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Exclusive Interview: Phyllis Borzi says Original Fiduciary 5-Part Test Left Plan Sponsors “Holding the Bag”

Exclusive Interview: Phyllis Borzi says Original Fiduciary 5-Part Test Left Plan Sponsors “Holding the Bag”
May 15
00:03 2018

For eight years Phyllis Borzi worked hard to make the fiduciary obligation consistent among service providers to the nation’s corporate retirement plans. When she retired last year, she looked forward to beginning to cross off those many deferred wishes from her bucket list. She has. But she hasn’t left the team. As a newly appointed member of the Advisory Board of the Institute of the Fiduciary Standard, her head remains vigorously in the game.

We thought readers might be interested to learn directly from a key player about some of the behind the scenes action at the DOL’s effort to offer, take back the offer, then offer again a solid Fiduciary Rule. And, even though many have called this Rule “dead,” with a respectful nod Monty Python, “It’s not dead yet” (at least in spirit).

FN: Phyllis, so glad to be able to speak to you again. It’s been a little over a year since you retired from the DOL. What have you been doing to keep yourself busy?
Borzi: I have been catching up with friends and family that I have neglected during the past 8 years, traveling to a couple of my bucket list destinations (including a glorious month in Southeast Asia earlier this year) and trying to stay involved in some of the retirement and health policy issues that I care about deeply. I also have been doing a bit of consulting and sorting through a few opportunities to serve on various boards. For instance, I was recently honored to be invited to join the Advisory Board of the Institute of the Fiduciary Standard. And I also have been speaking to various groups. One of the most interesting projects I am working on is acting as an expert adviser to an international organization which is advocating in the EU for more uniformity for cross-border pension arrangements. If successful, this would be a tremendous benefit for US multinational companies that have to comply with the myriad of pension laws in all the EU countries in which they have covered workers and would assure greater portability and more significant retirement savings for their workers who work in more than one EU country.

FN: That will certainly benefit many people. Now that you are no longer formally engaged at the federal level, how do you keep up with fiduciary matters?
Borzi: Great question! It is so much harder when you are on your own than when you work for an institution that subscribes to the many outstanding services that track developments. I try to go on-line each day and follow the trade press and have signed up for the various newsletters and trade publications that offer free or low-cost subscriptions on line. I particularly miss the daily clipping service that we had when I was at the DOL that culled the national and local press reports and was delivered daily into my e-mail mailbox. I also belong to several groups that share information via conference calls and e-mail on a weekly or monthly basis. And of course, like all of your readers, I look forward to your insights on fiduciary issues on a regular basis!

FN: There certainly has been a lot of action over the past year. Heck, there’s been a lot of action over the past month. In all this activity, what’s the single one thing about the state of “fiduciary” that surprised you the most?
Borzi: I wouldn’t say I have been surprised by much that has happened. I obviously was disappointed in the 5th Circuit decision since it was such an outlier. Many of the court’s findings were out of step with ERISA precedent and unfortunately revealed a misunderstanding of a number of important ERISA concepts, including DOL’s statutory authority over investment advice fiduciaries, the scope of the Secretary’s statutory authority to issue prohibited transaction exemptions and the careful and open public process that was used during the six-plus years of gestation of the rule. But given the deliberate choice of venue by the rules opponents, I can’t say I was particularly surprised by the result. And of course, the denial of motions to intervene and appeal by the AARP and the states of New York, California and Oregon, while always a long-shot given the 5th Circuit rules, was a disappointment as well.

FN: Before we get to talking too much about the present and future, let’s take a moment to revisit the past. Briefly tell us about the DOL’s first attempt to establish a Fiduciary Rule. What were you reacting to, and what convinced you to pull it off the table and restart the process?
Borzi: During both three plus decades of my work on the Congressional staff and then in private law practice, I increasingly heard about situations in which small employers and multiemployer trustees that hired investment professionals to advise them on how to structure their plans and select investment options for their employees found themselves on the opposite side of DOL investigations because they followed the advice of these professionals only to discover that it was imprudent or not compliant with the law. So, when the DOL investigators showed up, the small employer or trustees were left holding the bag for any violations or losses that their employees suffered because these professionals would claim they were not fiduciaries, citing the infamous “5-part test” that was incorporated in a 1975 DOL regulation. As 401k plans became more prevalent, issues around rollover advice and IRA investments also began to surface. Honestly, when DOL issued the regulation establishing the 5-part test, I never thought it was an accurate or consistent interpretation of the statutory language and was surprised that it was never challenged in court. As I progressed in my work on Capitol Hill, it became increasingly clear to me that the 5-part test had turned into a roadmap for financial professionals to receive handsome compensation for advice that might not be in the best interest of that small plan sponsor or individual client or be prudent, but that the advisor could fairly easily escape fiduciary liability accountability or fiduciary liability for their advice.

