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DOL Fiduciary Rule’s Conflict-of-Interest Split Personality

DOL Fiduciary Rule’s Conflict-of-Interest Split Personality
May 10
01:15 2016

A little more than a year ago, the White House announced its passionate support for a new “Conflict-of-Interest” rule that would eliminate specific self-dealing fees that academic studies have shown can cost retirement savers trillions of dollars. The DOL subsequently repurposed its proposal originally called the “Fiduciary Rule” as a brand new “Conflict-of-Interest” Rule that attempted to stay true to the White House announcement. But in the zero sum reality of the business world, those trillions of dollars of savings for retirement savers would come at a cost to the brokerage industry. This wasn’t news. Nor were we surprised by the response.

Unlike all those individual mom and pop retirement savers, the brokerage industry had the capacity to assemble a formidable lobby campaign. And they did. As a result, we saw a new “improved” final version of the DOL’s “Conflict-of-Interest” (nee “Fiduciary”) Rule. Unlike the stark simplicity of the original proposal, the finished form presented what might be characterized as a Yin and Yang regarding those supposedly evil conflicts-of-interest. They were at once both vilified and honored. This ambiguity has created a split personality that ERISA attorneys and advisers alike can easily point out.

How Does the New DOL Rule Prevent Conflicts-of-Interest?
It’s commonly understood that the new Rule places a client’s “best interests” above all else, leading many to believe this will have the effect of averting conflicts-of-interest. Ben Offit, Partner and Financial Planner at Clear Path Advisory in Baltimore, Maryland, says, “The DOL Rule prevents conflicts-of-interest because it is forcing advisors to adhere to the highest level of service and morality for their clients by law. If advisors don’t work within these laws, there are serious ramifications for their career and potential civil and criminal penalties. Because of this, the envelope will be pushed in a better direction to filter out advisors who are doing things the right way and will also shine a bright light on those not practicing the right way.”

It’s clear the DOL is attempting to reframe the broker-advisor service model from one based on “suitability” to that of a traditional investment adviser model of “best interests.” ‘The new DOL Rule prevents conflicts-of-interest by imposing a fiduciary standard upon all financial services professionals,” says Ryan Brown, partner of CR Myers & Associates in Southfield, Michigan. “Being a fiduciary in its most basic sense means that the fiduciary must put the client’s interests above his own. Physicians and lawyers are common fiduciaries. Up until the DOL Rule, most financial transactions only had to be deemed ‘suitable’ (i.e., appropriate given the totality of the client’s circumstances, objectives, and financial condition). All financial services professionals must make sure that the advice and recommendations given are for the client’s best interests – not theirs.”

The new Rule does contain specific language that increases the hurdles for service providers involved in self-dealing conflict-of-interest fees. Unlike what many people thought (and some continue to think), the Rule does not outlaw this conflict-of-interest fees. “The new rule doesn’t uniformly prevent conflicts-of-interest, but it certainly deters them,” says Jason Grantz, Institutional Retirement Consultant at Unified Trust Company in Lexington, Kentucky. “The primary deterrents will be increased difficulty in compliance and significant penalties for non-compliance. The new rules codify that conflicts-of-interest are prohibited transactions subject to penalty unless mitigated by one of the prescribed prohibited transaction exemptions – this will certainly act as a deterrent.”

The DOL is specifically targeting the abuse of proprietary products. While it doesn’t outright eliminate these conflicts-of-interest, the new Rule requires broader and more rigorous disclosures should these types of self-dealing fees continue. Hugh D. Berkson, a Principal at McCarthy, Lebit, Crystal & Liffman Co., L.P.A. in Cleveland, Ohio, says, “The DOL Rule doesn’t actually prevent conflicts-of-interest. What it does is ensure that, when there is a conflict-of-interest, the conflict is disclosed and any advice given be in the client’s best interest. A broker who can demonstrate that a proprietary product is in a client’s best interest will be required to disclose any compensation arrangement that could be influencing his recommendation.”

