August 11, 2017

Open Letter to the Office of Management and Budget

Re: Department of Labor’s Request for Additional Delay of Full Fiduciary Rule

The Department of Labor recently filed a request to delay the full effectiveness of the Department’s new fiduciary rule (Rule) for an additional eighteen months. I respectfully submit that said request should be denied, for the reasons set forth herein.

On June 9th, 2017, several portions of the DOL’s Rule went into effect, most noticeably the Rule’s Impartial Conduct Standards (ICS). The DOL has stated that the impartial conduct standards are “consumer protection standards that ensure that advisers adhere to fiduciary norms and basic standards of fair dealing.” The standards can be designated as

• The “best interest” standard – requires that advisers always act in the best interest of a “retirement investor.” The “best interest” standard actually consists of two separate fiduciary standards: the duty of prudence and the duty of loyalty.
• The “reasonable compensation” standard – requires that an adviser only receive “reasonable compensation in exchange for the advice and/or services provided to a customer.”
• The “misleading statements” standard – prohibits any misleading by an adviser regarding investment transactions, compensation, and conflicts of interest.

One of the key aspects of the Rule was the inclusion of the Best Interests Contract exemption (BICE). BICE would allow financial advisors to sell commission-based investment products to plan participants, sales which would otherwise be prohibited due to the inherent conflict of interest involved with such commission-based products.

In order to qualify for BICE, financial advisers would be required to fulfill certain disclosure and documentation requirements in order to provide plan participants with sufficient information to make informed decisions about such products and the potential conflicts of interests involves with such products. In the event of violations of BICE, the exemption would provide plan participants with resource to the courts through class actions.

The Rule and BICE were responses to the alleged questionable sales and marketing practices that the investment and insurance industries were using in connection with pension plan and pension plan participants. At the time the Rule and BICE were proposed, it was estimated that such practices were costing American workers billions of dollars annually.

Delaying the Department of Labor’s (DOL’s) fiduciary rule any further will cost retirement plan savers $7.3 billion over the next 30 years, the Economic Policy Institute maintains. Delays that the Trump administration has already instituted will already cost retirement plan savers $7.6 billion over the next 30 years, according to the Institute.

“Any delay will be enormously expensive to retirement savers—and not just during the period of the delay,” says Economic Policy Institute Policy Director Heidi Shierholz. “The losses that retirement savers experience from being steered toward higher-cost investment products during the delay would not be recovered and would continue to compound.

The projected costs from further delays in implementing the entire Rule, as well as denying plan participants the complete protection they need from the inequitable marketing tactics that the investment has chosen to employ against plan participants, are two reasons that the request for further delays in implementing the Rule should be denied.

The Investment Industry’s Arguments
Opponents of the Rule and BICE have basically advanced three arguments for delaying or killing the Rule altogether.

1. They are not ready to implement the complete Rule and BICE.
2. It will be too costly to implement the complete Rule and BICE.
3. Forcing fiduciary status on brokers and broker-dealers under the Rule and BICE will result in advisers refusing to provide advice and services to smaller accounts.

All of these arguments are completely meritless and unproven.

1. Most broker-dealers should be in position to easily implement both the Rule and BICE. As a former securities compliance director, both RIA compliance and general securities compliance, I know that most broker-dealers have their own proprietary RIA firms in order to service their existing brokers and as a marketing tool to recruit new brokers. Since RIAs and RIA representatives are fiduciaries by law, broker-dealers should already have supervisory procedures in place to monitor and supervise such fiduciaries. Expanding those procedures to any new fiduciaries under the Rule and BICE should be relatively simple.
2. Implementing both the Rule and BICE should involve very little cost. Since most broker-dealers should already have the necessary supervisory procedures in place to monitor and supervise any new fiduciaries under the Rule and BICE, there should be little costs involved in transitioning such policies and procedures to cover the new compliance rules under the Rule and BICE.
3. If broker-dealers and stockbrokers decide to stop servicing smaller accounts, that will be as a result of their own decision, since existing laws, rules and regulations already imposed a fiduciary standard on broker-dealers and stockbrokers before the Rule and BICE were adopted. There are several interesting aspects to this argument. The investment industry has yet to offer any admissible evidence to support this claim since they cannot do so until the complete Rule and BICE are in effect. Furthermore, as Bob Clark, one of the most respected commentators on the investment industry has noted, if stockbrokers are in the business of providing investment advice, then they are already held to a fiduciary standard under the Investment Advisers Act of 1940.

This argument also fails to recognize the fact that broker-dealers and stockbrokers are already held to a fiduciary standard under a number of scenarios, including state common law and the rules and regulations of SROs such as FINRA. Stockbrokers managing customer accounts on a discretionary basis are held to a fiduciary standard. The courts have also stated that they will impose a fiduciary standard on stockbrokers on non-discretionary customer accounts where the customer has reposed trust and confidence in the stockbroker and the customer lacks the knowledge, experience and understanding to personally evaluate the recommendations that their stockbrokers provide.