So, after I was confirmed by the Senate for my position as Assistant Secretary of EBSA, as I was trying to sort through which of the many issues I wanted to tackle during my tenure, I asked my office directors a simple question: if you had just been confirmed as Assistant Secretary, what issues would you prioritize. The career staff’s answer was clear: the definition of fiduciary in connection with investment advice. The staff described the many enforcement examples they had observed that resulted in harm/loss to participants where the plan sponsor had also been “victimized” by following investment advice that was imprudent or didn’t conform with applicable law. And most of the time, the advice was motivated by conflicts of interests where the investment professional was rewarded financially by a third party for the advice given even if it was not in the best interest of the client.

We understood that the pushback from the financial services industry would be swift and significant, but I don’t regret for a minute my decision to take on the conflict-of-interest problem and I am extremely proud of the hard work and dedication of EBSA’s career staff and all the other staff in the other federal agencies (such as Treasury, the SEC and the White House) and the outside regulators (such as the NAIC and the state securities regulators) that provided technical advice to us during the long public process.

As for why I pulled back the original 2010 proposal, the reason was simple: I became convinced that there was a better and more effective way to approach the project.

I think I made at least three big decisions/mistakes in promulgating that early proposal.

You might remember that EBSA’s original proposal was very prescriptive. We tried to spell out to the extent possible all the terms and conditions that must be followed because that was the EBSA way. Striving for clarity and detail was the hallmark of EBSA’s prior regulatory efforts. That was a mistake because it was very easy for opponents to fixate of a minor detail and make it seem like that was a fatal flaw in the proposal.

Next, we recognized that new PTEs or amendments to old ones would be necessary to implement a new standard, but we decided to simply note that and ask industry commentators to identify what the provisions or components of those PTEs should be. That was a mistake because it allowed opponents to allege that our proposal was unworkable because compliance would trigger PTs and no exemptions were available. They conveniently forgot to mention that we had acknowledged the problem and sought public comment on what these exemptions should be and look like.

Another mistake we made was not providing the type of robust economic analysis to accompany the proposed rule that we ultimately did for the final 2016 rule. Under the Administrative Procedures Act (APA) and the applicable Executive Orders the standard for an economic analysis is far less stringent for a proposed regulation than a final regulation. At the time of our 2010 proposal, the objective academic data was less available than by the time EBSA issued its final regulation in 2016. So, we carefully delineated in the proposal the types of data we were seeking and asked the financial industry commentators (who possessed at least some of this data) to supply it to us. Unfortunately, very little data was provided and in fact, in criticizing the DOL’s economic analysis, industry commentators listed all the data we asked for and alleged that since we did not have that data, we should be precluded from going forward.

We had nearly finished our revisions to the 2010 proposal, when I decided to pull it back and start again. I had become convinced by some on my staff that we could do better with a less proscriptive approach and I was committed to proposing the necessary PTEs and a developing a more robust economic analysis. So, I pulled it back. I have heard, in retrospect, some in the industry would have preferred the old rule to the 2016 one because with the benefit of several more years of consultation, research and analysis, the 2016 final rule was significantly more effective in mitigating conflicts, had fewer loopholes for the industry to exploit, and was more workable.

FN: In the ensuing Conflict-of-Interest (a.k.a. “Fiduciary”) Rule, Tom Perez became the face of it. Was that a conscious decision to have the Labor Secretary take such a public lead? How did that help? How did it hurt?
Borzi: Tom Perez is a dynamic, passionate, and effective advocate. I couldn’t have asked for a better partner in our effort to protect plan sponsors, plan participants and IRA investors. I had known him before his stint as Secretary of Labor and admired him because of his ability to listen to all sides and find that sweet spot where opponents might find common ground. In fact, I always described him as EBSA’s secret weapon. Without his encouragement and leadership, we might not have been able to successfully publish such a strong and workable rule. Once he came to DOL, there was simply no question in my mind that his public advocacy for the rule was the way to go.

