The woman was a longtime client who needed a second rollover because she had changed jobs. Financial advisor Keith Gillies was eager to help.
“It was literally a transfer amount of just a few thousand dollars, but we probably spent five or six hours doing paperwork on that,” recalled Gillies, managing principal of New Orleans-based Wealth Solutions. “We did it because we want to do and we feel at our firm that we should do those kinds of things.”
Other firms and advisors might not be so interested in combating the new regulatory regime in order to service those smaller accounts, he added.
Gillies focused much of 2017 getting his firm into compliance with the first wave of fiduciary regulations from the Department of Labor.
The impartial conduct standard went into effect June 9 and, among other things, requires advisors to act in the client’s best interest. To prove that involves documentation, and Gillies added a staff member just to make sure the firm is in compliance with the DOL rule.
“Basically, it’s just trying to keep up with the paperwork,” said Gillies, a certified financial planner. “And it seems like even though we try to get all the paperwork right the first time, it seems like there’s always another form.”
Unfortunately, the DOL rule is just the start of the regulatory headaches.
Gillies has two national partners — one headquartered in New York and the other in Maryland. Both states are among those with fiduciary or best-interest regulations in the works.
That means advisors are likely facing a future of compliance with federal regulations plus an added layer of differing state regulations.
It all leaves Gillies unsure about his future, an uncertainty shared by many, from manufacturers creating fee-based products that may or may not sell to independent marketing organizations (IMOs) that risk being frozen out of the business if the DOL rule isn’t amended.
While the DOL rule is delayed and likely to be neutered, new fiduciary rule efforts at the Securities and Exchange Commission as well as the states leave folks like Gillies more concerned than ever.
“I’m licensed in very many states, and if each state comes up with a different standard, I just don’t know what I’m going to do,” Gillies said. “I mean it may be just time to say, ‘You know, I’m just going to sell [the agency] and go spend some time on the beach.’”
As we near the one-year anniversary of the partial enactment of the controversial DOL fiduciary rule, the selling landscape for commission-based agents is more muddled than ever before.
For many years, it was just the DOL and its attempts to establish fiduciary rules for agents selling into individual retirement accounts and plans. The DOL draws its authority from the Employee Retirement Income Security Act of 1974.
In reality, the DOL’s best argument for acting was that it could. State insurance regulators were not interested, and the SEC was habitually beset by political infighting.
Now that the latter two actors are at full strength and ready to move on fiduciary or best-interest rules, a full-on turf war threatens to leave agents exposed to a myriad of regulation layers.
“Historically, these have been much more in synch,” said Bradford P. Campbell, partner with the law firm Drinker Biddle & Reath. “When we start having different new fiduciary standards, which are in theory higher than the existing standards in terms of their obligations, then we run the risk of them no longer being appropriately in synch or being less in synch than they are currently.”
DOL Working to Amend
In reality, the Trump labor team kicked off its fiduciary rule tinkering Jan. 3 when Preston Rutledge was sworn in as assistant secretary of labor for the Employee Benefits Security Administration.
“The significance of Preston Rutledge being at a desk … cannot be overstated,” said Fred Reish, partner with Drinker Biddle & Reath. “Without political leadership, nothing could proceed in terms of revising the fiduciary regulation and the prohibited transaction exemptions.”
The first set of fiduciary rules made it to the finish line after the Trump administration stumbled with its labor secretary nominee. By the time Alexander Acosta was confirmed on April 26, 2017, there wasn’t enough time to delay the Impartial Conduct Standards, which went into effect June 9, 2017.
Those standards require advisors and agents to act in the client’s best interest, make no misleading statements and accept only “reasonable” compensation. Acosta succeeded in getting the second round of fiduciary rules delayed until July 1, 2019.
That’s where Rutledge comes in — he will be the point man on any rule rewrite. And experts are convinced that will happen.
It’s the second part of the rule that is so loathed by the industry. It creates a private right of action within the Best Interest Contract Exemption, and also penalizes IMOs by not allowing them to act as “financial institutions” for the sale of certain annuities.
“I think it is very unlikely that notion [giving investors the right to sue] is going to be adopted by the Trump administration in whatever amendments they make,” Campbell said during a recent webinar on the issue. “That said, it is all still under review, and that’s one of the things we’ll see here in 2018.”
