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DOL fiduciary rule has enforcement gaps — and they could widen

Parts of the rule not subject to a contract requirement don't offer investors an avenue to recover losses if they receive bad advice

Sep 11, 2017 @ 2:42 pm

By Greg Iacurci

The Department of Labor's fiduciary rule, as it's currently written, has some enforcement gaps. And they could widen, especially for annuity products, depending on how the Trump administration's review of the rule shakes out.

The primary enforcement mechanism of the Obama-era regulation, which raises investment advice standards in retirement accounts, is a "best-interest contract" between an investor and financial institution such as a broker-dealer.

Beginning in January, firms that wish to use certain compensation arrangements, like commissions, must enter into a contract with an IRA investor affirming the broker's fiduciary relationship to the investor and that the investor is receiving advice that's in his/her best interest. The investor, in turn, will have a way to bring suit against the institution for breach of contract.

But, what if there's no contract? As it turns out, nothing would really change for IRA investors seeking to recover losses stemming from poor investment advice.

This is the current state of affairs. In June, the rule significantly expanded who is considered a fiduciary adviser. Because the rule's contract requirement doesn't kick in until January, there's currently no way to enforce this newly-minted fiduciary status. The DOL last month proposed a delay to the contract provision until July 2019.

So, for the next two years it is likely to be business as usual.

When the rule does fully go into effect, one thing is clear: Enforcement would still be nonexistent in a few areas. According to Micah Hauptman, financial services counsel at the Consumer Federation of America, those situations would be:

• When a broker or insurance agent recommends a fixed-rate annuity using money already in an IRA (not via a rollover);

• When a level-fee adviser recommends moving money that was already in an IRA to the adviser.

The fiduciary rule doesn't require a contract for these transactions. For example, brokers can recommend fixed-rate annuities using what's known as Prohibited Transaction Exemption 84-24, which doesn't come with a contract requirement.

The Insured Retirement Institute and other insurance industry advocates have been lobbying for all annuities, including variable and indexed annuities, to be sold under PTE 84-24. This could come to fruition depending on the outcome of a review of the rule being conducted by the Trump administration's DOL. If it does, investors would be limited to the enforcement mechanisms already in place.

For variable annuities, which are regulated as securities products, the avenue of relief would be via Finra arbitration for a violation of the "suitability" standard of conduct, a standard that's less stringent than the fiduciary standard.

The remedy is different for fixed and indexed annuities, which are regulated as insurance, not securities, products. There is no private enforcement mechanism for insurance agents.

A displeased purchaser has a few options, according to Sheryl Moore, president and CEO of Moore Market Intelligence, a market research firm:

• Most states have a 30-day free-look period, during which they can return the annuity for the premiums they paid.

• Thereafter, they still have the option of writing a formal complaint to the insurance company. The insurance company's response to such a complaint is dependent upon their findings and philosophy.

• The annuity purchaser also has the option of contacting their insurance commissioner to look into the matter. The insurance division's response will also depend upon their findings.

Though observers say it's unlikely, the Trump administration could ultimately remove the contract requirement altogether, and leave a rule that's essentially all bark and no bite.

Some proponents of the fiduciary rule believe that, absent a contract, retirement investors could benefit from the rule's expanded pool of "fiduciary" advisers in Finra arbitration proceedings. Mr. Hauptman says he believes that's an "open legal question," though.

"Just because there would be expanded circumstances in which a broker meets the definition doesn't necessarily mean that there is an explicit cause of action the investor could bring for violation of that standard," he said.

But, observers think the outlook is even hazier for insurance products. Even Phyllis Borzi, former assistant labor secretary during the Obama administration and a chief architect of the fiduciary rule, expressed a degree of skepticism.

She believes the expanded fiduciary definition would help investors in arbitration, but "there's an open question as to what the effect might be" on non-securities products not subject to Finra arbitration for disputes.

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