Department of Labor (DOL) Fiduciary Rule Explained
The DOL Fiduciary Rule was introduced in order to protect employees who invest in 401(k) or similar employer-sponsored plans and IRA holders.
The rule requires investment advisors providing such advice to act in plan participants' best interest as fiduciaries.
However, it provides an exemption from ERISA that allows advisors to receive compensation directly from mutual fund companies, with certain restrictions.
For instance, investment advice must be in the best interest of the investor and must not place any other interests ahead of that interest.
Supporters of the exemption said it means participants do not pay out of their own pocket for advice, which might otherwise be unaffordable for lower-income participants.
Opponents argue that the exemption allows advisors to engage in self-dealing by recommending a mutual fund with higher fees for which the advisor is paid more than an otherwise comparable fund with lower fees.
Proponents of the fiduciary rule said it would ensure conflicts of interest are eliminated and investors' interests are put first. They also said that it would help to prevent retirees from losing a large chunk of their nest eggs to fees.
What Is the DOL Fiduciary Rule?
The Department of Labor (DOL) released a fiduciary rule in April of 2016. This rule is designed to protect retirement savers from being taken advantage of by those who give them investment advice.
The rule requires that anyone who provides investment advice to retirement savers must act in the best interest of those savers.
The rule also establishes a new fiduciary duty for brokers, dealers, and insurance agents when they make recommendations about investments in ERISA-covered plans and IRAs.
The DOL fiduciary rule is based on the concept that investors are better off when the financial interests of their advisors are aligned with their own. The rule is also intended to crack down on abusive practices, such as hidden fees, that have eroded retirement savings.
The DOL fiduciary rule was originally scheduled to go into effect in April 2017. However, it was delayed by the Trump administration until June 2019.
The delay was designed to give the new administration time to review and possibly revise the rule before it goes into effect.
The Department of Labor has stated that it will not pursue any claims against investment advisors acting in good faith to comply with the new rule.
History of the Fiduciary Rule
The fiduciary rule has a long and complicated history. The DOL first attempted to introduce a fiduciary rule in 1975. However, this rule was overturned by the courts because it exceeded the DOL's authority.
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law.
The Dodd-Frank Act included a provision that required the DOL to undertake a study on whether investor protection rules needed to be strengthened.
The DOL issued its report in 2011, finding that investors were not adequately protected from conflicts of interest by brokers and other investment advisors who advised retirement plans.
In April 2015, President Obama directed the DOL to propose a rule that would require financial advisors who advise on retirement plans to act as fiduciaries.
The DOL issued its proposed rule in April 2015 and received more than 300,000 comments from the public before finalizing the new rule in 2016.
In May 2017, President Trump signed an executive order directing federal agencies to review and repeal any regulations that were deemed to be harmful to the economy. As a result, the DOL fiduciary rule was delayed until June 2019.
What Does the DOL Fiduciary Rule Mean for Investors?
The DOL fiduciary rule is designed to protect investors from being taken advantage of by those who give them investment advice.
The rule requires that all financial advisors who provide advice regarding retirement plans must act as fiduciaries and put their clients' interests ahead of their own.
The new rule is designed to help investors avoid conflicts of interest that can result in lower returns, higher fees, and other adverse outcomes.
For example, a financial advisor who receives commissions for recommending a particular mutual fund may be more likely to recommend that fund, even if it is not in the best interest of the investor.
The DOL fiduciary rule also provides investors with greater transparency.
Investment advisors are now required to disclose any conflicts of interest that they have and how those conflicts may impact the advice they give to their clients.
The DOL fiduciary rule is not without its detractors. Some investment advisors argue that the rule will make it more difficult for them to do business and that it will result in higher fees for investors.
Others argue that the rule does not go far enough in protecting investors from conflicts of interest.
Why Does the DOL Fiduciary Rule Matter?
Many people saving for retirement do not have a lot of investment knowledge and rely on advisors to help them make good decisions about their retirement accounts.
The fiduciary rule is designed to protect retirement savers from being taken advantage of by those who give them investment advice.
The rule applies to both employer-sponsored plans and IRA holders. It does not apply to non-retirement accounts, such as brokerage or taxable accounts.
The rule requires investment advisors to put their clients' best interests ahead of their own when providing advice on retirement accounts.
The fiduciary standard is stricter than the suitability standard that was previously in place, which allowed investment advisors to recommend products that were suitable for a client but not necessarily in his/her best interests.
Under the new rules, investment advisors are prohibited from entering into or renewing certain compensation arrangements with service providers.
This is to avoid conflict with the best interest standard that requires them to act in their clients' best interests when providing recommendations on rollovers of retirement assets.
Best Interest Contract Exemption
The Best Interest Contract (BIC) exemption permits investment advisors to continue to receive commissions and other forms of compensation when providing advice on retirement accounts, as long as they meet certain conditions.
In order to qualify for the BIC exemption, investment advisors must enter into a written contract with their clients that meets certain requirements.
To qualify for the exemption, the advisor’s firm will have to:
- Make a written commitment to comply with the best interest standard
- Negotiate a contract with each client that outlines the advisor’s fiduciary duties
- Disclose any conflicts of interest
- Adhere to certain recordkeeping requirements
- Work in their clients’ best interests
- Earn no more than reasonable compensation
The Bottom Line
The DOL Fiduciary Rule is a complicated and controversial rule that has been in the works for years. It was designed to protect investors from being taken advantage of by those who give them investment advice.
The fiduciary standard requires financial advisors to put their clients' best interests ahead of their own when providing recommendations on retirement investments or other accounts where there may be conflicts of interest.
The rule has been met with criticism by some investment advisors, who argue that it will make doing business more difficult and that it will result in higher fees for investors.
Others argue that the rule does not go far enough in protecting investors from conflicts of interest.
Despite the criticism, the fiduciary rule is now in effect and employers should ensure that any investment advisors they work with comply with the new regulations.
FAQs
1. Does the fiduciary rule apply to all investments?
The fiduciary rule applies only to retirement investments — 401(k)s, IRAs, and other related plans. It does not apply to non-retirement accounts, such as brokerage or taxable accounts. The Securities and Exchange Commission (SEC) may also adopt a fiduciary rule for the broader investment industry in the future.
2. What is the Best Interest Contract (BIC) exemption?
The fiduciary rule includes the BIC exemption, which allows advisors to continue to be paid on commission. To qualify for the exemption, the advisor’s firm will have to:
- Make a written commitment to comply with the best interest standard
- Negotiate a contract with each client that outlines the advisor’s fiduciary duties
- Disclose any conflicts of interest
- Adhere to certain recordkeeping requirements
- Work in their clients’ best interests
- Earn no more than reasonable compensation
3. Why would an advisor or intermediary need to use the BIC exemption?
Advisors who are considered fiduciaries under the new DOL rule can generally receive a commission or a 12b-1 fee from an IRA or other retirement plan.
But this is only if they comply with the terms of a prohibited transaction exemption, as the new BIC exemption.
4. Does the rule eliminate commission compensation entirely?
The BIC exemption allows advisors to continue receiving a commission, as long as they work in their clients' best interests and meet other requirements.
To qualify for the exemption, the advisor's firm will have to adopt policies to ensure that all advice meets impartial conduct standards, and earn no more than reasonable compensation.
5. Why didn’t the fiduciary rule need to be voted on by Congress to be passed?
The Department of Labor (DOL) has the authority to implement the fiduciary rule without congressional involvement. Congress can try to take some action to block or change the new rule. However, such an effort would face an uphill battle.
