The DOL is rushing through a new "fiduciary rule" that guts who is subject to fiduciary standards for those providing investment advice to plan sponsors and plan participants. It further guts ERISA's fiduciary standard and prohibited transaction requirements by tying the interpretation of the fiduciary standard to the SEC's flawed Regulation "Best Interests" - which is only a very modest enhancement of the (non-fiduciary) "suitability standard" of conduct that has long shielded broker-dealers and their registered representatives from being held accountable for their investment and portfolio advice.
In this blog post I reflect upon whether the DOL, by proceeding at warp speed, may be violating the spirit, if not the letter, of the Administrative Procedures Act.
THE REQUIREMENTS OF THE ADMINISTRATIVE PROCEDURES ACT, GENERALLY
The Administrative Procedure Act (APA), which applies to all agencies of the federal government, provides the general procedures for various types of rule making. The APA details the rarely used procedures for formal rules as well as the requirements for informal rule making, under which the vast majority of agency rules are issued.
For what is termed "informal rule making" under the APA (which is the vast majority of agency rule making), the notice requirement of § 553 of the APA is satisfied when the agency “affords interested persons a reasonable and meaningful opportunity to participate in the rule making process.” Once adequate notice is provided, the agency must provide interested persons with a meaningful opportunity to comment on the proposed rule through the submission of written “data, views, or arguments.”
While there is no minimum period of time for which the agency is required to accept comments, in reviewing an agency rule making, courts have focused on whether the agency provided an “adequate” opportunity to comment—of which the length of the comment period represents only one factor for consideration.
Although the APA sets the minimum degree of public participation the agency must permit, the legislative history of the APA suggests that “[matters] of great importance, or those where the public submission of facts will be either useful to the agency or a protection to the public, should naturally be accorded more elaborate public procedures.”
Agencies are required to respond to all public comments to a reasonable extent, and sufficient public opposition to or criticism of a proposed rule may result in modifications to the rule or, in cases of significant opposition, re-drafting of the rule with a new publication and comment period.
THE DOL INVESTMENT ADVICE (FIDUCIARY) RULE: A LONG HISTORY
The fiduciary rule is the product of more than ten years of work.
The actual history of efforts to re-define when fiduciary duties apply under ERISA goes back to the George W. Bush Administration. The U.S. Department of Labor (DOL) adopted as a final rule in the waning days of the Bush administration. The Obama Administration put the rule, which had not passed its effective date, on hold.
The DOL went back to the drawing board, under the Obama Administration. It first proposed a broadening of the application of the fiduciary standard to providers of investment advice to retirement plan sponsors and plan participants in 2010. After a comment period, the U.S. Department of Labor withdrew this proposal to address concerns that were raised. The DOL then consulted extensively, including with stakeholders and other government agencies, particularly the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).
The next iteration of the rule was proposed by the DOL in April 2015. After receiving requests for additional time to submit input on the revised rule, the DOL extended the comment period by two weeks in July and held a four-day hearing during the week of August 10, 2015. The DOL then re-opened the comment period again for an additional two weeks for additional public testimony and comments. In total, there were over 100 days for the public to comment on the draft rule The Department received 3,134 total comments, including 30 petitions that encompass an additional 386,889 comments. The DOL's proposal was strongly opposed by most broker-dealer firms and insurance companies (and their lobbying organizations, such as SIFMA, FSI, and ACLI). While the public participation in the process was dominated by securities broker-dealer firms and insurance industry firms and lobbyists, the Obama Administration's DOL did receive substantial input from as compared to public interest or consumer groups.
The DOL finalized its rule in 2016. After lengthy court challenges, in which the DOL prevailed in most of them, a divided 5th U.S. Circuit Court of Appeals overturned the DOL's fiduciary rule in June 2018. The Trump administration declined requests from consumer groups and others for further judicial review or appeal of the 5th Circuit's opinion.
The DOL, now acting under the Trump Administration, and led by U.S. Secretary of Labor Eugene Scalia (who represented the securities industry firms that challenged the prior DOL's rule, which prevailed I the 5th Circuit opinion) then proceeded to draft a new proposed rule, which was published in July 2020. The proposed rule would substantially weaken the previous rule's application of ERISA's fiduciary standard and prohibited transaction rules, both as to who it applied to, as well the requirements under ERISA when fiduciary status was applicable. A short 30-day comment period was provided. Thereafter, on August 25, 2020 a Notice of Hearing was published, providing only 3 days for those desiring to testify to submit outlines, and restricting the topics to mostly "factual issues" that could not be covered in comment letters. Presumably, those selected to testify will be notified by Tuesday, Sept. 1st, with the hearing to be conducted on Thursday, Sept. 3rd (and, if needed, Friday, Sept. 4th). Only those who submitted written comments or previously requested to testify are permitted to testify at the Sept. 3rd/4th hearings.
