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Exclusive Interview: Fred Reish says DOL “Conflicted” Over Conflict-of-Interest Rule Appeal

Exclusive Interview: Fred Reish says DOL “Conflicted” Over Conflict-of-Interest Rule Appeal
April 17
00:04 2018

Those of you who are voracious readers of fiduciary news (and can’t help but recognize the name of Fred Reish. Long a commentator and thoughtleader, for the past two years he’s been focusing on the DOL’s Conflict-of-Interest (a.k.a. “Fiduciary”) Rule. Despite the recent court ruling that has placed the Rule in limbo, he remains a font of ideas when it comes to dealing with its continuing wake (and you can interpret that both ways).

 Fred will be appearing at the fi360 conference next week and we were able to corner him long enough to get some good fiduciary dirt. Dig in and enjoy.

FN: Fred, it’s been some time since we’ve talked to you and there’s been lot of activity in all corners of the fiduciary front. Before we get into specific questions, let’s talk about some things of general interest. What is the process you use to keep abreast of breaking fiduciary matters and have you found it necessary to update that process in the last two years?
Reish: There isn’t any secret. I follow the industry media very carefully, as well as the social media, for example, Twitter. In addition, we have a number of DOL, SEC and FINRA attorneys in the firm who are well connected. So, it’s really a collective effort.

FN: Let’s get right to the nitty gritty: The DOL’s Conflict-of-Interest (a.k.a., “Fiduciary”) Rule has been vacated by the 5th circuit. Unless the DOL seeks appeal, this ruling will stand. Given that the DOL is currently reviewing the Rule, why (or why not) do you think they will be appealing the decision of the 5th circuit?
Reish: My understanding is that there is a conflict within the DOL about the issue of whether to challenge the decision or not. Also, the Department of Justice is part of that discussion. The word on the street is that the DOL will likely not challenge the decision, but we won’t know for sure until April 30th or until, if earlier, the DOL makes and publicizes its decision.

FN: If the DOL does appeal the 5th circuit decision, tell us how the process would proceed.
Reish: I’m not an expert on procedural issues. Somebody would need to answer this in detail. However, the Department of Labor could request a rehearing on en banc of all of the 5th Circuit judges or could request the Supreme Court to review the case. If that is the outcome, I believe that the DOL will ask for a “stay” of the decision until it is finally resolved.

FN: If the DOL does not appeal the 5th circuit decision, how do you see the process of the Fiduciary Rule going forward?
Reish: At that point, the Fiduciary Rule is dead. It won’t go forward. However, I believe that the DOL will work with the SEC to develop new exemptions and possibly to modify the old 5-part test. But, from that point forward, the SEC will have the leadership.

FN: It appears the marketplace has now adopted much of the heart of the Fiduciary Rule. Without any formal regulation to enforce it, why will certain portions of the Rule remain vital in the marketplace and why will other parts wither and die?
Reish: I think it’s too early to say that the Rule is dead. I believe that the SEC will be providing additional and, in some cases, enhanced standards and requiring better disclosures. So, while the particulars of the DOL Rule may have been killed by the 5th Circuit decision, I don’t know that the principles are necessarily dead. I think that the SEC will include some of those principles in their guidance. That could include, for example, better disclosures and higher standards of care. In any event, there will be a need for updated prohibited transaction exemptions since the 5th Circuit ruling also vacated the exemptions, for example, the Best Interest Contract Exemption, as broker-dealers and RIAs adopted new practices to comply with the Fiduciary Rules. Some of those practices were structured in a manner to obtain exemptive relief under BICE. That would include, for example, advisory services offered by recordkeepers concerning investments and rollovers. Since the recommendations under those services are often related to proprietary products, without relief that advice would result in a prohibited transaction.

Also, I think that greater emphasis was given to the RIA model under many of the changes implemented to comply with the new rule. I believe that, for the most part, those will stay in place. In other words, I believe that if we compare the future to the past, much more advice will be given under the RIA model than under the broker-dealer model. That is particularly true for plans and larger IRAs.

FN: The DOL (under the Obama administration) seemed to want the Rule to be used as a helpful guideline rather than a sharp whip. Some states, on the other hand, appear intent on using it as a strict enforcement rod. What do you think is motivating states to act unilaterally on this? In the long run, in what way is this positive for the concept of “Fiduciary”? In what ways do these actions hurt the Fiduciary effort in the long run?
Reish: I think the emotions about the word “fiduciary” are temporary. I don’t think there will be any long-term impact. The trend is in the direction of higher standards of care and either better disclosures of conflicts or better mitigation of conflicts. If I am correct, then the DOL efforts to establish a fiduciary standard will, at least in part, prove to be effective.

