As I've been touring the country and speaking with advisers, I'm astonished at the number of broker-dealer and dual registrant firms that have, apparently, told their own advisers to "not worry" about the U.S. Department of Labor's "Conflict of Interest" (Fiduciary) Rules (and the related prohibited transaction exemptions, such as the Best Interests Contract Exemption).
Advisers should be informed ....
(1) The U.S. Department of Labor's rules have only been partially delayed (now, until July 2019).
(2) While changes to the rules are expected before they are fully put into effect, including new or modified "streamlined" exemptions, the DOL rules are broadly applicable right now.
(3) The DOL Rules are enforceable through private right of action by clients. Yet, the largest impact of any complaint upon the individual adviser is upon the adviser's U-4. In essence, the largest risk posed to individual advisers is that to their reputation.
(4) While the DOL has stated that it will not seek to mandate the prohibition against client waivers of their right to pursue class-action claims as to IRA accounts, individual claims can still be brought. Of course, these claims will end up in FINRA arbitration, for complaints brought against broker-dealer firms and their representatives (including most or nearly all dual registrants).
(5) The claims exist for breach of fiduciary duty, and specifically for violation of the impartial conduct standards. These are tough standards, as they include the application of the prudent investor rule and its duties to avoid waste of client assets and to minimize idiosyncratic risk.
(6) How, specifically, can the claims be pursued? The DOL's "Definition of Fiduciary" rule makes nearly all of those providing recommendations to ERISA-covered retirement plans and to IRA accounts "fiduciaries." As a result, fiduciary duties might be breached in these circumstances:
(A) ADVICE PROVIDED TO PLANS, OR PLAN ACCOUNTS, GOVERNED BY ERISA. When a breach of fiduciary duty exists as to investment recommendations provided upon an ERISA-covered retirement plans, a private right of action exists under ERISA.
(B) ADVICE ON IRA ROLLOVERS FROM ACCOUNTS GOVERNED BY ERISA. When an adviser provides recommendations regarding a rollover from an ERISA-covered account to another plan's account, or to an IRA account, a private right of action exists under ERISA. This private right of action extends only to the advice regarding the rollover. Since that advice requires a due diligence analysis (and documentation of the cost-benefit analysis so undertaken), which in turn requires a comparison of the investments in the ERISA-covered account with those that would be recommended, it is likely that the implementation of the recommendations immediately following the rollover would be considered part of the rollover process (otherwise the due diligence analysis would be faulty).
(C) ONGOING MANAGEMENT OF IRA ACCOUNTS. For the ongoing management of IRA accounts, as to advisers who are not "level fee advisers" under the Best Interests Contract Exemption (prohibited transaction rule), there exists a "gray area" in the application of the fiduciary standards. There are two major theories, however, upon which fiduciary status can be asserted, and upon which fiduciary liability may rest:
1. COMMON LAW FIDUCIARY STATUS IS IMPOSED. There are reported court decisions in which status as a "fiduciary" under state common law has been found to exist by reason of the firm being a registered investment adviser or the individual individual adviser being an investment adviser representative by application of the Investment Advisers Act of 1940. In essence, because the law "declares" the person subject to registration under the Advisers Act to be a "fiduciary," courts have found that the person has fiduciary status under "state common law" (i.e., judge-made law, developed through the centuries). Sometimes this is a factor in determining fiduciary status - as to when a financial adviser is acting in a "relationship of trust and confidence" with the client. At other times court decisions have more or less directly proceeded from "you are a fiduciary under the Advisers Act" to "therefore you are a fiduciary under state common law." Not surprisingly, there are not a huge amount of cases in this area (as most complaints head to arbitration, and no court decisions result), and their are some differences among the several state courts that have addressed this issue.
It would be fair to say that, at a minimum, the DOL's imposition of fiduciary standards on those who provide ongoing advice to IRA accounts (and who are not "level fee advisers") makes in much more likely that state common law fiduciary status will be found to exist.