As of Thursday, August 27, 2020, it appears that the DOL is apparently rushing to finalize its new rule, which is decidedly pro-Wall Street, and pro-insurance company, so that it goes into effect prior to January 20, 2021 - which date could mark the beginning of the start of a new (Democratic) Administration, which no doubt would oppose the anti-consumer, pro-Wall Street proposed rule advanced and considered in July-September 2020 by the DOL.
MY CONCERNS: A RUSHED RULE MAKING PROCESS, THAT PROVIDES INSUFFICIENT TIME FOR PUBLIC INPUT AND REASONED ANALYSIS.
The DOL ("Department") should not constrain the topics addressed in the hearing, or constrain who can appear to testify, as the notice of hearing states.
There is a clear need for the Department to hear more factual and legal information regarding this proposed rule making, including but not limited to:
(1) A legal rebuttal of various arguments put forward by various industry organizations in their comment letters, including but not limited to arguments not reasonably anticipated by the Department’s own proposed rule, as well as similar arguments advanced by various law firms and others on behalf of certain financial services firms in their comment letters just submitted earlier this month;
(2) A more complete factual rebuttal of various arguments put forward in the previously submitted comment letters, by those who did not submit comment letters, but who possess evidence that would address the previous comments submitted;
(3) A more complete legal and factual analysis as to why the Department’s proposal to permit conflicted advice is violative of the prudent investor rule under ERISA, ERISA’s provisions for the grant of class exemptions, and the requirements of pertinent fiduciary law;
(4) An economic analysis of the negative impacts of the proposed rule upon:
a. individual retirement plan participants;
b. those who engage in rollovers to IRAs from qualified retirement plans governed by ERISA;
c. plan sponsors (including the viability and profitability of businesses, both large and small, when subjected to the increased risks, including those arising from class action lawsuits, which are certain to arise if the proposed rule is enacted);
d. the number of ERISA-covered qualified retirement plans, given the increased liabilities to plan sponsors (and lack of ability to hold those providing investment recommendations to plan sponsors responsible), at a time when increased availability of qualified retirement plans in the United States should be promoted;
e. capital formation in the United States (and the detriments to same occurring from higher fees and costs due to excessive intermediation, as well as from betrayals of trust);
f. U.S. economic growth, resulting from excessive intermediation and the resulting lower amounts of capital available for investment, especially given the compounding effects of high fees and costs on the availability of investment capital;
g. the personal savings rate in the United States, due to investor perception that will arise from conflicted advice provided to plan sponsors and plan participants; and
h. the investment advisory and financial planning professions, and the reputation and economic prospects of professionals within such professions, as plan sponsor and individual plan participant trust is increasingly betrayed.
(5) Recent developments regarding various interpretations of Regulation Best Interest, upon which the Department’s intended interpretation of its own rule expressly relies; and
(6) Much more, which time to properly consider the proposals would reveal.
I am concerned that the artificial limitation on testimony to “individuals or parties who submitted, in accordance with the instructions included in the proposed prohibited transaction exemption, a comment or hearing request on the proposed exemption before the close of the comment period” results in a lack of adherence to fundamental notions of fairness and the Administrative Procedures Act, especially given the Department’s receipt of evidence and legal arguments during the first short comment period. There would be, no doubt, interested parties who could provide meaningful insight to the Department, who do not meet the artificial constraints so imposed by the Department.
I am also concerned that the limitation of testimony is ill-advised: “Outlines should present material factual issues and demonstrate that the proposed testimony is both germane to factual issues needing exploration at the hearing that could not have been submitted in writing, and not duplicative of arguments and factual material previously included in the requestor’s comment letter.” This constraint is altogether non-sensical. Simple factual information, without more, could be presented in writing.
