The New Department of Labor Rule

Recently, Labor Secretary Tom Perez announced the Department of Labor’s long awaited Fiduciary Rule. Here are answers to common questions regarding the new rule:

Why is the Department of Labor promulgating rules on investment advice?

In 1959, Congress passed the Welfare and Pension Plan Disclosure Act (WPPDA) requiring employee benefit plan sponsors to file plan descriptions and annual financial reports with the government in the hope of preventing mismanagement of such plans. Subsequently, in 1962, the Department of Labor was tasked with enforcement of the WPPDA. The financial distress of Studebaker, an automobile manufacturer, a year later led to thousands of layoffs. Many of these employees lost part or all of their pensions. Later government investigations found no wrongdoing on the part of the plan administrators for mismanagement of the pension plan’s investments. In response to this and similar events, Congress enacted the Employee Retirement Income Security Act of 1974 (ERISA) to protect the interest of employees participating in employee benefit plans. Congress tasked the Department of Labor, among other agencies, with interpreting and enforcing ERISA. President Gerald Ford signed ERISA into law on Labor Day, 1974. Since then, the Department of Labor has been responsible for protecting the employee benefit plans of ordinary Americans.

What has changed since ERISA was enacted in 1974?

Previously, American employers favored defined-benefit retirement plans. Defined-benefit plans promise the employee a certain benefit at retirement and put the responsibility of contributing to and making investment decisions on the employer. Since the 1960s, American employers have started to shift to defined-contribution plans. Defined-contribution plans promise the employee a certain contribution and put the responsibility of making investment decisions with the employee. Such plans reduce costs and liability for employers. Today, defined-contribution plans are by far the most common employee retirement benefit plan. As Labor Secretary Tom Perez so eloquently put it, “gone are the days where retirement meant a pen, a party, and a pension.” This change has put much more responsibility to save for retirement on the ordinary American. Because most Americans are now responsible for their own retirement, they have been increasingly turning to the financial industry for help. But, members of the financial industry owe varying degrees of care to their clients.

What are the different duties of care owed by members of the financial industry to clients?

In SEC vs. Capital Gains Research (1963), the U.S. Supreme Court ruled that the Investment Advisers Act made all registered investment advisers (RIAs) fiduciaries. This meant that investment advice rendered by RIAs had to be in the “best interest” of their clients. Other members of the financial industry were held to a much lower standard. For example, broker-dealers’ recommendations only had to be “suitable.” ERISA raised the standard of plan administrators to fiduciary status. But broker-dealers’ advice still only had to live up to the suitability test. This lower standard of care, coupled with broker-dealers’ compensation methods which are generally based on commissions and other transaction-based income, creates conflicts of interest.
How does the new Department of Labor rule change the duty of care owed by broker-dealers?
Under the new rule, broker-dealers will be held to the more stringent fiduciary standards under certain circumstances, namely when advising that a client transfer money out of an employee retirement benefit plan into an IRA, known as a rollover. The Department of Labor estimates that by requiring broker-dealers to deliver investment advice that is in the best interest of their clients rather than merely suitable under these circumstances, Americans will save nearly $4 billion a year on fees charged by brokers for certain investment products.

What does this new rule mean for me?

We recognize that there will be more rules promulgated that will likely require increased reporting on our part to prove we are in compliance with the fiduciary standard, but the level and complexity of reporting remains to be seen. As an independent RIA, Deighan Wealth Advisors has always been held to the fiduciary standard. Placing our clients’ interests first is one of our cornerstone values. Clients of our firm should experience no changes with respect to their accounts managed with us.