If common law fiduciary status is found to exist for the ongoing management of IRA accounts, then the question arises as to what specific standards exist. For example, is having a "reasonable basis" for the investment decision sufficient, or does the tougher duty of due care found in the prudent investor rule (imposed by the DOL's impartial conduct standards) apply? In this instance, the DOL states that the impartial conduct standards apply. There have been many instances where courts look to federal regulations for determining the standard of care, in a wide range of situations. Accordingly, it is likely that the impartial conduct standards would be deemed to apply.
2. IMPLIED TERM OF AN EXPRESS CONTRACT. The DOL's rules that extend the deadline for full application of B.I.C.E. (and certain other prohibited transaction exemptions, such as portions of 84-24) do not require - during the extension period - that the contract with the client incorporate the impartial conduct standards, contain a fiduciary warranty, nor even acknowledge fiduciary status.
But, it is a long-standing principle of the state common law of contracts that adherence to the law is an implied term of nearly every express contract. (Indeed, a contractual term that obligates one to violate a law would likely be deemed void, as against public policy.)
Hence, fiduciary status may result, and the impartial conduct standards deemed to apply, if courts determine (as seems likely) that compliance with the DOL's impartial conduct standards (which the DOL mandates to so occur, under the extensions) is an implied term of every contract. And that any express term of the contract (e.g., brokerage firm - customer contract) that states otherwise (such as "you agree we are not fiduciaries") would be deemed null and void.
As I've written about before, in this blog and elsewhere, the impartial conduct standards are tough.
And, as I've written about before, a carefully undertaken cost-benefit analysis must be undertaken now, for rollovers to IRA accounts.
Advisers beware. If you firm is saying to you, "Don't worry" - perhaps you should really be worrying.
For both ERISA-covered accounts and for IRA accounts, you are highly likely to be a fiduciary. That means, quite simply, that you represent the client. Any duties you possess to your firm are secondary. (Fiduciary duties are subject to ordering, with the duty of the adviser to the client being paramount to any duties owned by the adviser to the firm.) You are no longer a salesperson. And, you should learn how to comply with the prudent investor rule, and all of its obligations.
ADVISERS - DON'T PUT YOUR REPUTATION AT RISK. If your firm continues to do business as before, and does not support full compliance with the DOL fiduciary rule, you are at risk. Firms find it easy to repair their reputations (by blaming actions on "rogue brokers" and via advertising). Advisers' reputations, once tarnished, are seldom brought back to a high degree of luster.
Advisers should be informed ....
(1) The U.S. Department of Labor's rules have only been partially delayed (now, until July 2019).
(2) While changes to the rules are expected before they are fully put into effect, including new or modified "streamlined" exemptions, the DOL rules are broadly applicable right now.
(3) The DOL Rules are enforceable through private right of action by clients. Yet, the largest impact of any complaint upon the individual adviser is upon the adviser's U-4. In essence, the largest risk posed to individual advisers is that to their reputation.
(4) While the DOL has stated that it will not seek to mandate the prohibition against client waivers of their right to pursue class-action claims as to IRA accounts, individual claims can still be brought. Of course, these claims will end up in FINRA arbitration, for complaints brought against broker-dealer firms and their representatives (including most or nearly all dual registrants).
(5) The claims exist for breach of fiduciary duty, and specifically for violation of the impartial conduct standards. These are tough standards, as they include the application of the prudent investor rule and its duties to avoid waste of client assets and to minimize idiosyncratic risk.
(6) How, specifically, can the claims be pursued? The DOL's "Definition of Fiduciary" rule makes nearly all of those providing recommendations to ERISA-covered retirement plans and to IRA accounts "fiduciaries." As a result, fiduciary duties might be breached in these circumstances:
(A) ADVICE PROVIDED TO PLANS, OR PLAN ACCOUNTS, GOVERNED BY ERISA. When a breach of fiduciary duty exists as to investment recommendations provided upon an ERISA-covered retirement plans, a private right of action exists under ERISA.
(B) ADVICE ON IRA ROLLOVERS FROM ACCOUNTS GOVERNED BY ERISA. When an adviser provides recommendations regarding a rollover from an ERISA-covered account to another plan's account, or to an IRA account, a private right of action exists under ERISA. This private right of action extends only to the advice regarding the rollover. Since that advice requires a due diligence analysis (and documentation of the cost-benefit analysis so undertaken), which in turn requires a comparison of the investments in the ERISA-covered account with those that would be recommended, it is likely that the implementation of the recommendations immediately following the rollover would be considered part of the rollover process (otherwise the due diligence analysis would be faulty).
