DOL Issues Proposed Exemption for Investment Fiduciaries

Summer 2020 Fiduciary Commentary

The DOL recently announced a proposed regulation that would provide an exemption under ERISA to permit fiduciaries to receive compensation for their advice services. As background, ERISA prohibits fiduciaries from acts of self-dealing, which includes receiving compensation for advice services.  The proposal will allow investment fiduciaries to provide advice services if they act in the savers’ best interest.

The fiduciary rule has been an ongoing financial saga for well over a decade. Most recently, a revised rule was introduced in April 2016. In March 2018, the Fifth Circuit struck down the rule citing the DOL overreached its authority, the same argument made by many influential Wall Street special interest groups.

The current DOL proposal is narrower in scope than the previous attempts of updating the long-standing fiduciary standard. The regulation does not expand the range of persons who may be considered a fiduciary or affect the definition of fiduciary. The proposed regulation would allow advice services to investors in ERISA plans and IRA accounts, including permitting advice to rollover a participant accounts from a qualified plan to an IRA or other similar types of rollover recommendations. The regulations require that advice provided be based on “impartial conduct standards,” the best interest standard, a reasonable compensation standard, and a requirement to not make misleading statements to the investor. These requirements appear to be an attempt to harmonize the DOL’s rulemaking with the recent implementation (June 30) of the SEC’s Regulation Best Interest (Reg BI). The SEC’s Regulation BI, supported by the broker-dealer industry, was designed to raise the advice standards for broker-dealers when making investor recommendations above the current suitability rule.

Advocates of the new rule say that the proposed exemption would give savers more choice of advice delivery. DOL Secretary Eugene Scalia asserts, “the exemption would add to the tools individuals need to make the right decisions for their financial future.” The standards in the proposed exemption “align with standards of other regulators, including the SEC,” Labor said.

The regulation faces criticism by advocates for the original, more impactful DOL fiduciary rule stating that the new regulation is simply too weak to ensure that investors’ interest will come first and curb broker conflicts of interest. Moreover, Regulation BI allows many more conflicts than ERISA fiduciary obligations and basing the new DOL rule on the SEC regulation is watering down of the current higher threshold standards.

Many industry practitioners believe that all investment and financial advice should be held to an elevated fiduciary standard because the cost to those receiving conflicted investment advice is too high to ignore. Wall Street has a strong financial incentive to maintain the status quo, and critics believe there is too much money being made to effect real change – and again, investors’ interest will be subordinated to the interests of Wall Street.

The DOL proposal will be published shortly in the Federal Register and will be open for public comment at that time. After reviewing the comments, the DOL could modify the proposal and then promulgate a final rule. That process could take months.

Participants Undeterred During Pandemic

Despite uncertain market conditions caused by the COVID-19 pandemic, participants continued to save for retirement through their employer-sponsored retirement plans. According to a study performed by the Investment Company Institute (ICI) in Q1 of 2020, plan participants’ contribution and investment allocation remain generally unchanged despite the pandemic induced volatility. The study tracked contributions, withdrawals, and other participant activity based on defined contribution plan recordkeeper data of more than 30 million participant accounts in defined contribution plans.

Estimates from the ICI study showed that only 1.4% of defined contribution plan participants stopped their plan contributions in that time period, compared with 0.9% in the first quarter of 2019 and 2.7% in Q1 2009 – a period of high volatility due to the Great Recession. Additional survey findings included:

  • Asset allocation: Most plan participants did not adjust their investment allocations in Q1. Though the stock market correction was approximately 20% in Q1, only 6.2% of participants modified their mix among asset classes. This observation was slightly higher than the change seen in the Q1 2019 (4.2%), and Q1 2009 (5.5%).
  • Withdrawals: Plan distribution activity remained low in Q1, albeit slightly higher than the activity in the same period in 2019. According to the study data, only 1.8% of participants took withdrawals in Q1 2020, compared with 1.4% in the first quarter of 2019 and 2.7% in the same period of 2009.
  • Loan activity: The study found that plan loan activity increased slightly. At the end of March 2020, 16.3% of plan participants had loans outstanding, compared with 16.1% in Q1 2019 and 15.9% in the same period of 2009.

Comparable studies have similar findings. Data compiled by Ascensus, “State of Savings: June 2020” found that more than 93% of retirement savers on its recordkeeping platform made no changes to their savings rates. The study found that in the first five months of the year, only 5.3% of savers stopped making plan contributions. In addition, only 1.8% reduced their plan contribution rate, and 3.8% boosted their deferral percentage.

At least to date, it appears that most plan participants are staying the course and maintaining their savings and investment practices despite the uncertainty of the economy and the fragile markets. What might be the reason for this stoic investor behavior in the face of an unprecedented pandemic and economic environment? There are many possible explanations – among them, plan automation features are likely having a positive effect on investor actions. Automatic enrollment and investments in default vehicles could be instilling a recognition in the positive value of a long-term investment stance and a “leave-it-be” attitude with investors. It is well documented that investors in target-date funds are less likely to make allocation changes than investors in other plan investments. In fact, according to T. Rowe Price, 98.5% of TDF investors did not make a change in their accounts during Q1’s correction. Whatever the reason, it is good not to see the knee-jerk decision making that many associate with market shocks. Let’s hope its sticks.

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