Outside voices and views for advisers

SEC and DOL should agree on tough fiduciary rules

Harmonizing between federal agencies and state regulators is a complex task in everyone's best interest

Oct 26, 2017 @ 12:23 pm

By Blaine F. Aikin

Harmonization is a beautiful concept. In standards-setting it means bringing into agreement different systems that have evolved separately to reduce or eliminate redundancies or conflicts. Yet the mechanics can be complicated, constrained by how each system has evolved, and contentious if stakeholder interests are misaligned. Harmonizing fiduciary regulatory systems is a case in point.

On Oct. 24, SEC Chairman Jay Clayton said his agency can take the lead on fiduciary rules, but that the SEC must "respect" the process of the DOL and state regulators rather than supersede them.

Harmonizing rules under vastly different laws with different purposes won't be easy. Unlike the DOL's legislative mandate, which allows it to regulate conflicts involving any kind of asset in a retirement plan, the SEC's authority is limited to securities products. That also raises the question of whether all 50 state insurance commissioners, which regulate annuity products and do not have a fiduciary mandate, will be willing or able to add a fiduciary standard to their suitability rules.

Then there is a question of regulatory equilibrium between the SEC and DOL. There have been persistent calls from Congress to let the SEC take the lead on harmonization. Proponents expect the SEC to craft a rule that is more along the lines of the fiduciary standard for investment advisers than the standard under ERISA. But that will be difficult for many reasons, including how each set of standards treats conflicts of interest associated with adviser compensation.


Both ERISA and the Investment Advisers Act of 1940 regulate compensation. However, the methodologies are starkly different. The Advisers Act is less restrictive and relies more on disclosure requirements and practical guidelines, whereas ERISA prohibits compensation-related conflicts unless specific prohibited-transaction exemptions are available to satisfy fiduciary obligations.

For example, the Advisers Act allows wide latitude for each adviser to decide how much they will charge for advice. One adviser may charge far more than another despite having comparable experience, expertise and services. SEC guidance imposes restraints by stating that an asset management fee of more than 2% is excessive. While the SEC does not appear to prohibit an AUM fee of, say, 2.25%, the adviser must disclose to clients that the fee is higher than the industry norm.

(More: Mitigating conflicts of interest in compensation.)

Disclosure is necessary but insufficient under ERISA; fees for advice must be objectively reasonable based upon the services provided and the facts and circumstances involved. Even though the DOL's fiduciary rule now allows variable compensation – such as commissions and solicitor and 12b-1 fees – the reasonableness requirement provides an added layer of investor protection.

Reconciliation of this regulatory discrepancy on compensation seems to require harmonizing up to the higher ERISA standards, for two reasons.

First, participants and beneficiaries in ERISA plans have private rights of action. They can sue for violations of ERISA, and courts are guided by the statutory construction of the law.


Conversely, federal securities laws do not have a private right of action, meaning clients cannot sue firms for fiduciary breaches under SEC or FINRA rules. Instead, most of their disputes will go to binding arbitration, where case law may be ignored.

Regulatory change is rarely easy but statutory change is much harder. Trying to harmonize to the lower disclosure-based regulatory approach of the SEC cannot be achieved without also changing statutory fiduciary obligations established under ERISA.

Second, consumer groups have been vocal proponents of a robust fiduciary standard. If they believe the DOL was simply adopting the SEC's disclosure-based standard, then it is likely they will sue to have the new, harmonized rule thrown out by a judge.

(More: 401(k) advisers under pressure to keep up with due diligence of investment products.)

In a recent conversation, a former regulator told me that a fundamental principle stressed early in law school is that in situations involving harmonization of conflicting laws or standards, always "top up." In other words, seek to raise the low bar to the level of the high bar rather than the other way around. "Topping up" is not only more practical, it is generally more consistent with legislative intent and the public good.

Contrary to expectations that harmonization may reduce investor protections, the SEC should move more toward ERISA's fiduciary standard. The process may be complicated and contentious but the odds favor topping up over ratcheting down.

Blaine F. Aikin is executive chairman of fi360 Inc.


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