No matter how demanding the regulation, there will always be those who attempt to skirt the rules. “No rule will completely prevent rogue advisors from engaging in bad behavior and hoping they will never get caught,” says Charles Field, Partner and Co-Chair of the Financial Services Litigation Practice at Sanford Heisler & Kimpel LLP in San Diego, California. “But for the rest, the rule seeks to deter conflicts-of-interest by now imposing liability against those financial advisers who put their interests ahead of the interests of the retirement plan.”

In the end, the intent of the DOL’s “Conflict-of-Interest” Rule is to dissuade the use of self-dealing fees by increasing the service provider’s fiduciary liability when relying on them. “Simply put, it enforces penalty if practiced and/or enables litigious action,” says Michael Zimmer, Owner of Fluent Technologies in Boston, Massachusetts.

How Does the New DOL Rule Allow Conflicts-of-Interest to Continue?
Although the new Rule clearly intends to discourage and reduce the use of self-dealing conflict-of-interest fees, the DOL did make some significant concessions to industry lobbyists. “Under certain circumstances, the rule allows the financial adviser to charge an asset based fee and a transaction based fee,” says Field.

In these “certain circumstances,” the DOL now requires some form of written disclosure in order to use or continue to use some proprietary products. Zimmer says the new Rule “allows a contractual agreement to advise of products outside of those in the clients ‘best interest’.”

It may surprise many to learn of the Rule’s flexibility when it comes to permitting the use of self-dealing transactions. “The DOL Rule still allows some conflicts-of-interest continue but only in a narrow sense,” says Brown. “For example, captive financial services professionals would technically have a conflict only being able to recommend proprietary products. To give an analogy, Cadillac car salesmen can only sell Cadillac just like Fidelity or Merrill Lynch professionals can only sell what their respective companies allow them to sell. The DOL recognized this and therefore allows captive agents to sell captive financial products. Disclosure to the client is absolutely critical. As long as a financial professional discloses the possible conflict and the client knows it, the DOL won’t be able to come down with an axe on them.”

In general, different types of situations will demand their own form of disclosure in order to mitigate the service provider’s fiduciary liability. “There are a couple of scenarios here,” says Grantz. “The first scenario has to do with existing financial arrangements that, unless changed, would be a conflict-of-interest as defined within the new rules. However, these arrangements will be allowed to continue without penalty with a simple negative election notice to clients, meaning no action is required by the clients. This might cause some clients to question their existing arrangements, but many will do nothing and the conflict-of-interest will continue. The second scenario is through several prohibited transaction exemptions. These exemptions are essentially in place to allow a conflict-of-interest to occur, mainly by following certain procedures to ensure that the client is aware of the conflict and OK with the arrangement anyway. We expect the Best Interest Contract Exemption (BICE) will be the exception used most within the industry.”

Some remain concerned that the Rule will encourage the use of higher fee alternatives. Offit says, “The DOL Rules allows conflicts-of-interest to continue because by forcing advisors to essentially use a level compensation model, they will not be bringing to the table as often commission based options which ultimately can be cheaper and in a better interest of the client. The advisor will be put in a position to always use fee-based investment models, which may not always be in the client’s best interest.”

Offit’s example may be one way to justify continuing the use of self-dealing fee models. “Again, the DOL Rule doesn’t prevent conflicts of interest,” says Berkson. “Accordingly, proprietary products will still exist and will still be sold. It is conceivable that a proprietary product’s specific benefits are worth the cost for a particular investor. Although, if a broker wants to sell the product and comply with the DOL Rule, the sale must demonstrably be in the client’s best interest and the client must have been advised of the compensation to be paid to the broker and his firm if the sale goes though.”

For individual retirement savers and plan sponsors alike, the complexity of the Rule might make it more difficult to determine if and when they are being presented with optimal solutions. will explore this issue from their perspectives in future articles.

Are you interested in discovering more about issues confronting 401k fiduciaries? If you buy Mr. Carosa’s book 401(k) Fiduciary Solutions, you’ll have at your fingertips a valuable reference covering the wide spectrum of How-To’s (including information on the new wave of plan designs) every 401k plan sponsor and service provider wants and needs to know. Alternatively, would you like to help plan participants create better savings strategies? You can buy Mr. Carosa’s latest book Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort right now at your favorite on-line or neighborhood book store.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


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