Appeals Court vacates DOL fiduciary rule

On March 15, 2018, the US Court of Appeals for the Fifth Circuit (the “Court”) issued a decision vacating the Department of Labor’s (DOL) “Conflict of Interest Rule” on fiduciary investment advice (the “Rule”).  The court concluded that the DOL exceeded its regulatory authority in implementing the rule, which set forth a new definition of an ERISA investment-advice fiduciary and modified and created new exemptions to prohibited transactions.  Because the court found that the regulatory package is “plainly not amenable to severance,” it vacated the rule in its entirety.

The court has until May 7, 2018 to file the mandate allowing the decision to take effect (giving the government time to file a petition for rehearing en banc or appeal to the Supreme Court). While there are several possible outcomes, including appeal, this decision is the most significant blow to the Rule since its finalization in April 2016.

If this decision is upheld, it will be as if the Rule never existed. The definition of ERISA investment advice will revert to the 1975 five-part test, which says that in order to be an ERISA Investment Fiduciary you must:

  • Provide buy, sell or valuation advice,
  • On a regular basis,
  • Via a mutual agreement,
  • That serve as a primary basis for investment decisions, and
  • Is individualized to the needs of the retirement plan (or IRA)

Because all five parts of the test must be met, it is much easier to avoid fiduciary status under the 1975 ERISA standard than the updated Rule. However, reverting to the five-part test after so many business decisions have been made to prepare for the updated rule may be disruptive for some financial institutions. Investment advice providers should closely review their businesses to ensure that they are prepared for this change. It must also be noted that all of the rule is vacated, including the exemptions that were created and modified, and that these will no longer be able to be relied upon.

Some key areas are highlighted below.

Rollover and distribution advice

Recommendations to rollover (or take other distributions from) a retirement plan will no longer automatically be considered fiduciary advice if the Rule is vacated. The most recent guidance on rollover advice prior to the Rule is from Advisory Opinion 2005 -23A, which stated that rollover advice, even with an investment recommendation, is not ERISA Fiduciary Advice unless the advisor (or financial institution) was already an ERISA Fiduciary to the client. However, the issue of whether a recommendation to rollover is very complex and is again unsettled. A prudent course of action for firms that have decided to offer rollover and distribution recommendations is to speak with ERISA counsel.

Rollover advice a still a major regulatory focus for both the Financial Industry Regulatory Authority (FIRNA) and the Securities and Exchange Commission (SEC).  Deloitte continues to view rollover advice as a high-risk area. Clients should carefully review FINRA guidance 13-45 to ensure their rollover programs meet the standards in that guidance. They should also carefully review their policies, procedures, controls, and supervision for rollover recommendations into advisory accounts due to the conflicts of interest inherent in these recommendations.

Managed accounts

In response to the Rule, many wealth managers have placed an increased emphasis on moving clients away from brokerage and into advisory accounts. We do not expect this trend to revert due to the court’s ruling.  We do expect continued regulatory focus on managed accounts, especially around conflicts of interest. Specific areas of focus are likely to be mutual fund share class selection and the suitability of converting accounts to advisory accounts (commonly referred to as “reverse churning”).

Discretionary accounts
There are several ways to become an ERISA Fiduciary, including exercising discretionary control over plan assets. The updated Rule that the court vacated only pertains to investment advice fiduciaries and does not impact discretionary fiduciaries. Therefore, if an advisor or firm has discretionary authority over a retirement account or IRA, it will continue to be a fiduciary under ERISA.  Such an advisor must still act in the best interest of clients and avoid conflicts of interest that would lead to prohibited transactions. Common conflicts include investments in propriety products and third-party payments. These and any other conflicts still need to be mitigated via an exemption or another means such as fee rebates.

SEC and the states

The SEC is actively pursuing its own version of a “best interest rule,” which some industry observers predict may be proposed as early as the second quarter of 2018.

In addition, several states appear to be following in the footsteps of Nevada, and are expected to issue their own regulations around standards of conduct related to sales practices. We expect this activity to continue and possibly accelerate in the wake of the Fifth Circuit ruling.

Insurance regulators are reportedly keen to harmonize with the forthcoming SEC rule, although the New York State Department of Financial Services (DFS), which issued a proposed regulation in December 2017 that would subject companies licensed to sell life insurance and annuity products to a best interest standard, may move ahead of the SEC timeline. The DFS may release a new draft for comment before moving forward to implementation.

While neither the SEC nor state standards are expected to be as onerous as the DOL Rule, the diversity and number of different fiduciary standards add tremendous complexity to overall compliance. For example, if the DFS rule becomes law, it is conceivable that a fee-based variable annuity sold in New York, and held in an IRA Discretionary Manged Account, could be subject to the DFS standard, the forthcoming SEC standard, and ERISA.

Policies and procedures

Policies that have been updated for the new advice rule should be closely examined to ensure that they do not impose obligations on your firm that are no longer relevant. The importance of this process is best illustrated by the recent Massachusetts regulatory action against Scottrade.  The action is notable in that it does not allege that Scottrade violated the DOL Rule, but rather alleges that the company did not follow the procedures put into place to comply with the DOL Rule.

Disclosures and agreements
If you have acknowledged to a client in writing that you are an ERISA fiduciary, the Fifth Circuit’s decision may not automatically extinguish that status. In such cases, institutions should immediately review their client disclosure contracts and other materials to determine the representations they have made regarding ERISA fiduciary status and how they align to the services being offered.

Impact of ruling on business trends

Deloitte expects many business decisions that have already been made in light of the Rule are likely to remain in place no matter the final outcome of this court case. New products and services have been rolled out to clients and advisors and new expectations have been set.  While driven by the regulatory environment, these were largely business decisions that are unlikely to be reversed.

We continue to expect a fiduciary future in wealth management, but it will be driven as much by competitive forces and client expectations as by regulation. We expect growing client demand for fiduciary advice, and the industry is responding accordingly. Traditional direct to investor providers are expanding their advice offerings and some heritage “face-to-face” advisory firms are looking to go direct. Nearly every major financial institution seems to be exploring a digital advice offering (although few seem to be satisfied with their results to date).

We believe that financial institutions that do not accept fiduciary status will be at a competitive disadvantage more so than in the past. As noted above, we also expect the shift to managed accounts to continue and even accelerate further. Finally, we expect low-cost products, both active and passive, to continue to gather an increasing share of asset flows.

Conclusion and next steps

While the Rule is not “dead” yet, it may be on its last legs. Financial institutions should immediately analyze the impact of the rule being vacated with a particular focus on the areas noted above.

As importantly, financial instructions should continue to prepare for a future where fiduciary advice is the standard for all accounts. Wealth managers should conduct a thorough review of their business and operating models to determine how to thrive in this fiduciary future.

Contacts

Maria Gattuso
Principal | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP

George Hanley
Managing Director | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP

Scott Parker
Principal
Deloitte Consulting LLP

Daniel Rosshirt
Principal
Deloitte Consulting LLP

Karl Ehrsam 
Principal | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP

Josh Uhl
Senior Manager | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP

Sean Cunniff
Specialist Leader | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP

Craig Friedman
Senior Manager | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP

Jared Bixler
Senior Manager | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP

Alex LePore
Senior Consultant | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.

As used in this document, “Deloitte” means Deloitte & Touche LLP, a subsidiary of Deloitte LLP. Please see http://www.deloitte.com/us/about for a detailed description of our legal structure. Certain services may not be available to attest clients under the rules and regulations of public accounting.

Copyright © 2018 Deloitte Development LLC. All rights reserved.

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