But the purpose of a hearing, to inform the government’s rule-making process, is much more than the mere receipt of explanations of faculty issues. There is a complex interaction between the application of a law (or rule, or proposed rule) and the factual circumstances as they relate to investments, the delivery of investment recommendations and advice, the marketplace for financial services, and the economic impacts that may occur. Limiting outlines to addressing “factual issues” alone ignores the absolute necessity to explore the complex and intertwined nature of the proposed rules and its legal, practical and economic impacts. “Factual issues” and “legal issues” are intertwined, especially in such a rule making as this proposed rule with its huge economic, industry, and social impacts.
As stated above, this stated constraint also likely runs afoul of the requirements of the Administrative Procedures Act, and is certainly evidence that the Department seeks to rush this rule making through without a proper consideration of its impact upon major areas of our economy, the financial services industry, consumers, financial professionals, and much more.
Hearings on rules of this nature should be designed to permit adequate exploration of the interplay of the rule, in all of its complexity, and a due consideration of the major ramifications and impact of this proposed rule. This involves exploring both factual and legal issues, and their interplay, and what lies in between. The exchange between those testifying, and those who are charged with adhering to the requirements for the adoption of rules that are neither arbitrary nor capricious as well as being reflective of the true environment in which the rule is intended to operate, should not be artificially restricted by the limits as to who may testify, or by limiting the topics upon which they may testify.
CONCERNS OVER RUSH OF THE HEARING SCHEDULING: FROM NOTIFICATION OF TESTIMONY TO THE DATE OF TESTIMONY.
I would also repeat my concerns that the Department’s proposed rule making, on an issue as complex as this, and which has such far-reaching implications for millions upon millions of business owners and retirement savers, as well as impacting upon capital formation and U.S. economic growth, is rushed in the extreme.
Additionally, there has simply been insufficient time to gather evidence and legal analysis and respond to the Department’s proposed rule, given the extraordinarily short comment period.
Nor has then been presented any time to submit comments to rebut the evidence, such as it is, and the legal arguments, from previously submitted comment letters (few if any of which were posted prior to the deadline of the comment period) of those who present arguments that are opposed to my own views.
The August 25, 2020 publication in the Federal Register of this “Announcement of Hearing,” with a reply required just three days later – by 11:59 p.m. on August 28, 2020, is also extremely rushed and gives little time to gather factual evidence and submit same.
Presumably, given the existence of Labor Day (a federal holiday), and with testimony to be scheduled on Thursday, Sept. 3rd (and “if necessary” Sept. 4th), those individuals invited to testify would receive notification that their testimony has been scheduled (at least in some, if not many, instances) less than 48 hours to prepare their actual testimony. This is insufficient time for those who desire to provide testimony to further consider the topics upon which they will be permitted to testify, and then to craft the succinct yet meaningful and impactful testimony the Department should expect.
I would note that if I possessed, myself, adequate time for thought on the complex interplay of the Department’s proposals with the complex web of financial services regulation at both the federal and state levels, the impact of preemption, the rise of state retirement plans which may or may not be covered by ERISA, recent SEC rule making, recent state legislative and regulatory developments, and for a review of all of the previously submitted comment letters earlier this month, no doubt I would identify other factual (as well as legal) issues deserving of commentary and, in many cases, rebuttal.
Accordingly, I remain concerned that the Department is not adhering properly to the Administrative Procedures Act by undertaking, in such a rushed and hurried fashion, with constraints on receipt of testimony and further comment letters, such a monumental rulemaking. The burdens of the COVID-19 pandemic, which are huge in terms of additional time to complete everyday work and personal activities, adds to my concerns over the inherent fairness of rushing the Department’s proposed rule through.
If the Department truly desires well-reasoned, thorough, thoughtful, and complete testimony, it would afford more time for those testifying to construct their testimony, both in establishing a far more reasonable time period to submit outlines, and with regard to permitting more time from notification of the testimony time and date to the actual date of the hearing.
THE CURRENT ATTEMPTS TO GUT FIDUCIARY DUTIES SHOULD FAIL
Fiduciary rule-making under ERISA has been made into a complicated process. The requirements for who constitutes a "fiduciary" have been substantially narrowed, far narrower than the clear language of ERISA itself. Now, the DOL attempts to further narrow to whom ERISA's fiduciary duties apply, and then also to gut the fiduciary standard itself.
The current Administration's attempt to gut principles-based fiduciary regulation, which has for over a century been applied to the delivery of investment advice by the courts, and by federal and state statutory regimes, is an ill-advised cowtow to the greed of Wall Street and the insurance companies. It is couched in terms of "less government." But, as James Madison so eloquently stated, "“If men were angels, no government would be necessary.”
