The Trump administration last week
delivered a clear signal it aims to kill one of the most hotly contested parts of its fiduciary rule — the provision about class-action lawsuits.
Beginning Jan. 1 — or July 2019 if the DOL delays that implementation date — financial advice firms will have to enter into a contract with retirement savers if the firm receives variable compensation, such as commissions, when delivering investment advice. The contracts cannot waive investors' right to bring class-action litigation against the financial institutions.
The Trump administration is currently reviewing the Obama-era rule, and the possibility of this provision going away raises a number of important questions and takeaways for broker-dealers and registered investment advisers.
Will the best-interest contract stay or go?
The contract, which affirms a broker or adviser is giving investment advice in an investor's best interest, is the rule's primary enforcement mechanism.
The contract is part of the
best-interest contract exemption, a section of the rule allowing firms to receive variable compensation if they meet certain conditions. Attorneys generally believe there will be some sort of contract requirement associated with BICE.
If there were, enforcement of the rule's provisions would likely come via individual arbitration if an investor felt he or she didn't receive advice adhering to the contract's terms. Firms would most likely insert mandatory-arbitration clauses into these contracts.
Absent a contract, most individual retirement account holders wouldn't have an enforcement remedy under the rule if they felt an adviser breached his or her fiduciary duty, said Andrew Oringer, co-chair of the employee benefits and executive compensation group at Dechert.
If there's no contract, the DOL will likely completely re-jigger BICE, said Jason Roberts, CEO of Pension Resource Institute, a compliance consulting firm.
While this is something for which rule opponents have lobbied, it could represent a be-careful-what-you-wish-for type of scenario — while BICE is challenging from a compliance standpoint, it's expansive in terms of admissible conduct and activity for firms and brokers, Mr. Roberts said. A replacement exemption might be less flexible.
"It'll be harder to live in that world than the BICE world from an adviser perspective," he said.
401(k) participants can still bring class-action claims
Doing away with the class-action provision won't eliminate the ability of 401(k) participants and participants in other retirement plans governed by the Employee Retirement Income Security Act of 1974 to file class-action litigation.
That mechanism has been available to participants since ERISA's inception. It's the same mechanism under which participants have been suing employers for
excessive 401(k) fees.
The fiduciary rule's first phase of implementation, which began June 9, broadened the definition of who is an ERISA fiduciary. So, thousands more advisers and their firms are, as of June,
subject to this ERISA litigation risk.
Those at risk are advisers providing employer-level advice on the investment lineup of a 401(k)s with less than $50 million in assets, as well as those advising individual participants on their investments, said Joshua Lichtenstein, an attorney in the tax and benefits department at law firm Ropes & Gray.
Rollovers still aren't safe
Advisers and firms soliciting rollovers from 401(k) participants are subject to this same class-action-litigation risk. ERISA covers this sort of recommendation because 401(k) money is involved in the solicitation, and plan participants can bring suit.
May make BICE more attractive
Removing the class-action provision from BICE "could make the BICE more appealing than other exemptions that could be available," Mr. Lichtenstein said. "This really could shift the balance."
For example, some firms had been considering an alternative exemption called 408(g) in place of operating under BICE, attorneys said.
408(g) is a section of ERISA that predates the fiduciary rule, and applies to level-fee advisers (or, those whose fees don't vary based on their investment advice).
But, not many, if any, firms currently comply with 408(g) in order to provide investment advice due to the compliance requirements involved with it, such as an annual audit, Mr. Lichtenstein said.
408(g) makes the most sense under the fiduciary rule for firms with affiliated investment products, such as broker-dealers owned by asset managers or insurance companies, Mr. Roberts said. "We have some clients using that in cases where it makes sense," he said.
However, it's a "very limited exemption," and doing away with BICE's class-action provision would likely make BICE a more appealing alternative, he added.
Attorneys less likely to bring litigation
Taking away class-action litigation would probably greatly reduce attorneys' appetite for pursuing a breach-of-contract claim on behalf of an individual investor.
"The practical reality is that a plaintiff's layer interested in pursuing this is much less likely to want to pursue 30,000 separate claims than one single claim covering 30,000 people," Mr. Oringer said.
Morningstar senior equity analyst Michael Wong had earlier this year
estimated the brokerage industry should expect to absorb between $70 million and $150 million annually in class-action litigation costs.
Of course, the fiduciary rule's trajectory will likely play out over several years. If the Trump administration ultimately amends the Obama-era regulation, and attempts to remove the class-action provision, proponents of the rule may challenge the decision in court.
