WASHINGTON — The Department of Labor’s (DOL’s) proposed fiduciary standard rule rattledthe sellers of financial and insurance products but also the regulators of them.
When the DOL proposed its rule, it was doing it as the regulator of private industry pension plans under the Employee Retirement Investment Security Act, better known as ERISA. By extension, it was dictating what kind of representative can deal with all qualified money, such as IRAs, even though IRAs are not pension plans.
So, why should this affect the insurance industry? Consider that about 60 percent of the dollars purchasing annuities come from qualified funds, such as IRAs, according to LIMRA. Under the DOL rule, even if an agent is selling a fixed annuity regulated by the state under the suitability standard, thatagent has now ventured into fiduciary territory.
The agent can be allowed to go forth with the sale as usual under a “prohibited transaction exemption.” Clients would have to sign a statement that they know their agent is not doing business in their best interest. But the compensation would have to be “reasonable” under the rule.
Although the PTE, as the exemption is known, would allow agents to continue selling as they have, they will have another regulator in this case. The Employee Benefits Security Administration in the DOL is expected to determine what compensation level is reasonable. Apparently that agency’s enforcement power would be limited, perhaps only allowing them to file a suit to address a violation.
Advocates for insurance agents and advisors support the exemption because it recognizes the important and distinctly different service that insurance professionals provide. Although at the same time, they took exception to the assumption that commissions always led to “conflicted” advice and that the suitability standard was always contrary to consumer security.
Also, the Securities and Exchange Commission (SEC) was directed by the Dodd-Frank reform act to investigate whether the fiduciary standard needed to be adjusted. The DOL’s proposal upset some people by saying that the SEC was the appropriate agency to review the standard.
The Financial Industry Regulatory Authority (FINRA) had problems with the proposal as well. FINRA’s chief said he believes that the DOL’s fiduciary standard proposal “will lead many firms to close their individual retirement account business entirely or substantially constrain the clients that they will serve.”
Richard G. Ketchum, FINRA chairman and CEO, embraced the DOL’s “best interest” concept as the appropriate core for a uniform fiduciary standard, but said the current DOL proposal doesn’t do the job it sets out to do.
Ketchum said he believes the SEC is the appropriate agency to set the standard, but acknowledged that “there is no question that designing such a standard is challenging.”
He made his comments at the opening of the annual FINRA conference on May 27.
At the same time, Ketchum defended the work of the SEC and FINRA, noting that bad-mouthing the current oversight environment for financial products is unfair.
“Depictions of the present environment as providing ‘caveat emptor’ freedom to broker/dealers to place investors in any investment that benefits the firm financially with no disclosure of their financial incentives or the risks of the product, are simply not true,” Ketchum said in an implied criticism of the Obama administration’s claim that present rules eat into the retirement savings of Americans.
“Nor are they an accurate starting point to justify a new standard of care,” Ketchum continued.
Ketchum said he believes the DOL is not the agency that should establish the standard of care because its proposal sets up the likelihood for a double standard where oversight for individual retirement account (IRAs) and 401(k)s is different than the standard of care applied for an investor’s other financial assets.
He said a “great many” investors simply do not plan for their retirement by segregating tax-advantaged vehicles from their other investment strategies. “An effective regulatory environment would apply a consistent best interest standard across, at least, all securities investments and have the examination and enforcement mechanisms to oversee compliance with the standard,” he said.
Ketchum said the DOL proposal “was a very good faith” effort to address an important investor protection imperative and DOL has a special interest in recommendations to move assets out of 401(k)s and IRAs.
Moreover, the core features of the proposal are “aimed at exactly the right areas,” he said.
He backed the prohibited transaction exemption, saying that it protected the customer’s best interest by identifying conflicts of interest. He also spoke out in favor of the management of compensation practices to avoid improper incentives for conflicted advice, and implementation of effective fee and risk disclosure requirements.
However, Ketchum said, the warranty and contractual mechanism employed by the DOL to address their limited IRA enforcement jurisdiction, “appears to me to be problematic.”
He said, “In one sweeping step, this moves enforcement of these provisions to civil class action lawsuits or arbitrations where the legal focus must be on a contractual interpretation.”
Ketchum said he is not certain how a judicial arbiter would analyze whether a recommendation was in the best interests of the customer “without regard to the financial or other interests” of the service provider.
“I’m not sure, but I suspect, a judicial arbiter might draw a sharp line prohibiting most products with higher financial incentives no matter how sound the recommendation might be,” he said.
“Put another way, the subjective language of the PTE, coupled with a shortage of realistic guidance, may lead to few providers of these critical investor services,” Ketchum said.