Let’s face it. The appeal of a show like “Jeopardy” is that, every once and awhile, you are able to shout out the answer before the reigning champion buzzes in. I experienced the same sensation after reading that an attorney as distinguished as Eugene Scalia – the former Solicitor of the U.S. Department of Labor – came to the same conclusion as I had in a prior piece published on this blog. (See “The DOL’s Proposal to Update ERISA’s Fiduciary Definition: Right Thought, Wrong Approach,” posted on May 16, 2011.)
While my article was not nearly as erudite and well-researched as Mr. Scalia’s, the legal reasoning was founded on the same premise – namely, that administrative agencies should not be permitted to change existing law through the regulatory process. Our Constitution specifically granted lawmaking authority to the legislative branch – and for good reason. While subjecting a proposed piece of legislation to the whims of a body comprised of 535 politicians certainly slows the process of change, it also helps to ensure that all potential ramifications of such a change are thoroughly vetted.
As I noted in my blog,
(T)he Department has attempted to pound a square peg into a round hole by using over 1,100 words to redefine the meaning of the phrase “investment advice” – as used within the statute – to significantly broaden the definition of a plan “fiduciary.” Needless to say, by straying so far from the common usage of the phrase, the DOL opened itself up for criticism stemming from the (presumably) unintended consequences of its proposed rule. For example, federal securities laws – namely, the Investment Advisers Act of 1940 – already regulate those who provide investment advice for compensation, and those rules apply whether the client is an 85-year old widow or a multi-billion pension fund.
As a result, I share in Mr. Scalia’s opinion that the Department lacks the authority to adopt the proposed regulation. However, I respectfully disagree to the extent he argues that no change in the current status quo is needed.
As the former General Counsel of a broker-dealer and registered investment advisory firm that served the largest network of independent investment professionals working with retirement plan clients, I witnessed the absurdity of having two financial professionals provide essentially the same services to a qualified plan – with one accepting the obligation to charge a level fee as an investment advisor/fiduciary, while the other was able to collect varying amounts of indirect compensation as a “mere broker.”
It is not surprising that we have arrived at this point once you consider how the retirement plan services industry evolved. With the explosion 401(k) plans and the advent of daily valuation technology, many human resource directors and chief financial officers suddenly found themselves responsible for overseeing complex investment operations over which they had little, if any, expertise. Not surprisingly, once they realized the personal liability the faced under ERISA, they began to rely heavily on the brokers who sold the group annuity contracts used to manage those plans. Because these brokers offered services that went far beyond those typically associated with the sale of an investment (i.e. – participant enrollment and educational services, vendor search support, advice on meeting the plan’s fiduciary duties, etc.), these brokers were able to establish close and long-lasting relationships with their plan clients.
More recently, the marketplace has been shifting toward a fee-based, advisory platform as consultants recognize the advantages of marketing their status as fiduciaries. Needless to say, though, some professionals who have serviced retirement plan clients as brokers for many, many years have understandably balked at the notion they must rush out and take their Series 65 exam if they want to continue assisting their long-term plan clients.
And that is one of the primary flaws in the DOL’s current approach. In trying to re-characterize every important vendor relationship as “investment advice,” the Department is bumping into other established regulatory regimes. However, while the services may not constitute “investment advice” – as the term is commonly understood - that fact does not diminish the importance of such relationships or the reliance many plan sponsors place upon them. In other words, while a CPA’s evaluation of a closely-held company’s stock price may not constitute “investment advice,” it is not unreasonable for a plan participant or committee member to expect that such an important service should be free from any conflict of interest.
In §3(21) of ERISA, Congress cited three types of persons who must act as fiduciaries to a qualified plan – those that exercise discretionary authority over the management of the plan, those that exercise discretionary authority over the administration of the plan, and those who are paid to provide investment advice to the plan. The difference between the groups should be readily apparent. Unlike the other two, a person providing investment advice does not have exercise any discretion to be deemed a fiduciary. The mere fact of providing advice, which the plan is free to accept or reject, was deemed sufficiently important to impose this heightened degree of duty.
This, then, begs the question – What is so different about investment advice? Presumably, it is the danger of self-dealing. In other words, because an advisor could vary his or her compensation based upon the advice provided, plan participants could only be protected by a law that ensured there was no such conflict of interest. However, it would seem that the same principle would apply to vendors such as appraisers and brokers who provide services to a plan that go beyond merely selling a particular product.
Even for a small government conservative zealot like myself, this seems like an easy sale. The overarching goal of ERISA was to protect retirement plan participants from unethical practices and expanding the scope of vendors who will be held to a fiduciary standard is necessary to accomplish that end. Therefore, as I mentioned in my earlier article, I do not dispute the Department’s intentions (although I do agree with Mr. Scalia that ERISA should not be extended to IRAs). I merely disagree with the method it has chosen. The DOL should press Congress to amend §3(21) to address the fiduciary issues the industry is currently confronting.