It is very likely the DOL will release its amended fiduciary rule in fall 2018, he said. The agency will need to allow time for public comment and perhaps a public hearing, depending on the changes it wishes to make.
All of that information gathering and feedback with the industry will start from scratch given the new team of regulators at the DOL, Campbell noted.
“So I think ’18 is going to be a flurry of activity as everyone goes in to discuss the rule and what should or shouldn’t be in the final version,” he said.
Although July 2019 is the effective date for the fiduciary rule, “we could be looking at July 2020 instead of July ’19 before compliance is required,” Reish added. “I think this is going to be a long, drawn-out process.”
Then there’s the lingering court case in the Fifth Circuit Court of Appeals in New Orleans. The industry plaintiffs are consolidated from three lawsuits that were filed in 2016 in U.S. District Court for the Northern District of Texas. While the plaintiffs lost the federal court decisions, the Dallas court was chosen specifically because appeals would go to the Fifth Circuit.
The Fifth Circuit is generally considered the most conservative in the country, with decisions that frequently define the government’s role narrowly.
The appeals court heard arguments July 31, 2017, and most industry experts predicted a ruling by the end of 2017 at the latest. But that hasn’t happened, and some analysts say the court might consider a ruling unnecessary since the DOL is likely to amend the rule anyway.
SEC on the Move
Meanwhile, the SEC began making moves to revive its own fiduciary rule almost as soon as Jay Clayton was confirmed as its new chairman. Agency staff worked diligently on a fiduciary standard for years under former chair Mary Jo White, but political divisions kept that work from seeing the light.
Things got so bad that the SEC was down two commissioners from late 2015 until Jan. 11, 2018, when Robert Jackson and Hester Peirce were sworn in. In their Oct. 14 testimony before the Senate Banking Committee, both Peirce, a Republican, and Jackson, a Democrat, voiced support for a fiduciary standard.
While there is an expectation that a Republican-led SEC will be able to work easily with a Republican-led DOL, some are not so sure about that. There are still “overlapping jurisdictions” and natural differences between the two agencies, said Michael B. Koffler, former SEC staffer and partner at Eversheds Sutherland.
The fiduciary issue has highlighted some of the differences in the regulatory regimes the agencies administer.
“The SEC saw what was happening in an area in which it traditionally has had jurisdiction,” he said.
“It didn’t like the direction the DOL was headed down.”
For his part, Clayton pledged to work with the DOL on a rule that will maintain the investors’ freedom of choice.
“They have a mandate; we have a mandate. They’re not the same, but we can cooperate and get there, I believe,” Clayton said during an October appearance before the House Committee on Financial Services. “The devil’s in the details, and we’re working on it.”
The SEC has an advantage in that it can set regulations for qualified and unqualified dollars, whereas the DOL is limited to qualified retirement assets. That also makes it harder for the two agencies to harmonize on a rule.
“There ought to be consistency with us and the Department of Labor,” Clayton told the committee. “We can’t have asymmetric standards. You can’t put one hat on when you’re talking about 50 percent of your assets and another hat on when you’re talking about another 50 percent. It makes no sense.”
The final SEC rule will largely build on the rule staff produced under the prior chair, Koffler said, with various tweaks to reflect the views of the new members. But Clayton would prefer a 5-0 vote on the rule, he added, as opposed to slipping something through by a slim 3-2 margin.
The insurance industry and broker-dealers will probably like what comes out of the SEC, Koffler said. Stand-alone advisors probably won’t like it as much. It would be a surprise if the SEC opted for a rule resembling the DOL’s complicated exemptions with the right to sue, Koffler said.
“I don’t think the SEC has nearly the appetite to come up with rulemaking like that,” he said. “It’s very complicated and very rigid, and I just don’t see the SEC wanting to follow that approach.”
The National Asso-ciation of Insurance and Financial Advisors is hopeful the SEC will produce an “umbrella” regulation that ends up outflanking other agencies, said Judi Carsrud, government affairs director for NAIFA.
“[The SEC] making it a priority is, I think, all good news in terms of having clear, straightforward rules easy to comply with and easy to know you’re in compliance with,” she said. “All of that is looking good to ease some of the confusion.”
