Can brokers be fiduciaries?

Judging by newly proposed regulations on investment advice, it looks as if the Department of Labor is trying hard to engineer a sharp turn from the course established by Congress.

On Aug. 22, the Labor Department released its long-awaited guidance to implement the investment advice provisions of the Pension Protection Act of 2006. But the DOL simultaneously proposed a new class exemption to allow commission-based registered representatives to become fiduciary advisers and give advice to participants and beneficiaries of participant-directed retirement plans and individual retirement accounts.

The new class exemption is a very big change that the DOL contended will “increase the variety of investment advice arrangements that are available and potentially lower the cost and promote the marketing of such arrangements, to the benefit of participants.”

To be clear, the phrase “variety of advice arrangements” refers to how advisers are paid, not to a substantive change in the quality or range of available investments. Specifically, the class exemption would allow those with conflicts of interest to be exempt from the prohibited-transaction provisions of the Employee Retirement Income Security Act that had prevented such non-level compensation models from being employed to date.

When Congress enacted the act, it included a prohibited-transaction exemption for sponsors of participant-directed retirement plans who enter into “eligible investment advice arrangements” with certain financial services providers. It did so with a clear concern for full disclosure and careful avoidance of conflicts of interest.

It also required advice givers to acknowledge their fiduciary status in writing and appropriately named them “fiduciary advisers.”

The DOL has seized on the opportunity created by the act to expand on the idea that most investors need advice. It chose to do so in two ways.

First, it would extend the regulations to address advice given to IRA account holders. Second, it proposed to allow conflicted financial services reps to give advice in competition with the fiduciary advisers contemplated under the act.

Extending the rules to cover advice given to IRA account holders is consistent with the apparent intent of Congress. However, through the class exemption, the DOL has departed from the congressional approach to avoid conflicts of interest by structuring the new rules to accept and manage conflicts.

Ironically, a major premise of the class exemption is that according to the DOL, “risks attendant to conflicts of interest may be mitigated by their [participants’ and beneficiaries’] ability to make rational and well-informed purchases in a vibrant, competitive market for investment advice and other financial products and services in which some vendors will offer unconflicted advice.”

But the whole point of giving investment advice to individuals is that most have proven to be incapable of making rational and well-informed investment decisions on their own. What makes the DOL think that investors will make better decisions by introducing the added uncertainty of how conflicts of interest affect the advice they receive?

The class exemption effectively will convert commission-based reps from their traditional non-fiduciary role into functional fiduciaries without forcing them to give up their conflicted compensation arrangements. The class exemption imposes Pension Protection Act-like conditions upon this new breed of fiduciary advisers.

The DOL’s commentary that accompanies the new class exemption proposal makes very clear that it doesn’t know if this change will ultimately help or hurt investors.

Whether investors will in fact benefit hinges upon whether all fiduciary advisers will be able to adapt to the new rules, and the fiduciary standard of care they are designed to promote, quickly and effectively.

While the impact on investors is uncertain, there are three clear winners under the proposed rules: commission-oriented firms and their reps, who will gain new access as advisers to IRA account holders and participants in 401(k) plans; those who consult for retirement plans and financial services companies on fiduciary matters and perform fiduciary audits; and lawyers who draft disclosure documents, prepare compliance policies and procedures manuals, and litigate for breaches of fiduciary responsibility.

There is one way to avoid the new rules. Advisers who fully em-brace a fiduciary standard of care and consistently apply fiduciary practices don’t need exemptions from prohibited transactions, be-cause their business model is designed to avoid them.

Blaine Aikin is president and chief executive of Fiduciary 360 LP in Sewickley, Pa.

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