Presidential directive to Department of Labor could impact retirement plans offered by employers.
A directive by President Donald Trump to the U.S. Department of Labor (DOL) may delay implementation of the department’s controversial Fiduciary Duty Rule, which could force changes to employer-offered retirement plans.
The DOL not only manages the federal wage and hour law (Fair Labor Standards Act), it has administrative oversight of, and enforcement responsibility for, a host of other laws including the Employee Retirement Income Security Act. Commonly referred to as “ERISA,” the act regulates the pension and welfare (group health insurance) benefit plans sponsored by employers.
The DOL has published a final rule requiring anyone who provides investment advice to retirement plans (such as a 401(k) or an IRA) to comply with the fiduciary standard. Let’s look at why this matters to your plan and employees.
Financial advisors are compensated primarily in two ways – by an hourly fee or by commissions. Those paid by the hour are typically registered through the Financial Industry Regulatory Authority (FINRA) and, if so, are already bound by fiduciary standards. That means the advisor is required to provide advice and make recommendations that are in their clients’ best interests and not their own.
It is often mistakenly assumed that all financial advisors make investment recommendations that are in their clients’ best interests, but that is not necessarily true. Advisors who are paid by commissions have an inherent conflict of interest because some of the financial “products” they offer to sell a client (i.e., annuities) yield higher commission payments to the advisor than others. This incentivizes advisors to recommend products that will provide them with higher commissions.
Because of the inherent conflict of interest resulting from commission payments, some unethical advisors engage in “churning” client accounts. Churning is excessive trading largely to generate the commissions made with each purchase. Thus, the unethical advisor may suggest selling one annuity product and the purchase of another annuity product, repeatedly, when there is little or no financial advantage to the client and, in fact, may result in penalties for the early surrender.
To protect plans subject to ERISA (which are the only investment accounts that the DOL has jurisdiction over) and the savings of the plans’ participants, the new DOL rule requires all investment advisors providing recommendations concerning investment policies or strategies, portfolio composition, rollovers, transfers, etc. (with some limited exceptions) to abide by the fiduciary duty standard.
Some of the nation’s brokerage, advisory and insurance firms that sell financial products for commissions have lobbied hard to defeat the new rule, claiming it will be harmful to their industry. Some have predicted that certain financial products may all but disappear since an advisor may not be able to recommend the purchase of certain products that are seldom in the clients’ best interests.
The rule was to take effect April 10, 2017. However, on Feb. 3, 2017, President Trump issued a memorandum to the secretary of labor requiring the DOL to take a second look at the proposed rule. In it, President Trump states, in relevant part:
Department of Labor Review of Fiduciary Duty Rule
(a) You are directed to examine the Fiduciary Duty Rule to determine whether it may adversely affect the ability of Americans to gain access to retirement information and financial advice. As part of this examination, you shall prepare an updated economic and legal analysis concerning the likely impact of the Fiduciary Duty Rule, which shall consider, among other things, the following:
(i) Whether the anticipated applicability of the Fiduciary Duty 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;
(ii) Whether the anticipated applicability of the Fiduciary Duty Rule has resulted in dislocations or disruptions within the retirement services industry that may adversely affect investors or retirees; and
(iii) Whether the Fiduciary Duty 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.
(b) If you make an affirmative determination as to any of the considerations identified in subsection (a)-or if you conclude for any other reason after appropriate review that the Fiduciary Duty Rule is inconsistent with the priority identified earlier in this memorandum-then you shall publish for notice and comment a proposed rule rescinding or revising the Rule, as appropriate and as consistent with law.
While the President’s memorandum to the secretary of labor does not provide for a delay in the rule’s implementation, it may have that effect or it could result in the revising or rescinding of the rule. The DOL has issued a proposed rule that would delay the effective date of the fiduciary rule for 60 days (or until mid-April) and requested public comment on the proposed delay and on the Feb. 3 directive by the White House.
At the time President Trump issued his memorandum, his nominee was Andrew Puzder who, according to the New York Times, came from the business sector (former CEO of the company that franchises Hardee’s and Carl’s Jr. restaurants) and has been an outspoken critic of many worker protections enacted under the Obama administration, including an increase to the federal minimum wage. However, amid growing resistance, Puzder withdrew from consideration. President Trump has since nominated Alexander Acosta for secretary of labor, who is viewed as more friendly to labor than the original nominee. While this rule has been years in the making, there is now a cliff hanger. Stay tuned!
Incidentally, plan sponsors (employers) have been coming under attack for not providing appropriate investment options for employees. Often the issue is the high fees attributable to the mutual funds being offered. In January, for example, Schwab was sued in a California federal district court by its own employees who complained that their employer (Schwab) breached its fiduciary duties by providing them with expensive and poorly performing investment choices. You guessed it…the funds offered were Schwab funds.
The lesson today is that employers need to be careful who they receive advice from and carefully evaluate the mix of funds being offered to their employees. For example, many employers now include among the investment choices some exchange traded funds (ETFs) which on average have significantly lower administrative fees than mutual funds. Obtaining sound advice from an advisor having a fiduciary responsibility is the key.