States in Play
The relatively quick passage of a state fiduciary regulation in Nevada last summer sent a chill through the industry. Even more surprising was Republican Gov. Brian Sandoval’s decision to sign the bill.
The law took effect in July and imposes a fiduciary standard on brokers and advisors that applies to both retirement and non-retirement accounts. Moreover, it extends existing fiduciary rules from “financial planners” to brokers and investment advisors.
State regulators took note in New York, California, New Jersey and Connecticut and quickly got to work on their own fiduciary rules.
“The message that has started to come out from the states is ‘If the SEC doesn’t act, then we will.’” Koffler said. ‘We are not going to stand on the sidelines when it comes to protecting our citizens.’ So that’s another pressure point for the SEC to act.”
Like toothpaste released from a tube, the state’s rush to enact fiduciary rules is likely not reversible. And that means a major headache for the insurance industry — a complex fiduciary scheme that varies from state to state.
New York upped the ante when it introduced a best-interest proposal that covers “all sales of life insurance and annuity products, beyond the types of advice covered by the DOL rule,” Gov. Andrew Cuomo said.
The New York standard would continue to exempt policies/contracts used to fund qualified retirement plans, ERISA plans and employer-sponsored IRAs. The proposal also would not apply to sales of mutual funds or other securities unless related to an annuity or life insurance product.
For all other sales, the proposal would require licensees to apply a standard very similar to the DOL’s best-interest standard as well as the ERISA “prudent person” rule.
Critics claim the New York proposal, which was scheduled to become law after this issue went to press, is too punitive on insurers.
The New York proposal imposes “burdensome compliance obligations” and “certain requirements that appear impractical,” Drinker Biddle & Reath concluded in its analysis.
NAIC in the Game
In an attempt to bring some uniformity to state rules, the National Association of Insurance Commissioners took on the charge to create a model law. What the NAIC produced, however, seemingly failed to please either side.
Similar to the DOL rule, the NAIC model would place limits on agent compensation, require more disclosures and set a best-interest standard. NAIC model laws must then be adopted by a state before they are applicable.
On one side, industry organizations say the model law standards are too harsh and will suffocate annuity sales. These organizations are precise with their arguments, having battled the DOL over its fiduciary rule for the past several years.
“The proposed revisions to the existing model would dramatically alter the standard of care that applies to the sale of all forms of annuities and impose broad new compensation restrictions without offering clear benefit to consumers,” wrote Wesley Bissett, senior counsel for government affairs for the Independent Insurance Agents and Brokers of America.
On the other side, several state officials weighed in urging the NAIC to strengthen the model law to cover life insurance in addition to annuities.
Likewise, the NAIC stipulation that all “non-cash” compensation exceeding $100 must simply be disclosed was termed “insufficient” by Jodi Lerner, attorney for the California Insurance Department.
“Bonuses, contests, special awards, differential compensation and other incentives that are won or received as a result of having sold a threshold dollar amount of annuities would reasonably be expected to affect a producer’s ability to act impartially and in the consumer’s best interest,” Lerner wrote. “Therefore, these types of incentives should be prohibited.”
The NAIC is “likely” to issue a revised draft of its model law, Eversheds Sutherland lawyers wrote in a client alert. The timeline puts “the New York proposal on a path for potential adoption before the NAIC completes its process,” the alert stated.
The longer the NAIC process drags on, the less it will even matter. More states are likely to follow New York and pass fiduciary rules without waiting.
Products with more complex models are sure to attract the attention of state regulators, said Howard Mills, global insurance regulatory leader for Deloitte.
“I think they’re going to get much more granular on what is a suitable sales practice, on insurers acting in the best interests of their consumers, particularly around products like variable annuities, long-tail products,” he said. “I think that’s going to be clearly a very strong focus going forward.”
While all of the fiduciary activity swirls about the industry, one thing few have feared is punishment. Although the Impartial Conduct Standards carry a significant burden, the DOL forewarned the industry that it would not seek to punish offenders as long as they were making “good-faith” efforts at compliance.
As a result, some firms focused more on adopting the necessary policies and procedures than putting them into practice. That might prove to be a mistake.
On Feb. 15, Massachusetts Secretary of the Commonwealth William Galvin surprised the industry by announcing state charges against Scottrade Inc. for violations of the DOL fiduciary rule.
