to retirement accounts by broker-dealers and investment advisers.)
The final rule and the RIA reflected a bias against advice provided in a context in which the advice provider receives transaction-based compensation rather than ongoing asset-based compensation, as well as a bias against products that provide lifetime income guarantees, such as insurance products. NAIFA argued that the PTE structure for annuities under the final rule is particularly complex and confusing in that it splits up rules and requirements for annuities by type of product (fixed rate vs. all other types), making the offering of these products more difficult and costly. IALC asserted that the adverse treatment of fixed indexed annuities in the final rule was without merit.
The liability risk associated with being a fiduciary would result in a major shift to the use of passive investment strategies, such as indexing strategies, with potentially unintended consequences for the securities markets.
The delay proposal also presented a list of 20 questions on which the DOL requested comment. Comment letters generally did not address the 20 questions specifically, although, as discussed below, most of the industry letters urged changes to the fiduciary regulation and the BIC exemption. A few Industry letters, such as those filed by the Chamber and NAFA, responded to all 20 questions in the delay proposal. Also, in response to DOL’s questions about changes firms might be making, Morningstar submitted a white paper discussing the so-called “T” share and “Clean” share classes. The white paper explains that these classes are being developed by the mutual fund industry for retirement investors, and suggests that a move to the new share classes may “reduce conflicted advice” for investors.
Recommendations to Revise the Investment Advice Fiduciary Regulation
A number of Industry letters urged the DOL to reconsider the scope of the investment advice fiduciary definition in the final rule. Several industry letters, including SIFMA’s and WLF’s, urged the DOL to include a “seller’s exception,” one that would allow a person to avoid fiduciary status by disclosing that he/she is acting in a selling capacity and has conflicts doing so. Some industry letters, such as those submitted by SIFMA, IAA and MFA, also urged the DOL to reconsider the “hire me” exception and allow a person to provide more information about his/her services without the information being deemed a “gating” recommendation triggering fiduciary status.
Other industry letters urged the DOL to revisit the definition’s exception for persons dealing with “independent fiduciary with financial expertise” (IFFEs) describing the exception’s conditions as unduly restrictive and cumbersome, and in a few cases, suggesting that the exception be available for all plan fiduciaries and not be limited to those who manage at least $50 million in assets. A number of industry letters, including SIFMA’s and Spark’s, also complained that the exception from the investment advice definition for investment education is too narrow, particularly in the context of conversations regarding distributions from plans, and adversely impacts participants. Industry letters also asserted that the exception unnecessarily restricts call centers from providing helpful information to plan participants. A couple of trade groups, including SIFMA’s Asset Management Group and ACLI, as well as firms, urged the DOL to restore a mutuality provision to the investment advice fiduciary definition, as was included in the five-part test. They also urged DOL to reconsider the application of the final rule in the IRA rollover context.
Recommendations to Revise the BIC Exemption
Industry letters also urged the DOL to make a number of changes to the BIC exemption. For example, a number of industry letters urged the DOL to eliminate the written contract requirement applicable to retirement accounts not subject to ERISA. Relatedly, they also urged the DOL to permit arbitration for class actions. Several industry letters focused on the “best interest” standard as codified in the BIC exemption, and urged the DOL to remove the limiting phrase that recommendations must be made “without regard to the financial interest of the adviser, financial institution or affiliates or other party,” noting that it was an untested and undefined standard.
Industry letters also urged the DOL to modify its requirement for levelized compensation, noting that, particularly in the commission-based model, levelizing compensation at the adviser level has not been operationally feasible. SIFMA also described significant operational difficulties created by the BIC exemption’s requirement to provide on-demand fee and cost disclosure to retirement investors. SIFMA’s letter also asserted that the website disclosure requirement is “overly broad, very impractical and extremely costly and cumbersome to build, administer and maintain.” Finally, several comment letters argued that the safe harbor within the BIC exemption for a “level fee fiduciary” has not proven to be practical, nor has the safe harbor for pre-existing transactions.
The new applicability date for the final rule is June 9, 2017, a couple of weeks away. The new DOL secretary has announced that the DOL will not be taking administrative action to further delay the applicability date before June 9, and is focusing on its examination of the final rule. The Financial CHOICE Act, noted above, which would among other things repeal the final rule, is moving its way through the U.S. House of Representatives, but final action before June 9 seems doubtful. The trade groups that filed a preliminary injunction against the final rule are still awaiting a decision on their appeal. Meanwhile, the DOL has a lot of comment letters to review and consider as it proceeds with its examination of the final rule.
Susan Krawczyk is a partner at Eversheds Sutherland in Washington, D.C.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice. 82 F. Reg. 12319 (March 2, 2017).  A. Acosta, Deregulators Must Follow the Law, so Regulators Will Too, Wall Street Journal, May 23, 2017, A19.  81 F. Reg. 20946 et seq. (April 10, 2016).  Chamber of Commerce, et al, Plaintiffs-Appellants’ Emergency Motion for an Injunction Pending Appeal, U.S. Court of Appeals for the Fifth Circuit, No. 17-10238 (March 21, 2017).  82 F. Reg. 9675 (Feb. 7, 2017).  82 F. Reg. 16902 (Apr. 7, 2017).  DOL Employee Benefit Security Administration, Conflict of Interest FAQs (Part I – Exemptions), Oct. 27, 2016, available at https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our- activities/resource-center/faqs/coi-rules- and-exemptions- part-1.pdf; DOL Employee Benefit Security Administration, Conflict of Interest FAQs (Part II – Rule), Jan. 13, 2017, available at https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our- activities/resource-center/faqs/coi- rules-and-exemptions- part-2.pdf; and DOL Employee Benefit Security Administration, Conflict of Interest FAQs (Transition Period) available at https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi- transition-period.pdf.  Financial CHOICE Act of 2017, H.R. 10, 115th Cong. (2017).