Congressional Research Service Issues In-Depth Report on Fiduciary Rule

By John Iekel • November 09, 2015 • 0 Comments

No proposed regulation has generated more activity, discussion and controversy this year than the proposed fiduciary rule the Department of Labor (DOL) re-issued in April. As the DOL prepares the final iteration of the rule, it may be useful to look back on how this all came about and what it entails.

The Congressional Research Service (CRS) is facilitating just that kind of review through “Department of Labor’s 2015 Proposed Fiduciary Rule: Background and Issues,” a comprehensive report it recently issued.

The report harks back to the 1970s as the time it all began, noting that under ERISA, enacted in 1974, a person who provides investment advice has a fiduciary obligation — which, it says, “means that the person must provide the advice in the sole interest of plan participants.” It adds that therefore, redefining the term investment advice “could affect who is subject to this fiduciary standard.” The report then notes that regulations issued in 1975 define investment advice using a five-part test, and that the proposed rule would replace the current test with a more inclusive definition.

Comparing the Rules

The report provides a comparison of the current and proposed rules:

Current Rule. An investment adviser is a fiduciary if all of the following apply:

  • the adviser makes recommendations on investing in, purchasing, or selling securities or other property, or gives advice as to their value;

  • the adviser provides the advice on a regular basis;

  • the advice is provided pursuant to a mutual understanding;

  • the advice will serve as a primary basis for investment decisions; and

  • the advice will be individualized to the particular needs of the plan.

Investment advisers who are fiduciaries can only receive compensation if it is for a level fee unless they are covered by an appropriate Prohibited Transaction Exemption (PTE).

Brokers and dealers who are not fiduciaries are subject to the Security and Exchange Commission’s suitability standard which says that recommendations must be “suitable” for the investor.

Brokers and dealers, when not acting as fiduciaries, may receive compensation in the form of commissions and other fees that vary depending on the financial product purchased.

The current rule does not apply to IRAs. However, IRAs are subject to prohibited transaction provisions in the Internal Revenue Code.

Proposed Rule. A person would be considered a fiduciary if he or she receives a direct or indirect fee and provides a recommendation regarding:

  • the purchase or sale of securities or other property;

  • the advisability of taking a distribution from a plan or IRA;

  • the investment of securities or other property that are rolled over from a plan or an IRA;

  • the management of securities or other property including rollovers from a plan or IRA;

  • the appraisal or a fairness opinion of the value of securities or other property if connected with a specific transaction by a plan or IRA; or

  • a recommendation of a person who is going to provide investment advice for a fee or other compensation.

Brokers and dealers who are not fiduciaries would continue to be subject to the Security and Exchange Commission’s suitability standard.

Commissions and third-party fees would be prohibited unless a broker or dealer abides by the best interest contract (BIC) or another exemption. The BIC would allow current compensation practices to continue provided the individual or financial institution agrees to provide advice in the best interest of the retirement investor and to adhere to other provisions that would ensure that the best-interests standard is met.

The proposed rule would apply to IRAs.

Brokers and Dealers

Securities brokers and dealers who provide services to retirement plans and who are not fiduciaries under current regulations are not required to act in the sole interests of plan participants, the report says. Rather, it notes, their recommendations must meet a suitability standard which requires that recommendations be suitable for the plan participant.

That, the CRS says, is “a lower standard than a fiduciary standard.” But the proposed rule could cover brokers and dealers nonetheless, the report warns, noting that they could be considered fiduciaries when they provide recommendations to participants in retirement plans.

Carve-Outs

The report notes that in addition to broadening the definition of investment advice, the rule would provide carve-outs for situations that would not be considered investment advice, such as providing generalized investment or retirement education. And it adds that the proposed rule is accompanied by proposed prohibited transaction exemptions (PTEs) and proposed amendments to existing PTEs that would allow fiduciaries to continue to engage in certain practices that would otherwise be prohibited.

Pro and Con

The report addresses the arguments that the Obama Administration makes in support of the rule, as well as the reasoning of those who oppose it. It also discusses stakeholders’ perspectives on the rule, and what one may expect if the rule is implemented.