(C) ONGOING MANAGEMENT OF IRA ACCOUNTS. For the ongoing management of IRA accounts, as to advisers who are not "level fee advisers" under the Best Interests Contract Exemption (prohibited transaction rule), there exists a "gray area" in the application of the fiduciary standards. There are two major theories, however, upon which fiduciary status can be asserted, and upon which fiduciary liability may rest:
1. COMMON LAW FIDUCIARY STATUS IS IMPOSED. There are reported court decisions in which status as a "fiduciary" under state common law has been found to exist by reason of the firm being a registered investment adviser or the individual individual adviser being an investment adviser representative by application of the Investment Advisers Act of 1940. In essence, because the law "declares" the person subject to registration under the Advisers Act to be a "fiduciary," courts have found that the person has fiduciary status under "state common law" (i.e., judge-made law, developed through the centuries). Sometimes this is a factor in determining fiduciary status - as to when a financial adviser is acting in a "relationship of trust and confidence" with the client. At other times court decisions have more or less directly proceeded from "you are a fiduciary under the Advisers Act" to "therefore you are a fiduciary under state common law." Not surprisingly, there are not a huge amount of cases in this area (as most complaints head to arbitration, and no court decisions result), and their are some differences among the several state courts that have addressed this issue.
It would be fair to say that, at a minimum, the DOL's imposition of fiduciary standards on those who provide ongoing advice to IRA accounts (and who are not "level fee advisers") makes in much more likely that state common law fiduciary status will be found to exist.
If common law fiduciary status is found to exist for the ongoing management of IRA accounts, then the question arises as to what specific standards exist. For example, is having a "reasonable basis" for the investment decision sufficient, or does the tougher duty of due care found in the prudent investor rule (imposed by the DOL's impartial conduct standards) apply? In this instance, the DOL states that the impartial conduct standards apply. There have been many instances where courts look to federal regulations for determining the standard of care, in a wide range of situations. Accordingly, it is likely that the impartial conduct standards would be deemed to apply.
2. IMPLIED TERM OF AN EXPRESS CONTRACT. The DOL's rules that extend the deadline for full application of B.I.C.E. (and certain other prohibited transaction exemptions, such as portions of 84-24) do not require - during the extension period - that the contract with the client incorporate the impartial conduct standards, contain a fiduciary warranty, nor even acknowledge fiduciary status.
But, it is a long-standing principle of the state common law of contracts that adherence to the law is an implied term of nearly every express contract. (Indeed, a contractual term that obligates one to violate a law would likely be deemed void, as against public policy.)
Hence, fiduciary status may result, and the impartial conduct standards deemed to apply, if courts determine (as seems likely) that compliance with the DOL's impartial conduct standards (which the DOL mandates to so occur, under the extensions) is an implied term of every contract. And that any express term of the contract (e.g., brokerage firm - customer contract) that states otherwise (such as "you agree we are not fiduciaries") would be deemed null and void.
As I've written about before, in this blog and elsewhere, the impartial conduct standards are tough.
And, as I've written about before, a carefully undertaken cost-benefit analysis must be undertaken now, for rollovers to IRA accounts.
Advisers beware. If you firm is saying to you, "Don't worry" - perhaps you should really be worrying.
For both ERISA-covered accounts and for IRA accounts, you are highly likely to be a fiduciary. That means, quite simply, that you represent the client. Any duties you possess to your firm are secondary. (Fiduciary duties are subject to ordering, with the duty of the adviser to the client being paramount to any duties owned by the adviser to the firm.) You are no longer a salesperson. And, you should learn how to comply with the prudent investor rule, and all of its obligations.
ADVISERS - DON'T PUT YOUR REPUTATION AT RISK. If your firm continues to do business as before, and does not support full compliance with the DOL fiduciary rule, you are at risk. Firms find it easy to repair their reputations (by blaming actions on "rogue brokers" and via advertising). Advisers' reputations, once tarnished, are seldom brought back to a high degree of luster.
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