FN: In the last bit of history, you’ve often said the Conflict-of-Interest Rule wasn’t perfect, but it was the first step towards where you’d like to see things go. In your mind, what would a “perfect” Rule look like and what’s holding us back from getting there?
Borzi: This is a great question. Given the complexity of the investment marketplace, there is no single federal agency that has the statutory authority to adopt a uniform consistent standard applicable to conflicts-of-interest.  The SEC’s statutory authority is limited to securities. While retirement plans and individual investors do hold securities, there are many more types of investments (non-securities) that are in plan and individual retirement portfolios, so the SEC can’t regulate the whole investment marketplace. DOL’s oversees investments in retirement plans and programs, including through the PT rules in the Internal Revenue Code, IRAs. So, in essence, DOL regulation can reach tax-favored retirement investments, but not non-retirement investments.  Certain investment products fall outside the jurisdiction of both agencies, primarily non-securities non-retirement insurance products. So, the argument of financial industry opponents that DOL ceding jurisdiction to the SEC so that uniform regulation could result is simply wrong.

In a perfect world, if one wanted to adopt a mostly uniform standard, the DOL and the SEC would work together to issue identical standards because together they could cover a large part of the marketplace. However, the major legal barrier to that is the regulatory approach to conflicts of interest that is the bedrock structure of each statute. The securities laws generally allow conflicts-of-interest as long as they are disclosed and, in some cases, mitigated. But ERISA flatly prohibits conflicts-of-interest unless there is an applicable PTE governing the transaction. As the EBSA career staff discussed technical issues regarding the DOL proposed and then final rule, it became apparent at least to some that these fundamentally different approaches probably could not be easily reconciled except to the extent that the higher legal standard were to be followed.

FN: Now to the present. It looks like the Conflict-of-Interest Rule has not survived its court challenge and that the current administration seeks to, in essence, rewrite it. Still, the impact of the Rule remains. The term “fiduciary” – in part thanks to your efforts, in part thanks to John Oliver – has been elevated in the minds of the investing public. What aspects of the Conflict-of-Interest Rule are now “baked into the cake” of the retirement industry and would be hard to reverse, formal regulation or not?
Borzi: It’s probably too early to tell. But one of the lasting legacies of the DOL conflict-of-interest rules is in the greater public understanding of the need to seek an advisor who is willing to agree in writing to be a fiduciary. Unfortunately, most consumers are not yet at the point where they can tell for sure whether someone who assures them they are acting in their best interest (and thus using that term as a marketing slogan) is genuinely accepting legal liability as a fiduciary. That’s why consumers must get that acknowledgement of fiduciary status in writing and not simply accept the representations of individuals purporting to be acting in their interest.

FN: Perhaps in response to the DOL time clock initiated by the 5th Circuit decision, the SEC hurriedly came out with its controversial “Best Interest” Proposal. Unlike the Conflict-of-Interest Rule, which relied on a legal contract called the “Best Interest Contract,” the SEC merely seeks some form of disclosure when it comes to identifying conflicts-of-interest. In what ways is a contract (like the Best Interest Contract) more beneficial to the investor?
Borzi: The contract requirement in the Best Interest Contract Exception (BIC) was designed to make the acceptance of fiduciary status and standards a legally enforceable obligation (at least in states where individuals had the legal right to enforce a contract). Bare promises of doing right by the investor have no legal significance nor does mere disclosure of conflicts. So simply additional disclosures by themselves offer little or no protection to investors beyond current securities rules and other laws governing misleading statements and misrepresentation.

One of the things that is most troubling to me about the SEC’s proposed Regulation Best Interest is that it appears to allow brokers to continue to claim they are giving best interest advice without any fiduciary responsibility.