Furthermore, establishing a principles-based standard, such as the fiduciary standard, does not require detailed rules promulgated by government. It just requires the government to respect that, given the substantial public policy considerations that favor the application of the fiduciary standard of conduct in this ever-more-specialized society, and ever-more-complicated capital markets, that government agencies stick with the broad principles-based regulation and permit them to be enforced, without limitation or restriction, by the courts.
We must realize that it would be far simpler to just enact a rule that follows ERISA's statutory language, as to whom is a fiduciary for purposes of ERISA. Any augmentation to such should just clarify that "anyone in a relationship of trust and confidence" with a plan sponsor, or plan participant, should also be considered a fiduciary.
The fiduciary standard is a principles-based standard. The tough "sole interests" trust law-based standard in ERISA should be interpreted by the courts. Enacting exemptions that meet the "best interests" fiduciary standard, while also not running afoul of the requirements for class exemptions from the prohibited transaction rules, should be VERY carefully undertaken, and only for necessary and narrow exemptions.
The DOL suggests that it is trying to assist consumers, by creating more choice. Yet, the fiduciary standard, by its nature, constrains choice. The fiduciary standard ensures that "bad choices" - in this instance, bad investment products, not be recommended to plan sponsors and plan participants. The DOL's emphasis on "consumer choice" is but a red herring.
THE FIDUCIARY STANDARD IS A TOUGH STANDARD, THAT THE DOL SEEKS TO IGNORE.
The U.S. Supreme Court has previously written about the fiduciary standard, generally, and in particular the fiduciary duty of loyalty. In Justice Douglas’s majority opinion in Pepper v. Litton, it was stated: "He who is in such a fiduciary position cannot serve himself first and hiscestuis second … He cannot use his power for his personal advantage and to the detriment of [the cestuis], no matter how absolute in terms that power may be and no matter how meticulous he is to satisfy technical requirements. For that power is at all times subject to the equitable limitation that it may not be exercised for the aggrandizement, preference, or advantage of the fiduciary to the exclusion or detriment of the cestuis. Where there is a violation of those principles, equity will undo the wrong or intervene to prevent its consummation … Otherwise, the fiduciary duties … would go for naught: exploitation would become a substitute for justice; and equity would be perverted as an instrument for approving what it was designed to thwart."
The observation that a person cannot wear two hats and continue to adhere to his or her fiduciary duties was again echoed early on by the U.S. Supreme Court, “The two characters of buyer and seller are inconsistent.” The U.S. Supreme Court also observed: “If persons having a confidential character were permitted to avail themselves of any knowledge acquired in that capacity, they might be induced to conceal their information, and not to exercise it for the benefit of the persons relying upon their integrity. The characters are inconsistent.”
In an early speech by the Louis Loss, for long the leading scholar on the federal securities law, presented at a time when he served the Commission, Professor Loss stated: “[A]s an eloquent Tennessee jurist put it before the Civil War, the doctrine ‘has its foundation, not so much in the commission of actual fraud, but in that profound knowledge of the human heart which dictated that hallowed petition, ‘Lead us not into temptation, but deliver us from evil,’ and that caused the announcement of the infallible truth, that ‘a man cannot serve two masters.’ ’ ” Louis Loss, Address entitled “The SEC and the Broker-Dealer” by Louis Loss, Chief Counsel, Trading and Exchange Division, U.S. Securities and Exchange Commission on March 16, 1948, before the Stock Brokers’ Associates of Chicago.
As well-known in the early case law regarding fiduciary relations: "The principle is undeniable that an agent to sell cannot sell to himself, for the obvious reason that the relations of agent and purchaser are inconsistent, and such a transaction will be set aside without proof of fraud.” Porter v. Wormser , 94 N. Y. 431, 447 (1884).
Simply put, you either possess a duty of loyalty to the client, as an expert, trusted adviser bound by ERISA's tough prudent investor rule and standard for due care. Or you are a product salesperson. You cannot be both, at the same time.
It is an undeniable truth that no person can serve two masters. And the DOL, and the SEC, must at some time revert back to this longstanding principle, establish more clearly when fiduciary standards apply (and always apply them where relationships of trust and confidence exist), and restore the fiduciary standard to its rightful place as the toughest standard of conduct found under the law.
- Ron A. Rhoades, JD, CFP
These views are my own, and are not necessarily the views of any institution, firm, organization, cult, or gang with whom I am currently associated or from which I have ever been expelled.