FN: The SEC has recently indicated they will be pursuing their own Fiduciary Rule. What are the potential advantages and disadvantages with the SEC starting from scratch and not “harmonizing” with the DOL Rule? On the flip side, what dangers does “harmonization” pose?
Reish: The rules will never be identical. For example, the SEC’s standards of care will be based on registration, such as registration as a broker-dealer or as an RIA. The ERISA and DOL definition of fiduciary is functional. That is, under the ERISA/DOL approach, an adviser becomes a fiduciary if the adviser performs certain activities regardless of the adviser’s registration. That will continue to be the case. However, I do think that there will be some “harmonization” because I believe that the DOL’s prohibited transaction exemptions will probably adopt, as conditions, much of the SEC guidance.

FN: In general, where do you see the trend of fiduciary liability headed? Is it going up or down? Is the trend different for plan sponsors compared to plan service providers?
Reish: It’s difficult to know. If we knew what the future claims were going to be, everybody would behave better in those areas, and the claim would never come to pass. However, it’s almost certain that, where money is involved, there will be litigation.

The only impact of a fiduciary rule is that it holds advisers and plan sponsors to a higher standard of care than a commercial rule would. In other words, it makes it easier to prove a case where a plan sponsor or adviser has been asleep at the switch—in the sense of being negligent, or where an adviser or plan sponsor clearly did the wrong thing. In that regard, I think that the greatest potential for liability is closely associated with the largest sums of money. So, that means that there will continue to be litigation related to retirement plans. On the other hand, I do expect that there will be a new round of litigation related to IRAs and personal accounts . . . once we have our next market crash. Stated slightly differently, the claims by individual investors tend to be predicated more on investment losses, and less on issues such as the quality or expenses of investments.

FN: For more than a century, the trust industry has been able to work within the framework that trustees could not enter into any self-dealing transactions. How might the investment advice industry use this as a guide when determining an operational definition of “best interests”?
Reish: I don’t think that the securities laws are going to change to prevent conflicts of interest. Also, I think that the DOL will issue exemptions where they determine that the safeguards are adequate. On the other hand, I believe that plan sponsors and most of the investors, and their advisers, will prefer conflict-free arrangements. That could have the practical effect of, over time, significantly reducing the financial conflicts in those types of accounts.

In that regard, it’s possible that a long-term effect of the 5th Circuit decision and new SEC guidance will be that institutional and wealth investors will live, for the most part, in a conflict-free environment, while smaller investors will continue to engage in investment arrangements that have conflicts.

FN: What’s the most frequently asked question your get from plan sponsors? Why do you think they’re asking it? What’s the answer you usually give them?
Reish: Actually, we aren’t getting any questions from plan sponsors about the fiduciary rule. By and large, the attitude of plan sponsors seems to be that the fiduciary rule doesn’t apply to them—in the sense that it doesn’t increase or reduce their responsibilities. To a degree, that is correct. The fiduciary rule only applies to non-discretionary investment advice. I that regard, it seems to me that the two issues for plan sponsors are: Is your adviser subject to the fiduciary standard of care, which would be closely aligned to your standard of care? and What are the conflicts of interest in the agreements and services with your adviser?

FN: What’s the most frequently asked question your get from plan service providers? Why do you think they’re asking it? What’s the answer you usually give them?
Reish: The one issue that extends across almost all service providers is what can we do in terms of recommending or educating about distributions and rollovers? The answer depends on whether the service provider is willing to be a fiduciary for that advice. If they are, we help them with the fiduciary standard of care and the prohibited transaction exemptions. If they aren’t, then we help them design a distribution and rollover education program.

FN: Finally, give us a sense for what attendees to your upcoming workshop at the Annual fi360 Conference might expect.
Reish: We are in an uncertain period. The 5th Circuit decision may or may not become final on May 7th. Hopefully, we will know the answer to that by the end of the month. If it doesn’t, and if the DOL obtains a stay as it challenges the opinion, that uncertainty will continue into the future. If the 5th Circuit decision does become final on May 7th, advisers and other service providers will be caught between the old rules, including the 5-part test for fiduciary status, and the emerging rules from the SEC . . . with follow up from the DOL. We expect the SEC to issue proposed guidance in the very near future—before the conference, and that will be discussed as a part of my program and other programs at the conference. The critical issue is, how does an adviser provide investment and other services in an environment where the rules are changing this quickly? Should an adviser comply with the old fiduciary rule, with the new fiduciary rule, or with the proposed SEC rules? Is there a way to operate with confidence that an adviser’s recommendations and services are compliant regardless of the outcome of these changes?

FN: Fred, wow! As usual, your insights are most thoughtful and enlightening. There are plenty of complex variations that may be unfolding before our very eyes as the DOL exits the stage and the SEC enters. This is a great time to be talking about and living in the world of “Fiduciary.” No doubt your session at the fi360 annual conference will reveal more wisdom and maybe even a news breaker or two (assuming the SEC performs as predicted).

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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