The reasons that full and immediate implementation the investor protections provided by the Rule and BICE are needed are essentially the same as those set forth in a study conducted by the SEC in 2011 on the need for a fiduciary standard for the securities industry in general. (https://www.sec.gov/news/press/2011/2011-20.htm) The SEC study recommended that the SEC adopt various regulations requiring that

when providing personalized investment advice about securities to retail customers, a fiduciary standard no less stringent than currently applied to investment advisers under Advisers Act Sections 206(1) and (2)…. Specifically, the Staff recommends that the uniform fiduciary standard of conduct established by the Commission should provide that: the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.

The Staff believes that the uniform fiduciary standard and related disclosure requirements may offer several benefits, including the following:

• Heightened investor protection;
• Heightened investor awareness;
• It is flexible and can accommodate different existing business models and fee st It would preserve investor choice;
• It should not decrease investors’ access to existing products or services or service providers;
• Both investment advisers and broker-dealers would continue to be subject to all of their existing duties under applicable law; and
• Most importantly, it would require that investors receive investment advice that is given in their best interest, under a uniform standard, regardless of the regulatory label (broker-dealer or investment adviser) of the professional providing the advice.

The SEC study went on to note that existing rules and regulations of investment industry SROs also held broker-dealers and stockbrokers to high standards of conduct similar to a fiduciary standard,

Broker-dealers are also required under SRO rules to deal fairly with customers and to “observe high standards of commercial honor and just and equitable principles of trade.” Sales efforts must therefore be undertaken only on a basis that can be judged as being within the ethical standards of [FINRA’s] Rules, with particular emphasis on the requirement to deal fairly with the public. [A] central aspect of a broker-dealer’s duty of fair dealing is the suitability obligation, which generally requires a broker-dealer to make recommendations that are consistent with the best interests of his customer.

These duties have been articulated by the Commission and courts over time through interpretive statements and enforcement actions. As the Commission has pointed out, “a broker has ‘an obligation not to recommend a course of action clearly contrary to the best interests of the customer.’” Just as BICE would require certain disclosures and documentation, the regulators require that actions taken by the broker-dealer that are not fair to the customer must be disclosed in order to make this implied representation of fairness not misleading.

So any arguments by the investment industry that the fiduciary duties imposed on broker-dealers and stockbrokers under the Rule and BICE are onerous and/or unfair are meritless, as those same duties have already been recognized by their own SRO, FINRA and its predecessor, the NASD. In 2012, FINRA released Notice 12-25, in which it reiterated the duty of broker-dealers and stockbrokers to always act in a customer’s “best interest,” including references to numerous enforcement actions upholding such duties.

One last point of contention by the investment industry with the Rule and BICE appears to be BICE provision allowing plan participants to participate in class actions involving violations of the ICS or BICE. As an attorney, my guess is that the investment industry is more concerned about the broad discovery rights that would be granted to plan participants under BICE’s class action provision than BICE’s disclosure and documentation themselves. The solution is simple enough – do not violate the Rule, the ICS and/or BICE and the class action provisions are inconsequential.

The reasons set out in the SEC’s study for the need of a universal fiduciary standard are equally applicable to the Rule and BICE. The investment industry now comes forward with “unclean hands” and requests for a further delay in full implementation of the Rule and BICE without any justifiable reason for same, for the sole purpose of extending the time that they can inflict further harm on plan participants by peddling  products which they know cannot satisfy the “best interest” requirement of a fiduciary standard, products such as variable annuities, equity indexed annuities and the majority of actively managed mutual funds.

Variable annuities and equity indexed annuities routinely show up on the annual list of regulators’ customer complaint leaders. The Standard & Poor’s Indices Versus Active (SPIVA) reports consistently show that the overwhelming majority of actively managed mutual funds fail to outperform comparable and less expensive index funds. So why do stockbrokers and other financial advisers continue to recommend such products. Commissions, and the conflicts of interest they create, the very conflicts of interest that the Rule and BICE were created to address in order to provide plan participants with much needed protection against the investment industry long-standing history of abusive sales practices.

The investment industry has not, and cannot, produce any legitimate and legally admissible evidence to support their claims. Thus far, the investment industry has produced nothing more than self-serving rhetoric and pure speculation with regard to their claims. The significant and irreversible damage that has already been done, and will continue to be done, by further delaying full implementation of the Rule and BICE has been documented by several independent research organizations.

In deciding on the request for further delay in the full implementation of the Rule and BICE, I would ask the OMB to consider the admonition of the court in Norris v. Hirshberg v. SEC, (177 F.2d 228, 233) in rejecting a broker-dealer’s suggestion as to the purpose of securities laws, stating that

To accept it would be to adopt the fallacious theory that Congress enacted existing securities legislation for the protection of the broker-dealer rather than for the protection of the public. On the contrary, it has long been recognized by the federal courts that the investing and usually naive public needs special protection in this specialized field.

This need is equally applicable to plan participants investing in ERISA pension plans and in making rollovers from such plans upon retirement. For these reasons, I respectfully request the OMB provide plans and plan participants with the much needed protection they need by denying any and all requests to further delay the full implementation of the Rule and BICE.

Thank you for your time and consideration.

Sincerely,

James W. Watkins, III, J.D. CFP®