We are issuing the latest update to our series of Alerts regarding the final rules issued by the Department of Labor (“DOL”) with respect to fiduciaries under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the DOL’s Best Interest Contract Exemption (“BIC Exemption”) from ERISA’s prohibited transactions provisions as well as Congress’s attempts at blocking implementation of the ERISA Fiduciary Rule and BIC Exemption. On October 12, 2017, the House of Representatives Financial Services Committee approved by a vote of 34 to 26 the “Protecting Advice for Small Savers Act of 2017” (or the “PASS Act of 2017”). This legislation, which was introduced into the House by Rep. Ann Wagner (R-Mo), would void the Fiduciary Rule and BIC Exemption and in its place establish a “best interest” standard of conduct applicable to the making of investment recommendations to retail customers. The text of the bill can be found at the following link: https://www.congress.gov/115/bills/hr3857/BILLS-115hr3857ih.pdf
The PASS Act of 2017 would expressly nullify the Fiduciary Rule and BIC Exemption, providing in Section 2 that these regulations “shall have no force or effect.” In its place, the proposed legislation would establish a “best interest” standard of conduct for broker-dealers and their registered representatives when making investment recommendations to retail customers. Section 3(a)(1) of the PASS Act of 2017 provides that a recommendation is deemed to be in a retail customer’s best interest at the time it is made where the recommendation “(i) reflect[s] reasonable diligence; and (ii) reflect[s] the reasonable care, skill, and prudence” that a broker-dealer or registered representative “would exercise based on the customer’s investment profile.” Expressly incorporating by reference the definition of “recommendation” under Rule 2111 of the Rules of the Financial Industry Regulatory Authority (“FINRA”), the bill defines the term as meaning either (i) “[a] recommendation to buy, hold, or sell securities, or to follow an investment strategy involving securities, for taxable or non-taxable accounts;” or (ii) “[a] non-discretionary recommendation to rollover or transfer assets in an employer-sponsored retirement plan to an individual retirement account.” The bill also incorporates by reference FINRA Rule 2111 for purposes of defining the terms “reasonable diligence” and “customer’s investment profile.” The bill would also require a broker-dealer or registered representative, before “execut[ing] a transaction for the first time for each retail customer based on a recommendation to such retail customer,” to “disclose prior to the point of sale to such customer, in a clear and concise manner” (i) the type and scope of services being provided by the broker-dealer or registered representative, (ii) the applicable standard of conduct, (iii) the types of compensation that the broker-dealer or registered representative receives, and (iv) any material conflict of interest. Moreover, the best interest standard of conduct would not be violated by the mere “receipt of compensation, including transaction-based compensation….” Nor would the standard of conduct be violated where the broker-dealer or registered representative recommends principal transactions or “affiliated, unaffiliated, or proprietary products or services….” The proposed legislation would also limit what a broker-dealer or registered representative is required to do in order to fulfill their responsibility under the best interest standard of conduct, providing that a broker-dealer or registered representative is not required to “recommend the least expensive security or investment strategy … or to analyze all possible securities, other products, or investment strategies before making a recommendation.” Significantly, the PASS Act of 2017 expressly disclaims that the best interest standard of conduct creates any fiduciary obligation on the part of a broker-dealer or registered representative. The bill provides “[t]he fact that a person may owe, or in fact comply with, the standard of conduct under this subsection shall not mean or create any presumption that such person is a ‘fiduciary’ under [ERISA], Section 4975 of the Internal Revenue Code of 1986, the Investment Advisers Act of 1940 … or any other Federal, State, or local statutory or regulatory fiduciary regime.”
The PASS Act of 2017 thus goes much further than the Financial Choice Act of 2017, which the House of Representatives passed in June 2017, with respect to establishing a standard of conduct for broker-dealers and registered representatives to replace the Fiduciary Rule. That bill deals with the issue of an alternative standard of conduct by requiring the Securities and Exchange Commission (“SEC”) to take the lead in determining whether the adoption of a uniform fiduciary standard is appropriate and thereafter drafting such a rule. By contrast, the PASS Act of 2017 would create a replacement standard of conduct legislatively. Moreover, that standard is clearly not a fiduciary standard, unlike any standard that the SEC were to establish under the Financial Choice Act of 2017. In that regard, it is arguable that by expressly incorporating the definitions of recommendation, reasonable diligence and customer’s investment profile set forth in FINRA Rule 2111, the PASS Act of 2017 would effectively be implementing the FINRA suitability standard of conduct. In other words, compliance with FINRA Rule 2111 would satisfy the proposed best interest standard of conduct.