SEC best-interest proposal doesn't affect 401(k) brokers

The proposed standard applies only to 'retail customers,' a definition that seems to omit broker recommendations to retirement plans. RIAs, though, are still on the hook

Jun 12, 2018 @ 1:23 pm

By Fred Reish

When it comes to big news, it doesn't get much bigger than the last few months. First, the 5th Circuit Court of Appeals threw out the Department of Labor fiduciary rule; then a month later, the Securities and Exchange Commission issued its best-interest proposals for broker-dealers and registered investment advisers.

The 5th Circuit Court of Appeals decision "vacates" the fiduciary rule (although we're still waiting for the court to enter that order). In other words, it's as if the fiduciary rule had never taken effect. Because of that decision, we are, and we have been — even though we didn't know it — under the old DOL regulation that defines fiduciary advice: the five-part test.

While that may help broker-dealers avoid fiduciary status in some cases, it does not provide much relief for RIAs. That's because in the typical situation, the services of an investment adviser will satisfy each of the five parts in the old regulation.

As a result, RIAs should assume that they and their advisers are fiduciaries to the plans they work with. There may be cases where RIA services don't amount to fiduciary advice, but that road should only be traveled with the help of a knowledgeable attorney.

While the SEC has proposed to impose a limited, or transaction-based, best-interest standard on broker-dealers, that only applies to investment recommendations made to "retail customers." Based on the SEC's definitions, it does not appear that retirement plans are retail customers. As a result, broker-dealer investment recommendations to retirement plans would not be covered by the best-interest standard.

On the other hand, the SEC's proposed "Interpretation Regarding Standard of Conduct for Investment Advisers" (the RIA interpretation) imposes a best-interest standard of care on RIAs for all advice to all clients. If the SEC's proposal is finalized, investment recommendations made by investment advisers to retirement plan sponsors will be governed by a best-interest standard of care and a duty of loyalty. While the SEC guidance does not define the best-interest standard of care, it does suggest that it is based on principles similar to the DOL's best-interest standard of care, which includes a prudent-person rule and duty of loyalty.

As this discussion suggests, the DOL's best-interest standard and the SEC's proposed best-interest standard are strikingly similar. The good news, though, is that compliance with one standard of care should also be compliant for the other.

However, there are differences between the two regulatory schemes. Those differences are most obvious in the regulation of conflicts of interest. Generally speaking, the SEC takes the position that disclosing conflicts of interest in effect "cures" the conflict. (However, the SEC appears to be adopting an "informed consent" approach, in the sense that it is taking the position that if the disclosures are not adequate for the investor to make an informed consent, the disclosures were not adequate to overcome the conflict.)

For the DOL, though, there are more stringent requirements for conflicts. Those are found in the prohibited transaction rules, which generally prohibit any payments from third parties or compensation that varies with the advice. For the moment, the DOL has issued a nonenforcement policy, which permits those additional payments for nondiscretionary advice if the RIA complies with the "impartial contact standards." Those standards are: the best-interest standard of care (including the duty of loyalty); the receipt of no more than reasonable compensation; and not making any materially misleading statements.

Going forward, I expect the differences between the SEC's and DOL's treatment of financial conflicts of interest to be narrowed. For example, I think that the DOL will adopt the SEC's proposed position that conflicts must be adequately disclosed so that retirement plan fiduciaries and participants can make fully informed consents. And I expect that the SEC will impose a duty of loyalty and a best-interest standard that are similar to rules in the Employee Retirement Income Security Act of 1974.

For now, the best approach would be to follow a process compliant with the DOL's prudent-man rule and duty of loyalty and to ensure that conflicts are fully disclosed in an individualized manner. (For example, a disclosure that the adviser "may" receive 12b-1 feesisn't individualized to the transactions for that plan, participant or IRA.) That requires that an adviser act with the care, skill, diligence and prudence that a knowledgeable investment professional uses. It also requires that the advice be appropriate for the particular investor or retirement plan, based on the investor's needs or the needs of the covered workforce.

(More: What the 5th Circuit decision doesn't do)

Fred Reish is a partner at the law firm Drinker Biddle & Reath.


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