Debating the Fiduciary Proposal: Pros and Cons

The Department of Labor held hearings with stakeholders on December 12 and 13 to further solicit public comment on its retirement security rule proposal. Also known as the fiduciary rule proposal, the proposed changes would replace the current five-point fiduciary test with one that applies fiduciary status to many one-time transactions, including rollovers to individual retirement accounts, annuity sales and qualified retirement plan investment menu design.

The points of debate between the proposal’s supporters and opponents have generally fallen into three buckets:

• Whether the Securities and Exchange Commission’s Regulation Best Interest is adequate to address rollovers to IRAs;
• Whether the National Association of Insurance Commissioners’ Suitability in Annuity Transactions Model Regulation is adequate in regulating annuity sales; and
• Whether the proposal will reduce access to financial services for consumers, particularly those without the assets to afford a full-time financial adviser.

Rollovers and Reg BI

The SEC, through Regulation Best Interest, or Reg BI, requires registered investment advisers to provide advice to clients on securities trades that are in their best interest, that do not place the adviser’s interest ahead of the client and that are individualized to that client’s profile. Opponents of the DOL’s proposal argue that Reg BI, in its current state, is adequate, since nearly all rollovers involve the sale and purchase of securities.

Jason Berkowitz, the chief legal and regulatory affairs officer at the Insured Retirement Institute, opposes the rule on behalf of the IRI. He argues that making rollover sales subject to ERISA standards will create new burdens for suppliers of rollover services and create a right of private action against those suppliers.

That setup could lead to costly class action lawsuits brought against providers, including some that are not well-founded. This, in turn, would make smaller accounts not worth servicing, since they are unlikely to be worth the legal risk.

But proponents of the rule argue that fiduciary standard is exactly what is needed to protect everyday investors.

David Certner, the legislative counsel and policy director for AARP, who supports the proposal on behalf of AARP, notes that Reg BI does not apply to non-securities, such as real estate, physical commodities and most cryptocurrency assets. Certner acknowledges that these areas are relatively small in the retirement context, “but they are a component” not addressed by the SEC, since they fall outside of its authority.

He adds that a fiduciary standard in this space is part of creating a “more uniform standard for all types of financial products sold to retirement savers.” The shift from pensions to individual accounts increases the importance of trust in the retirement saving process and also increases the societal impact of conflicted advice given to retirees. In addition, he argues, “just because SEC is doing something does not mean DOL shouldn’t.”

Annuity Sales and NAIC Model

The proposal would also extend fiduciary status to one-time sales of annuities to retirement savers. Currently, annuity sales are primarily regulated by states, most of whom have adopted the NAIC’s model regulation. Opponents of the proposal argue this regulatory model is adequate in protecting consumers.

AARP’s Certner disagrees, arguing that the NAIC model is “not really a best interest standard” and instead is a “much lower, suitability standard.” He says the NAIC model excludes how much and by what means a salesperson is paid from potential conflicts, and this is “the biggest potential area for conflicts of interest.”

He highlights that the proposal would require annuity sales to be made in a saver’s best interest and to account for the compensation as a source of conflict. He explains that, “very often, the source of the conflict of interest is being compensated much higher for one product over another.”

For example: An annuity product may cost more and lead to higher compensation for the agent or adviser than another product. This can incentivize the sale of that product by the adviser, even if alternatives that are a better fit for the client are available.

Certner underscores that the proposal would not require low-cost sales for advisers; it would just require higher costs to be justified.

Rule opponent Berkowitz acknowledges that annuities are typically more expensive than common long-term investment alternatives, such as mutual funds, but counters that annuities are a better value for many investors and are justified in their costs, as they are a far more labor-intensive product on the supply side. Annuities provide income for life, and training agents to understand them and be able to explain them effectively to customers is naturally a more expensive process, he says.

Berkowitz further notes that ERISA is better understood as a “sole interest standard,” rather than a best interest standard. If this is the case, it is not clear how insurance agents are supposed to do their job, since they are paid for the sale. “If you don’t complete the sale, you don’t get paid,” he says.

By compromising the current compensation model, Berkowitz argues, the proposal will reduce access to annuity products, especially to savers with lower balances. Sales-based compensation, or commission, offers a simple and often cheaper “one-and-done” approach to payment, as opposed to continuing fees that a personalized financial adviser might charge.

Access to Financial Products

The IRI’s Berkowitz argues that the proposal will go beyond just rollovers and annuities to other investment services, too.

The added legal risk will move advisers away from the retirement space, he says, which he believes is unnecessary because “low-cost advising is [not] really on a fiduciary basis.”

The last time the DOL tried to regulate this space, Berkowitz says, in a 2016 rule, millions of savers received notices from financial professionals that they would have to end their relationship. The rule was later struck down in 2018 by the U.S. 5th Circuit Court of Appeals.

Many supporters of the proposal “are trading in hypotheticals” that other professionals will fill the void, he says. But he is also “not sure who” those professionals are, because, based on the real world experience of 2016, “that’s not how that played out.”

AARP’s Certner counters that many advisers already adhere to a best interest standard, and “I don’t see any access problem with getting advice here.”

Advisers that do not adhere to a best interest standard may leave the market, “but that may not be a problem,” since they were not putting the saver’s interest first anyway, he says.