The Big Fidu
My expert witness firm is expanding its footprint and as one of the original horses in their stable, I am called up to support the initiative an whatever ways I can. What’s good for SEDA has pretty much been good for me. So, after seeing my name attached to three noteworthy case outcomes and remembering that I have previously written two articles for the firm’s newsletter, I decided that I needed to write another piece for them. It so happens that there is change afoot in the realms that I have often been called to the bar to testify about…fiduciary obligations.
I grew up at Bankers Trust Company, the bank formed by J.P.Morgan and others, specifically to act as a fiduciary in ways that the commercial banks increasingly thought they could not. Over the 20th Century, the bank built a formidable fiduciary business and was one of the three leading trust and custody banks in the world. On the 100th anniversary of its founding, its successor owner, Deutsche Bank, sold that fiduciary business to State Street Bank and Trust. For much of the 1990’s, I ran large parts of that fiduciary complex both for ERISA pension clients and for private high net worth clients, and for a number of those years I was the senior fiduciary for the bank. The fiduciary obligations to both pensioners and private banking clients alike are part of my fabric.
Ever since the promulgation of ERISA in 1974, the regulatory agencies, including the Department of Labor and the Securities Exchange Commission have more or less continuously tweaked the definitions of fiduciary obligation. What everyone agrees is that a fiduciary has several basic duties including to act exclusively in the best interest of their client (for whom they are managing money or property), to manage their money and property carefully and prudently, to keep that money and property separate from all other, especially their own, and to keep very good records of all transactions that affect that money and property. This standard applies to a broad range of clients ranging from individuals for both their taxable and retirement funds and to ERISA pension plans of all sorts. Professionals in the industry have argued for years about who has fiduciary obligations and whether there are different standards for different levels of fiduciary obligation. This has been the source of much debate and litigation over the years.
In 2015. President Obama addressed the issue directly by saying, “Today, I’m calling on the Department of Labor to update the rules and requirements that retirement advisors put the best interests of their clients above their own financial interests. It’s a very simple principle: You want to give financial advice, you’ve got to put your client’s interests first.” The DOL created an updated fiduciary rule, expanded to include the “investment advice fiduciary” definition under ERISA. It served to elevate financial professionals of all types that worked with retirement plans to being designated as fiduciaries and thus obligated to those higher standards. Plan fiduciaries under ERISA (trustees, administrators and plan sponsor investment committees) already worked under those obligations. This now captured all those who provided investment advice, administered plans or provided any type of financial advice to participants or individuals. These fiduciaries had to act prudently and diversify the plan’s investments in order to minimize the risk of large losses. In addition, they needed to follow the terms of plan documents to the extent that those terms are consistent with ERISA. Importantly, they also are required to steadfastly avoid conflicts of interests such as by not engaging in transactions that benefit parties other than the plan and its participants, such as other fiduciaries, services providers or the plan sponsor. This was all about insuring the optimal creation of retirement income security for the burgeoning cohorts of retirees coming on line soon through the Baby Boom generation and beyond.
The new DOL fiduciary rule was scheduled to go into effect on April 10, 2017, but of course, there was a new sheriff in town in the form of the Trump Administration. Not surprisingly, after a quickly mandated foot-dragging “study” period, on June 21, 2018 the Fifth Circuit Court of Appeals vacated the proposed rule. But meanwhile, the SEC was busy by itself working to resurrect the rule. This was a very hotly debated rule to be sure, with most brokers and investment firms working hard to keep it from enactment. To them, suitability standards were sufficient, but the proposed fiduciary standards insisted on a higher standard, one that clearly put their client’s best interests first, rather than simply the standard of finding “suitable” investments. The reality was that this higher standard would undermine the industry’s commission structure as well as a host of things like proprietary product sales and that was and is a big deal.
On June 30, 2020 the SEC’s efforts implemented Regulation Best Interest (Reg BI) as part of the Securities Exchange Act of 1934, establishing the best interests standard for broker-dealers and investment advisors in their recommendations to retail customers, including actions like the types of accounts they should establish (like discretionary versus non-discretionary…a popular broker/dealer loophole). This portends at least as high a standard is needed for retirement investment accounts under the purview of ERISA and is thus a leading indicator of where DOL regulations are likely to return in one form or another sooner or later.
The financial services industry has seen the retirement locomotive barreling down the tracks for over thirty years. Demographers and economists have made it very clear that the combination of the Baby Boom generation and the increase in longevity are combining to create a impending pension crisis. Much of the focus has been on what are called unfunded pension liabilities as generally defined by the insufficiency of defined benefit pension plans in some private sector arenas, but in almost all of the public sector plans. The world at large, and especially in the United States, has chosen to address the problem by replacing defined benefit plans with defined contribution plans. These, like 401(k), 428 and 403(b) plans as designated by the Internal Revenue Service regulations (not to mention the full array of IRA accounts) are sponsored and organized by the companies and organizations where employees work, but are self-directed and voluntary. But none of that leaves the plan participants without responsible fiduciaries to exercise due care over the investment programs of these participants. Those who provide investment advice, administer plans or provide any type of financial advice to participants will be affected.
This latest proposal being touted this month by DOL is specifically designed to address and being referred to as the “retirement security rule” rather than the “fiduciary rule”, and is clearly intended to go even further in the direction first outlined by President Obama. DOL is saying that the rule will capture “practices of investment advisers, and the expectations of plan officials and participants, and IRA owners who receive investment advice, as well as developments in the investment marketplace, including in the ways advisers are compensated that can subject advisers to harmful conflicts of interest.” That seems pretty clear and its fair to suggest that broker-dealer and investment advisors are girding their loins for the change. In the meantime, we can be assured that there will be a battle Royale put on by the industry practitioners. I, for one, work on the assumption that, given the scale of the pension crisis facing our world in the coming years, attempts to avert these new best interest, retirement security and fiduciary standard are likely to fail and what will remain will be a boatload of litigation against any and every fiduciary, as newly and precisely defined, that has fallen short of those standards.