Last month, the Department of Labor proposed to expand the definition of the term “fiduciary” under the Employee Retirement Income Security Act of 1974.
According to the DOL, the rule “would protect beneficiaries of pension plans and individual retirement accounts by more broadly defining the circumstances under which a person is considered to be a fiduciary by reason of giving investment advice to an employee benefit plan or a plan's participant.”
What precisely is the rule intended to prevent?
Assistant Labor Secretary Phyllis Borzi, who heads the Employee Benefits Security Administration, crystallized the answer in just two words: “schlocky advice.”
There is much to learn by studying the 16,500-plus words published in the Federal Register to describe the proposed rule, its purpose and anticipated impacts, But it really does boil down to a campaign for quality on the part of the DOL.
“Schlock” refers to goods or services that are cheap, damaged or of inferior quality. There is a related term for purveyors of damaged or inferior goods or services: “schlockmeisters.”
Before any reader jumps to the wrong conclusion, it is clear that Ms. Borzi isn't suggesting that non-fiduciaries such as brokers who don't provide advice are schlockmeisters. In the context of her comments, the pejorative term is reserved for those who provide advice and are perceived by clients as being impartial but who seek to avoid fiduciary accountability through a technicality — specifically, an unworkably narrow definition of “fiduciary” under ERISA.
The proposed rule change would make two especially important and well-justified changes.
First, it would remove the requirement that advice be “regular” in order for the advice provider to be considered a fiduciary.
The DOL correctly asserts that investors have the same high expectations regarding the competence and impartiality of their financial adviser, regardless of whether the advice is rendered only once or on a continuing basis. This is the standard for professional advice in law or medicine, and it is unreasonable to expect that it should be different for advisers.
Second, under the expanded definition, the adviser would be considered a fiduciary regardless of whether his or her advice were deemed the “primary basis” for investment decisions. As explained in the published proposal, “The [DOL] believes that when a service provider is retained to render advice, the plan should generally be able to rely on the advice without regard to whether the parties intend it to be a primary or lesser basis in the fiduciary's [e.g., plan sponsor's or participant's] decision making.”
Underlying these two changes is the recognition that advice is inherently a fiduciary function. The reality of the advice being rendered shouldn't be denied simply by arbitrarily defining it away.
With the proposed expansion of the definition of a fiduciary, many brokers who render investment advice outside the current narrow definition would become subject to the higher fiduciary obligation. This is what prompted a reporter interviewing Ms. Borzi to note: “Some in the industry likely will oppose the proposal, claiming it will chill the desire to give advice out of fear of litigation if an investment goes awry.”
To this Ms. Borzi replied: “If it dries up schlocky advice [401(k) plan] fiduciaries are getting, I don't have a problem with that.”
Advisers should recognize that these quotes follow the same theme as the proposed extension of the fiduciary standard under the Dodd-Frank Act to all who provide advice to retail investors. The DOL action provides additional momentum to the overall regulatory trend to meet investors' expectations of trustworthy advice by codifying the protection afforded by the fiduciary standard.
Further, advisers should note that the expanded ERISA definition of “fiduciary” extends to the provision of advice to holders of individual retirement accounts. Because most retail investors have individual IRAs, the vast majority of advisers will need to understand and adhere to the ERISA fiduciary obligations for at least some of their advisory activities.
Thus, for the sake of efficiency, it would appear to be a practical necessity of advisers to design their service delivery model to meet the high ERISA fiduciary standard for all client types and for compliance departments to gear their oversight activities accordingly.
In short, the anti-schlock campaign of regulatory reform is likely to promote constructive competition. In an increasingly fiduciary culture, what is best for advisers is to do what is best for investors.
Blaine F. Aikin is chief executive of Fiduciary360 LLC.
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