Reason #5 to Worry about the Labor Department’s “Reform” of Retirement Investment Advice: Its Proposed Reform Conflicts with Securities Laws

Monday, March 28, 2016 - 3:15pm

Last month’s Issue Brief on the Labor Department’s retirement investment advice regulation identified 7 reasons you should be worried.  We talked about reasons one, two, three and four in earlier blogs.  Today, we’re going to discuss the fifth reason on the list:  due to its own lack of expertise, and due to inadequate coordination with other regulators, the Labor Department regulation conflicts with existing securities laws and regulations. 

Unfortunately, the fact that the Labor Department is not truly a financial regulator didn’t stop it from proposing to fundamentally change the rules governing advice to $16 trillion held by retirement plans and IRAs…or stop it from ignoring the advice it received from actual financial regulators.

The Labor Department Knows Best?

As a recent report by the Senate Government Affairs Committee shows, the Labor Department ignored, disagreed with, and argued forcefully with the Securities and Exchange Commission (“SEC”) staff.  It apparently paid even less attention to the Financial Industry Regulatory Authority (“FINRA”),   the entity charged with overseeing broker-dealer practices, as FINRA went so far as to file a formal public comment letter identifying specific conflicts between the proposed rule and the securities laws. 

The unsurprising result of the Labor Department thinking it knows best is a proposed rule that doesn’t mesh with long-standing financial regulations issued by real financial regulators.  Here are a few of the problems in the proposed rule:

  • Illegal Investment Performance Predictions:  The Best Interest Contract (“BIC”) Exemption would require advisors to provide “reasonable estimates” of future investment returns as part of disclosing the fees they would charge for advice.  The problem is that it is illegal for advisors to make these types of projections due to the potential to mislead investors.  This is a pretty basic error that routine coordination with the SEC and FINRA should have prevented. 
  • Labor Rule Incents Illegal “Reverse Churning:”  As proposed, the Labor Department rule effectively requires the use of fee-based accounts due to the administrative complexity of leveling commissions.  This conflicts with SEC efforts to combat “reverse churning” (shifting investors from commission-based accounts into higher-cost, fee-based accounts).  It is worth noting that fighting reverse churning is a national SEC enforcement priority—this is not a technicality.  Securities laws require the advisor to utilize the structure that best suits the client, but the Labor Department seems to think fee-based accounts are right for everyone.
  • Labor Rule Flouts Congressional Direction in Dodd-Frank: Congress prohibited the SEC’s new fiduciary standard from requiring ongoing monitoring by broker-dealers.  However, FINRA’s comment letter stated that the Labor Department’s ERISA-based fiduciary rule will require ongoing monitoring, not only contradicting Congress, but exposing broker-dealers to “churning” allegations due to the regular investment recommendations monitoring requires.  Moreover, Congress also explicitly mandated the preservation of a commission based model for advisors in Dodd-Frank, yet the Labor Department rule steers investors towards a fee-based model.
  • Labor Definition of Investment “Recommendation” Differs from Longstanding Securities Law Definition:  Instead of using the established securities meaning of an investment “recommendation” (taking advantage of its history of readily understood compliance standards), the Labor Department proposed a slightly different and more ambiguous definition.  This is a recipe for confusion and compliance challenges that provides no additional protection to retirement savers.

The Labor Department may believe that it knows what it’s doing, but the text of the proposed regulation shows the truth—securities regulation is best promulgated by experienced securities regulators.  We can only hope that the Labor Department finally listens to the SEC and FINRA in drafting the soon-to-be-released final rule. 

After all, your advisor can’t act in your best interest if contradictory regulations prevent her from giving you advice at all.