The U.S. Department of Labor (DOL) has issued new fiduciary rules regarding investment decisions, giving more power to retirement savers. Considered the biggest change in retirement planning services since Congress passed the Employee Retirement Income Security Act of 1974 (ERISA), the rule released in early April was six years in the making. It was crafted in response to major changes in retirement financial services during the decades since ERISA was enacted, when pensions increasingly gave way to 401(k)s and assets held in IRAs and annuities.
The rule updates loopholes in the law that have allowed certain financial advisers to avoid liability for losses their imprudent advice caused their clients by requiring that companies either change their compensation models or enter into a contract with investors affirmatively acknowledging their fiduciary status. While these contracts may still contain forced arbitration provision and/or a waiver of punitive damages and rescission as a remedy for breach (but only as permitted by applicable laws), contracts may not contain any provisions disclaiming or otherwise limiting liability, including any waiver of an investor’s right to participate in a class action or any pre-dispute agreement to an amount of liquidated damages or other damages cap.
One of the most controversial changes to the rule is the definition of fiduciary, and a fiduciary’s requirements, under ERISA. Paul Borden, a lawyer with Morrison & Foerster, says some firms that sell securities to individual retirement accounts or pension plans will become fiduciaries under ERISA under the new rules. He said this opens up another avenue for litigation, adding: “Becoming a fiduciary under ERISA will expose them to the fiduciary breach and self-dealing prohibited transaction provisions of ERISA.”
The rule will require those financial professionals who provide investment advice to plans, plan sponsors, fiduciaries, plan participants, beneficiaries, IRAs, and IRA owners to do so without regard to their own interests, or the interests of anyone else other than the customer. This includes a requirement that they charge only reasonable compensation, make no misrepresentations to their customers regarding recommended investments, and assume a fiduciary responsibility for which they will be legally accountable upon the provision of conflicted or biased advice that is not in the investor’s best interest.
Experts have said the rules provide investors and their attorneys an important new tool to bring claims when they suspect their broker-dealer doesn’t have their best interests at heart. Not only does the regulation provide some protection to investors on the front-end – when the investments are made – it provides an extra avenue for enforcing proper investment procedures on the back-end.
The regulation’s requirement that brokers enter a contract with clients affirming they will uphold the client’s best interest – or disclose when they can’t – has provided a new and definite avenue for investors to bring claims over bad advice. Barbara Roper, the Director of Investor Protection at the Consumer Federation of America, said: “That enforceable contract provides a hook for litigation.”
It’s expected that there will be more litigation because of the new rules. Ms. Roper added that the so-called best interest contract exemption (sometimes simply called BICE), which allows brokers to continue to collect commissions from sales as long as they acknowledge their fiduciary duty to clients, and disclose conflicts of interest, will eliminate ambiguity over whether fiduciary standards apply to brokers that give advice to retirement accounts. The contract rule was developed in order to provide investors with a legal basis to bring a claim if brokers and broker-dealer firms breach their fiduciary duty commitments. This allows for claims that weren’t previously available under the Employee Retirement Income Security Act.
A major benefit to the changes in the definition of a fiduciary is that it allows claims for breach of fiduciary duty against parties that previously disclaimed any fiduciary relationship. For example, “[t]he primary claim brought against broker-dealers in FINRA arbitration is violation of fiduciary duty, even though they don’t legally have a fiduciary duty,” Ms. Roper said. A 2015 report from the Public Investors Arbitration Bar Association found that many brokers advertise that they act in customers’ best interests, but deny that they have any fiduciary duty behind the closed doors of arbitration fights. In that kind of case, Roper said, the new rules will make it easier for investors to prevail by eliminating the need to prove that a broker-dealer had a fiduciary duty or claimed that it was acting with the investor’s best interests.
There is already opposition to the new rules. In fact, three Republican senators have banded together to try to kill the Labor Department’s new fiduciary rule. Senators Johnny Isakson of Georgia, Lamar Alexander of Tennessee and Mike Enzi of Wyoming have introduced a resolution to stop implementation of the new regulation that was released April 6. If the Senators can manage to get the resolution passed, which is very doubtful, President Obama will certainly veto it. Investors and consumer advocates alike have lauded the new rules for the protections and enforcement provisions they create. The ability to claim breach of fiduciary duty against investment advisors that previously disclaimed a fiduciary relationship is good news for investors.
Sources: Law 360.com; www.investmentnews.com and www.accountingweb.com
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