Hayley McClenahan 

On April 20, 2015, the United States Department of Labor (DOL) issued a proposed rule that would impose a fiduciary duty on broker-dealers and others who advise clients regarding individual retirement accounts (IRAs) and employee benefit plans within the meaning of the Employee Retirement Income Act of 1974 (ERISA) and the Internal Revenue Code (Code).[1] Although the DOL’s intent behind the rule is aimed at consumer protection, the unintended consequences of the rule’s implementation, such as higher costs for and decreased access to financial services, are likely to be passed onto the consumer.[2]

Prior to the adoption of this rule, the DOL promulgated a five-factor test to determine if a financial professional was acting in the capacity of a fiduciary, and as such, if they owed a duty of loyalty and care to their client.[3] If so, that financial professional, typically a registered representative of a licensed broker-dealer, would have to act in that client’s best interest.[4] In the world of financial products, a registered rep typically fulfills that requirement by recommending the absolute best product for the plan, when considering risk tolerance, growth goals, and a myriad of other factors.[5] However, as the five-factor test operates now, registered representatives generally are not subjected to a fiduciary duty if they are acting in a traditional capacity.[6] As such, they are only required to meet a suitability threshold when recommending products.[7] This threshold normally means that the product must be suitable for the plan’s needs, but that it does not necessarily have to be the best product available for it, either.[8] Typically a registered representative would choose merely a suitable product over the best product because of the commission scheme on which broker-dealers have traditionally paid their representatives.[9] One product may be slightly more advantageous for a plan, but not pay as high a rate on commission.[10] If DOL’s proposed rule is adopted, anyone who gives financial advice of any kind, even if that advice is merely incidental to a sale, will have a fiduciary duty regarding that advice.[11]

When viewed from a surface level perspective, the DOL’s regulation would appear to promote consumer protection. The rule essentially says that if a person gives financial advice, that person must act in a fiduciary capacity, and thus, recommend the best product.[12] However, this rule is likely to, in effect, place a large strain on the financial industry. By imposing a uniform standard, the DOL is forcing broker-dealers to move away from operating in their traditional capacity: recommending and selling financial products and turning a commission on those sales.[13] If every product sold must be the best product, it eliminates the competitive drive that fuels these sales. As such, broker-dealers may be less willing to work with clients with modest investments, such as average middle-class individual investors.[14] With little return on the sale and the risk of liability for recommending a product that is not the best available, many broker-dealers may conclude that the risk of doing business with these types of plans is not worth the mediocre payoff.[15] This class of investors may be forced to proceed without guidance from industry professionals, as access to these services may prove unaffordable.

In order to combat the access issues that this rule may create, Congress should carve out an exception for broker-dealers who give financial advice that is purely incidental to the sale of the product. This Note will propose an exemption that would cover providing the individual or plan with an understanding of the features of the product and how it would behave as applied to the plan’s situation. By allowing this type of advice to continue to operate outside the fiduciary scheme, the Congress could preserve the commission based payment operations and incentivize registered reps to recommend competitive products.[16] Although this class of investor would not receive the benefit of a fiduciary relationship with their registered representative, it also would not be left without access due to unaffordability. Simply put, some advice that has a self-serving spin is arguably better than no advice at all for the unsophisticated investor.

In sum, although the DOL has good intentions in promulgating a rule that would impose a near-blanket fiduciary duty upon investment professionals, it will likely also have the effect of burdening modest investors. By carving out an exception for incidental advice, Congress can ensure that these plans still receive some clarifications around their investments while preserving the incentive based compensation scheme for broker-dealers and their registered representatives.

Questions and inquiries regarding this Note may be forwarded to the author at LawReview@vermontlaw.edu.

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[1] Definition of the Term “Fiduciary”; Conflict of Interest Rule—Retirement Investment Advice, 80 Fed. Reg. 75 (proposed Apr. 20, 2015) (to be codified at 29 C.F.R. pt. 2509-10).

[2] Bonnie M. Treichel, Note, The Quest for Financial Regulatory Reform: Will a Uniform Fiduciary Standard Guide the Way?, 4 J. Bus. Entrepreneurship & L. 151, 157 (2010).

[3] Lydia S. Amarmoo, Why Brokers are not Investment Advisers: ERISA’s Fiduciary Duty Only Applies Investment Advice to Pension Plans, 9 Cardozo Pub. L. Pol’y & Ethics J. 119, 125 (2015).

[4] Nikhil Bhargava, Broker-Dealers and Investment Advisors: The Administrations’s Plans for the Future of Regulation, 61 Admin. L. Rev. 907, 909 (2009).

[5] Id.

[6] Amaroo, supra note 3 at 120.

[7] Id.

[8] Bhargava, supra note 4 at 909.

[9] Treichel, supra note 2 at 157.

[10] Id.

[11] Definition of the Term “Fiduciary”, 80 Fed. Reg. 75 (2015).

[12] See Fact Sheet, Department of Labor Proposes Rule to Address Conflicts of Interest in Retirement Advice, Saving Middle-Class Families Billions of Dollars Every Year, U.S. Dep’t of Labor (last visited Feb. 14 2016) http://www.dol.gov/ebsa/newsroom/fsconflictsofinterest.html (President Obama adamantly supported the 2010 proposed version of this rule).

[13] Treichel, supra note 2 at 157.

[14] Id.

[15] Id.

[16] Letter from Marcia E. Asquith, Sr. V.P. & Corp. Sec., FINRA, to U.S. Dept. of Labor (July 17, 2015) http://www.finra.org/sites/default/files/FINRACommentLetter_DOL_07-17-15.pdf.