FN: If the complaint is the SEC has muddled the definition of “Best Interest” by failing to distinctly define it in their proposal, the industry appears to have also muddled the definition of “conflict-of-interest.” A conflict-of-interest used to simply be defined as obtaining some material benefit (direct or indirect) through the use of someone else’s assets while in a fiduciary role. After the DOL’s Rule came out, we saw ERISA attorneys creating conflicts-of-interest where none existed before. For example, some feared a fiduciary condition pre-existed any client agreement when no prior affiliation had been in place. In other words, the act of offering your service with no prior relationship might be considered a “conflict-of-interest” simply because you charge a fee. 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 and that charging a reasonable fee was not considered self-dealing. How might the investment advice industry use this as a guide when determining an operational definition of “best interests”?
Borzi: We tried to address the commonplace problem of ERISA attorney’s coming up with hypotheticals that greatly expanded the scope, application or intention of the rule by clarifying both transition rules and grandfathering, but obviously we were not fully able to stay ahead of creative interpretations of the rule that had the effect of making already nervous financial professionals more nervous! One of the techniques we used was to try wherever possible to utilize existing terms or concepts so that investment professionals might feel more comfortable that they understood what was being required of them. Building on well-established frameworks, as you suggest, seems to me a fruitful way to proceed. I haven’t thought about the example you suggest enough to be able to actually endorse the concept, but it does merit further thought.

FN: Another area we’ve touched upon in the past is the use of misleading titles. This, again, falls within the domain of the SEC (who may or may not have been complicit on the proliferation of the use of these misleading titles). The SEC seeks to prohibit the use of the term “adviser” or “advisor” by anyone other than a Registered Investment Adviser. How does this fail to solve the confusion?
Borzi: Although restricting titles might have some superficial appeal, we decided that it was ultimately unworkable. Most individual investors simply can’t distinguish among titles that sound awfully similar. The solution is not to encourage adviso(e)rs to be more creative in their titles but to acknowledge that in today’s marketplace, even brokers who are only salespeople hold themselves out as adviso(e)rs. Their marketing materials are indistinguishable from those of fiduciary advisers so they ought to be regulated under the same standards. By the way, the SEC proposal actually makes this worse because it creates an even less level playing field than currently exists by allowing brokers and dual registrants to choose the much less stringent disclosure regime and still be able to tell clients they are in effect giving best interest advice.

FN: Finally, the future. Where do fiduciary proponents go from here? It’s clear by now that those who live by regulation, die by regulation. Is there a more effective path to protect the true best interests of investors?
Borzi: I assume that fiduciary proponents will work with the SEC to strengthen and improve their proposals from an investor point of view and continue to advocate for the DOL to retain some plan sponsor, participant and IRA investment protections in future regulatory guidance despite the 5th Circuit decision. For my part, I intend to keep encouraging plan sponsors, plan participants, and individuals to be careful to only do business with financial professionals who are willing to commit to fiduciary status in writing. There are plenty of financial professionals who are adhering to a fiduciary standard of conduct now and so potential investors should shop around. Seeking out a Registered Investment Adviser is certainly one way to go.

FN: Are there any other thoughts or questions you like to share with our readers?
Borzi: Just one final thought – I’ve spent more than half my career in public service and, contrary to popular belief, the career employees that I worked with at EBSA and throughout the federal government were among the most dedicated and talented individuals that I ever had the privilege to meet. Regardless of who the political appointees are or their political or policy views, these individuals do their jobs day in and day out with skill and loyalty to the agency’s mission: protecting the benefits of the millions of working men and women who have been promised and earned those benefits. They understand that regardless of their own personal beliefs, they are obligated by their oath of office to carry out the priorities of the agency leadership to the best of their abilities and to the extent that those priorities are consistent with our Constitution and laws.

However, an important part of their job also included keeping someone like me – a person of strongly held opinions – from going off the rails and making decisions that might have imposed unnecessary burdens and expenses on plan sponsors and needless or counterproductive regulations on the regulated community. I welcomed their input (even when it was different from my own beliefs and instincts) and I am so very proud of all the work that we did together in the 8 years I was the Assistant Secretary. Naturally we made some mistakes along the way and I take full responsibility for those, but we did a lot of good work, and that was because of their effort and dedication, not any special talent of mine. I miss them all and thank them for their friendship and support.

FN: Phyllis, once again it’s an honor to speak to you on a matter so important to the readers of We cannot say enough about the sincerity of your efforts on behalf of plan sponsors and retirement savers. We wish you continued success and humbly suggest you leave the ice to the professionals in the NHL 😉

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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