More 401(k) advisers face litigation risk in June under DOL fiduciary rule

Certain provisions of the rule will kick in putting those affected advisers more squarely in the line of fire of the litigation enforcement mechanism of ERISA

Apr 11, 2017 @ 2:41 pm

By Greg Iacurci

A greater number of advisers and firms servicing 401(k) plans and their participants could be at risk of litigation in a few months' time, when implementation of some provisions of the Labor Department's fiduciary rule are set to kick in.

This is due to the details of the recently finalized delay to the fiduciary rule issued last week by the Trump administration, as well as nuances of the regulation and its interplay with federal retirement law.

While the delay pushed off compliance with some aspects of the rule until 2018, advisers will have to act as fiduciaries and adhere to impartial conduct standards when giving investment advice for a fee in retirement accounts come June 9.

That's significant for non-fiduciary advisers to 401(k) plans and participants: They may take on fiduciary status in June, depending on the nature of their advice, putting them more squarely in the line of fire of the litigation enforcement mechanism that exists under the Employee Retirement Income Security Act of 1974.

Investors would, in theory, be able to sue for breach of fiduciary duty, similar to claims in excessive-fee lawsuits that have targeted plan sponsors and financial services firms over the past decade, said those with knowledge of such litigation.

To this point, advisers and their broker-dealers have largely avoided 401(k) lawsuits alleging fiduciary breach, because proving an adviser served as a fiduciary to a 401(k) plan is difficult under current law.

"The ERISA litigation has been there and the risk of ERISA litigation was always there," David Levine, principal at Groom Law Group, said. "The rule becomes applicable Jun. 9 and more people could be in at that point."

A similar enforcement mechanism doesn't exist for retail retirement investors in individual retirement accounts. The best-interest contract exemption, a provision of the fiduciary rule, will give these investors the right to bring class-action litigation against financial firms, though. BICE is currently set to come into force in January 2018.

The only enforcement that's currently available in the IRA market are excise taxes imposed by the Internal Revenue Service. So, come June, there will be an expanded pool of fiduciary advisers, but relatively little by way of enforcement in the retail retirement market, observers said.

For 401(k) advisers and non-fiduciary 401(k) service providers, they will "have to do all the preparation [for the rule] they anticipated" to reduce their litigation risk, albeit with an extra 60 days to do it, said Michael Hadley, a partner at Davis & Harman, a lobbying firm for financial services organizations.

"In the 401(k) market, the class action plaintiffs' lawyers have found 401(k)s as fertile ground for securing settlements, because it is very hard to get rid of these cases early on," Mr. Hadley said. "And the class-action plaintiff's lawyers know it."

Although more advisers and firms will be exposed to this risk, the environment for litigation, which could pertain to investment advice to a 401(k) plan or rollover recommendations to a 401(k) participant, may not be as ripe as may seem from the outset, some observers said.

That's largely because compliance with the DOL rule between Jun. 9 and the beginning of 2018 won't be too difficult, relatively speaking, they said.

For example, the DOL's 60-day delay of the fiduciary rule eliminated the need for certain disclosures associated with the BICE, such as written fiduciary acknowledgement for clients.

So, the only thing that firms need to do to receive relief from BICE (an exemption allowing for receipt of variable compensation, otherwise prohibited by the rule) is adhere to impartial conduct standards. There are three factors involved: acting in a client's best interest, receiving reasonable compensation and making no misleading statements to clients.

Mr. Levine referred to this form of BICE compliance as BIC Ultra Lite, and it's one route firms can take to protect themselves from ERISA lawsuits. "It's very, very simple. It's extremely short," he said.

Further, some brokerage firms have already moved to levelize compensation for advisers in order to avoid running afoul of the rule, he added.

And, since some of the more detailed parts of BICE won't come into effect until next year, bringing class-action lawsuits under ERISA will likely be more difficult during the transition period from June to January 2018 when the broad principles-based impartial conduct standards are the only applicable factor, said Andrew Oringer, a partner at Dechert.

There will be less room for plaintiff's attorneys to sue firms for "mistakes and footfaults" in technical compliance, he said.

"The mechanics and the plumbing [of the BICE] are getting put off. And that's often where people bring claims," Mr. Oringer said. "Those sort of laser-shot claims are going to be harder to make."

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