Massachusetts regulators claim the discount brokerage engaged in improper sales practices. Scottrade “knowingly” tied sales contests to retirement accounts, regulators say in the 20-page court filing.
But all of the violations alleged by the Massachusetts Securities Division are of state law. In short, the state claims Scottrade ignored the policies and procedures it put in place starting June 9 to comply with the DOL rule.
By ignoring those policies, the state claims Scottrade violated state laws by conducting transactions in bad faith. Galvin seeks a return of profits Scottrade earned from the alleged activities and is seeking an undisclosed administrative fine.
The Scottrade situation is unsettling to the industry.
“So the state is asserting that Scottrade’s failure to follow its own policy constitutes a violation of Massachusetts state law,” said Bruce L. Ashton, a lawyer with Drinker Biddle & Reath. “They only quote one part of the policy, and there may be other aspects of the Scottrade written supervisory procedures that are relevant and show that the company is not failing to observe the standards. But that remains to be seen.”
Court documents reveal how Scottrade prepared for the initial requirements of the DOL rule — very well, it seems — and then allegedly failed to adhere to its new standards.
State regulators described an “aggressive sales culture” that peaked with “call nights” and sales contests between December 2015 and April 2017 as Scottrade sought business ahead of its merger with TD Ameritrade.
Scottrade crafted strong policies to comply with the new rules, state regulators said in court docs, but they never put those standards into practice.
“Despite its addition of policies related to the fiduciary rule, Scottrade expanded the scale and scope of the very sales practices its policies were designed to curtail,” the court filing reads.
Scottrade launched a pair of sales contests between June and September 2017, with the first campaign offering $285,000 in cash prizes, according to court documents.
“Both the Q3 and Q4 sales contests perversely incentivized Scottrade agents to bring in new assets from customers, including through the rollover of retirement assets,” according to court documents.
Still, the charges do not specifically say incentives were awarded for sales, Ashton noted.
“Were the contests and any accompanying rewards directed at effort rather than results?” he asked. “If directed at effort, this might not violate either the policy or the Impartial Conduct Standards.”
A Strong Precedent?
The big news is the precedent set by the Scottrade charges. Other regulatory entities might now view DOL rule violations in the similar context.
The Massachusetts strategy reflects “emphasis by all securities regulators on individual investors, especially retirement investors,” said Brendan McGarry, an attorney at Kaufman Dolowich & Voluck in Chicago, who advises broker/dealers and advisors.
Scottrade’s reaction will be noteworthy, he added. Will the firm argue that state regulators are usurping the DOL? Or will they bypass a counterargument and move straight to negotiations?
Meanwhile, the pro-fiduciary forces are pleased by the Massachusetts news, said Barbara Roper, director of investor protection for the Consumer Federation of America.
“We’ve always hoped that the states could play a role in enforcing the rule, but we didn’t know this was in the works,” she said. “It is very encouraging to see them step in and play this role, and hope this is just the beginning.”
Eugene Scalia, attorney for plaintiffs in the Fifth Circuit appeal, took immediate note of the potential harm to the industry. In a brief filed the day after Garvin announced the Scottrade charges, Scalia urged the court to rule sooner rather than later.
“Although Massachusetts’s attempt to use the Fiduciary Rule in this manner lacks merit, it confirms Appellants’ concern that the portions of the Rule that took effect on June 9, 2017, will continue to impose extensive burdens and costs on Appellants’ members, even while other aspects of the Rule have been postponed,” the brief read.
Pay Attention – It’s the Law
While the Scottrade case can be dismissed as an outlier from a very liberal state, the simple reality is the fiduciary rule, at least parts of it, is the law. The Drinker Biddle legal team, who count many large firms among their clients, say they are concerned about lax attention to the new rules.
“The area that I’m most concerned about are recommendations for distributions from plans and rollovers to IRAs. That is the one area that applies to RIAs as well as broker/dealers,” Reish said. “Just in talking to people in the industry, I’m concerned that folks are short-circuiting the process.”
Furthermore, the burden of proof — should a recommendation be challenged in court — lies with the advisor, Reish noted.
“The burden of proof is on the advisor, the RIA, the broker/dealer, to show they complied,” he said. “Therefore, you need documentation. That’s a huge difference from traditional thinking, and processes have to be documented.”