On Wednesday, February 8, the United States District Court, Northern District of Texas upheld the Department of Labor’s Fiduciary Duty Rule. The Order may be found here.
The implications of the Order are unclear, given last Friday’s Presidential Memorandum directing the DOL to examine the Rule and to rescind or revise the Rule “as appropriate and as consistent with law.” Our post discussing the President’s Memorandum is here. In this post, we offer some predictions. In subsequent posts, we will provide updates on this rapidly developing situation.
In response to the President’s directive the DOL has at least four options.
First, the DOL could simply revoke the rule.
Second, the DOL could propose to the White House’s Office of Management and Budget a regulation that would delay the applicability date by at least 180 days with a short notice and public comment period.
Third, the DOL could find there is “good cause” to avoid rulemaking, determine that notice and comment would be “impracticable, unnecessary or contrary to the public interest,” and decline to enforce the Rule. This would not, however, stop private litigation.
Fourth, the DOL could advise the President that its efforts have been affirmed by the judiciary, and nothing more needs to be done. In doing so, the DOL could take the position that it has spent seven years reviewing, accepting comments, revising and studying the Rule, which efforts have been affirmed by the Judicial Branch.
This would be an interesting tack, pitting an executive department against the President to whom it reports. This could, in turn, create a major crisis of government and Constitutional issues. We are hard-pressed to recall a situation in which a department of the Executive Branch rebelled against the President in such a manner. If this were to occur, it might take an Act of Congress to legislate against the Rule.
From our perspective, the Rule could and should be refined in the following ways:
- The DOL should amend the Rule to simply provide that an adviser will place his or her client’s interests first, and nothing more. There should be no commentary on whether the lowest fee is appropriate, as that notion creates a conflict as to whether an adviser should emphasize low fees or performance.
The Rule in its current form will drive advisers to implement the lowest fee for retirement clients, through the concept of “reasonable compensation.” Obtaining the lowest fee may very well sacrifice return. If the adviser seeks a better return, she could be penalized in litigation for not obtaining the lowest fee. On the other hand, if the adviser seeks the lowest fee, he could be penalized for not obtaining the highest return. The Rule creates traps from which the adviser cannot escape.
- The Rule should eliminate the provision that for purposes of Title I of ERISA, the terms “employee pension benefit plan” and “pension plan” do not include an individual retirement plan established and maintained pursuant to a state payroll deduction savings program if the program satisfies all of the conditions set forth in paragraphs (h)(1)(i) through (xi) of the Regulation.
This means that states and employers using a state payroll deduction savings provision are immune from ERISA liability. In our judgment, this provision is unfair. We believe that employers will use state payroll deduction savings programs to escape liability. If this happens, free choice and investment return will be severely restricted.
If a governmental body assumes a role routinely assumed by the financial services industry, that governmental body should be subject to the same liability imposed upon private entities. If the DOL is truly interested in protecting retirement savers, then states and employers should be subject to the liability provisions of ERISA.
As it stands now, the Rule discriminates against the small investment firm. It eliminates the free choice that is the hallmark of our free market system. Firms will restrict the programs offered on their platforms. If a client likes his or her adviser, the client will be restricted to those programs offered by that adviser’s firm, and cannot take advantage of programs not offered in the adviser’s firm.
It is clear the Rule will destroy jobs in the investment industry because it will cause investment professionals to send their less well-heeled and beginning investors to so-called robo-advisers. It is unlikely that as young investors mature, they will seek human advisors.
Finally, with ambiguous terms and requirements and no regulatory enforcement mechanism, the Rule invites private litigation to define itself. If the Rule goes forward in its present form, it will be a field day for plaintiff’s lawyers. They will use the DOL’s FAQs interpreting the Rule (located here and here) to set an impossibly high standard of conduct. They will argue that any adviser with disappointing returns failed to meet the DOL’s high standard, or that the fees incurred in obtaining returns were not “reasonable.”
Two simple changes — setting a “client first” standard and eliminating the immunity from liability provision of the Rule for state-sponsored savings programs — could solve the problem.