President Trump’s pronounced distaste for financial regulations placed the fiduciary duty into the national spotlight earlier this year when the executive branch halted the rollout of an Obama-era Department of Labor policy. President Obama’s proposed regulation broadens the scope of a provision in the Employee Retirement Income Security Act of 1974 (“ERISA”), which imposes a fiduciary duty on financial professionals who invest in employee retirement plans. President Trump delayed the new regulation by ordering the Department of Labor to move the regulation’s effective date from April 10, 2017 to June 9, 2017, with the financial industry’s general expectation being that the executive branch would ultimately prevent the regulation from ever taking effect. Despite expectations and the delay, the Obama-era regulation is poised to take effect tomorrow.

ERISA is a sizeable piece of legislation that regulates the investment and management of employee contributed benefit and retirement plans. Under the current ERISA (which has not yet incorporated the Obama-era change) a fiduciary duty is owed by “investment advisors fiduciaries,” which is anyone who provides investment advice if he or she either possesses discretionary authority over the portfolio or provides investment advice, which forms the primary basis for financial decisions, on a regular basis. The fiduciary duty is best characterized as a special confidence and trust that requires the fiduciary to act for another individual’s benefit while subordinating the fiduciary’s personal interests to that of the individual to whom the fiduciary duty is owed.

President Obama’s proposed change would remove the regularity and primary basis requirements from the ERISA definition of investment advisor fiduciary. The seemingly minor tweak belies a significant expansion in the reach of ERISA regulation as the definitional change effectively closes what amounts to a loophole for “broker-dealers.” Without the proposed change broker-dealers may avoid the fiduciary duty by documenting or stating that their investment advice is not to serve as the primary basis for an investment decision or otherwise skirt the duty in transactions lacking ERISA’s required degree of regularity.

Understanding the practical distinction between a broker-dealer and an investment advisor is essential to appreciating the consequences of President Obama’s proposed changes. A broker-dealer typically trades securities, maintains custody of funds and securities, lends money to investors and advises about investment decisions. On the other hand investment advisors chiefly function in an advisory capacity with respect to portfolio management, diversification and selection, asset allocation, and financial planning. Currently, broker-dealers owe a duty of “suitability,” which is a duty to ensure that an investment recommendation or strategy is suitable for a particular individual at a particular time. On the other hand, investment advisors owe a more rigorous fiduciary duty.

To illustrate the practical effect, consider a scenario where a broker-dealer and investment advisor provided advice to an investor about purchasing shares in various Silicon Valley tech companies. If we assume each of the various companies all have uniform financial performance, a broker-dealer can properly recommend investing ERISA funds in the tech company that would maximize the broker-dealer’s own compensation even if investment in another tech company is less costly to the investor. However, under the fiduciary duty, it would be inappropriate for the investment advisor to recommend (without disclosing the conflict of interest) investment of the ERISA funds in the tech company that maximizes the advisor’s compensation but has the highest cost to the investor. Under the new rules broker-dealers in the aforementioned scenario would violate their fiduciary duty if they fail to disclose their conflict of interest.

The above illustration is one of several dozen practical implications that will arise as a consequence of imposing the fiduciary duty on broker-dealers. The imposition of the fiduciary duty on broker-dealers will also require broker-dealers to familiarize themselves with the ERISA requirements for a “Prohibited Transaction Exemptions” (“PTEs”). The fiduciary duty will render certain transactions improper, and broker-dealers will need to meet the requirements set forth by the PTEs to carry out what would otherwise constitute a prohibited transaction.

It will be interesting to see how the new rules play out from a practical stand point, as well as how the courts evaluate issues likely to arise. The Department of Labor has already indicated they may create a sort of grace period as the financial industry adjusts to the new standard.