Who to Trust With Your 401(k): DOL’s Fiduciary Rule Explained

The US Labor Department faces the daunting task of sifting through more than 17,000 public comments it received on a proposed rule that would strengthen investor protections against conflicts of interest in retirement advice.

The barrage of comments submitted ahead of Tuesday’s deadline show the DOL’s Employee Benefits Security Administration has struck a nerve on Wall Street with the fourth attempt over more than a decade to revise fiduciary conduct rules. The proposal unveiled in November would broaden the kinds of financial advice held to the strictest fiduciary standard under federal benefits statutes and common trust law.

Interactive timeline: The Biden Department of Labor’s newly proposed rule is the fourth reiteration of fiduciary regulations since they were first introduced during the Ford administration.

If finalized, the rule would give the federal government new authority to scrutinize retirement account rollovers and monitor insurance companies increasingly staking claims in workplace 401(k)s. Financial advisers, meanwhile, would be prohibited from earning commissions on the products they sell without complying with toughened legal exemptions the department is also reforming under the proposal.

Regulators say they’re rooting out bad apples from the retirement investment marketplace and ensuring financial advisers are well informed before they make decisions that affect their clients’ life savings. Industry groups representing 401(k) plan service providers claim the department is improperly lumping sales conduct and true financial advice together and that a fiduciary-only standard will price out low- and moderate-income investors.

1. What is a fiduciary?

A fiduciary is a representative legally bound to put their clients’ interests above their own. In the world of retirement benefits, the term applies to those responsible for overseeing workplace plans or investing money on behalf of individual retirement account holders.

The Employee Retirement Income Security Act of 1974 (Pub. L. No. 93-406) defines an investment advice fiduciary as someone who renders such advice “for a fee or other compensation, direct or indirect, or has any authority or responsibility to do so.”

In Title I ERISA plans such as pensions, 401(k)s, or 403(b)s that are directly managed by an employer, fiduciaries have a duty of prudence and loyalty that are backed up by a private right of action; participants and beneficiaries can sue their employer if they run afoul of their fiduciary duties. Title II plans such as IRAs are sponsored by an individual, but, just like 401(k)s, their investment management fiduciaries can’t carry out “prohibited transactions” that are generally designed to prevent conflicts of interests from clouding judgment.

Fiduciary duties are rooted in common trust law dating back to before the country’s founding, but EBSA alone has the authority to clarify what constitutes fiduciary duties and to determine the process for exempting prohibited transactions. The original, 1975 five-part test from the agency defined an investment advice fiduciary as someone who:

1. “renders advice to the plan as to the value of securities or other property, or makes recommendations as to the advisability of investment in, purchasing, or selling securities or other property;
2. “on a regular basis;
3. “pursuant to a mutual agreement, arrangement, or understanding with the plan or plan fiduciary;
4. “for which the advice will serve as a primary basis for investment decisions with respect to the plan;"
5. and “for which the advice will be individualized based on the particular needs of the plan.”

2. What would the proposed fiduciary rule do?

The proposed rules package (88 Fed. Reg. 75890–76045) would eliminate the 1975 five-part test and replace it with a simplified version that largely hinges on whether recommendations are based on a person’s “particular needs or individual circumstances” and if an investor would reasonably believe that the advice is meant to be in their best interest.

It may appear pretty straight forward, but by nixing some key features of the old five-part test, EBSA is inserting itself into new areas of the investment management landscape.

Take the original “regular basis” component: By eliminating it, DOL would have the ability to apply a “fiduciary duty” to advisers who make a single recommendation to roll over all or part of an investor’s 401(k) into an IRA or an annuity offered by an insurance company.

The Biden administration has said it believes account rollovers like that are “among the most, if not the most, important financial decisions” plan or IRA participants and beneficiaries can make.

If an adviser gets more money by funneling their client’s funds into a product with higher fees and lower returns, they may be inclined to put their own interests first. If they aren’t held to a fiduciary standard, there may be nothing stopping them from doing that, and the account balance will suffer, the DOL says.

Industry groups have pushed back at that notion, pointing out that other state and federal regulators now require best-interest standards in all transactions.

The proposal would also eliminate the “mutual agreement” and “primary basis” prongs in the five-part test the DOL says advisers have used to skirt fiduciary duties by writing fine-print disclosures.

3. How bad are investment advice conflicts of interest?

There is some evidence that retirement plan participants who receive fiduciary investment advice are sold better investment products. A 2019 American Economic Review article the DOL pointed to in its proposal found that, under lighter regulatory standards, “advisers were more likely to receive complaints, particularly advisers with past complaints or with conflicts of interest.”

Aggregate rollover transactions are expected to surpass $4.5 trillion by 2027, according to a Cerulli Inc. estimate. The Council of Economic Advisers in 2015 said $1.7 trillion of IRA assets were invested in products with a payment structure that generates conflicts of interests.

The US Securities and Exchange Commission adopted a best-interest standard for securities transactions in 2019. The rule does overlap with ERISA somewhat, the DOL said, but it doesn’t account for advice regarding alternative assets such as real estate, nor does it protect retirement plans themselves.

More than 40 states have also adopted a best-interest model for insurance-related sales, but the model language differs slightly between states and carves out monetary compensation from its list of potential conflicts.

There’s also evidence that a standard applying fiduciary standards more broadly drives up the cost of investment advice. When the Obama administration finalized a substantially similar fiduciary rule in 2016, more than 10 million smaller retirement account owners with more than $900 billion in savings lost the ability to work with their preferred financial professionals, a Deloitte LLP study found in 2017.

The Obama-era rule was eventually vacated by the US Court of Appeals for the Fifth Circuit for violating an administrative procedures law and for stepping outside the bounds of the common-law understanding of fiduciary duties.

4. What’s next for the fiduciary rule?

The community of industry critics and Wall Street heavyweights that oppose the rule have a lot of sway in the halls of Congress and federal agencies. Pressure from businesses have tanked prior fiduciary proposals, but senior department officials have said they remain committed to seeing these investor protections through.

Already, the DOL has received pressure from Democrats and Republicans to extend the comment period on the proposed rule. The 60-day window that expired Tuesday is significantly shorter than the Obama-era 2010 and 2016 rules. The agency may be rushing to complete the rule well ahead of the general election in order to avoid a congressional review.

Regardless of when the rule is finalized, lobbyists have all but promised to challenge it in federal court. The proposal suffers many of the same setbacks that defeated the Obama-era version in the Fifth Circuit review, critics say.

Yet, the DOL has morphed the proposal by introducing language that suggests that an investor would need to reasonably believe that the advice they’re receiving is fiduciary in nature.

The prior rule’s requirement that IRA companies enter into a private-right-of-action contract with their participants was also left out of the new proposed rule, but it remains to be seen how courts will determine whether ERISA Title I fiduciary status could be applied to advisers recommending rollovers into ERISA Title II plans.

To Learn More:

• DOL Faces Democratic Pressure to Extend 401(k) Rule Comments
• Wall Street Firms Demand Complete 401(k) Advice Rule Withdrawal
• New 401(k) Fiduciary Rule Undermines Exemption, Advocates Say
• Biden 401(k) Rule Triggers New Look at Employer Provider Risks
• 401(k) Fiduciary Rule Encounters Republican Pushback in Congress
• 401(k) Fiduciary Rule Comments Extension Request Denied by DOL
• Fiduciary 401(k) Proposal a ‘Broadside Attack’ on Annuity Market
• Biden Rolls Legal Dice by Proposing Fourth Fiduciary 401(k) Rule